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IAS 37 — Costs considered in determining whether a contract is onerous

Date recorded:


This was a new issue.

The IC received a request to clarify which costs an entity should consider when assessing whether a contract within the scope of IFRS 15 is onerous in terms of IAS 37.

From its 2015 Agenda Consultation, the Board is already aware of this issue as well as other practical challenges when applying the onerous contract requirements. The Board intends to address these issues in the project on Provisions within the research pipeline.

Staff analysis

IFRS 15 specifically requires an entity to assess whether a contract with a customer is onerous in terms of IAS 37. IAS 37 defines an onerous contract as a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. IAS 37.68 states that the unavoidable costs reflect the lower of the cost of fulfilling a contract and any compensation or penalties arising from failure to fulfil it. In cases where the penalties exceed the costs of fulfilling the contract, the question naturally falls on what constitutes ‘unavoidable costs of fulfilling a contract’.

IAS 37 is silent on this matter. Nor does it contain any basis for conclusions that explains the Board’s intention behind these words. In light of this, the Staff proposes two views for the interpretation of ‘unavoidable costs of fulfilling a contract’:

View 1 – they are the costs that an entity cannot avoid because it has the contract

This view adopts a literal interpretation of the words ‘costs to fulfil a contract’ and includes as unavoidable costs all costs that are necessary to complete a contract. These include an appropriate allocation of depreciation, overheads and other resources that must be used in order to fulfil the contract, even if those costs would have been incurred without the contract under review.

View 2 – they are the costs that an entity would not incur if it did not have the contract

This view interprets unavoidable costs as the incremental costs of having the contract. This would include costs such as direct materials and direct labour that are specifically acquired and hired to fulfil the contract. This view would not regard as unavoidable costs items such as an allocation of depreciation of assets that are also used for other projects, and an allocation of overheads that the entity would have incurred even if it did not have the contract.

Appendix C to the paper includes the Staff’s assessment of which costs would be considered unavoidable under each of the above views.

The Staff also considered and rejected interpreting unavoidable costs by applying the IAS 11 or IFRS 15 guidance on what constitutes contract costs and costs to fulfil a contract respectively. They reasoned that it would not be appropriate to refer to IAS 11 as it will be withdrawn once IFRS 15 becomes effective, and the guidance in IFRS 15 was not written for the purpose of assessing whether a contract is onerous.

Staff recommendation

The Staff recommend that the IC not add this issue to its agenda on grounds that it would not be effective to amend only a portion of the requirements on onerous contracts without a comprehensive review of all of those requirements. Instead, the Staff recommend that the IC issue a tentative agenda decision outlining the two views set out above in assessing whether a contract is onerous.


The IC approved the Staff’s recommendation by a narrow margin (7 out of 13). The members agreed with the staff’s technical analysis – they only disagreed on whether the IC should take on a narrow scope standard setting project to address the issue. Those who voted in favour of the Staff’s recommendation believe that the issue is too broad for the IC and that it would be better to let the Board deal with it as part of its research project on Provisions.

There was hardly any debate on the technical aspects of the submission. Instead, the bulk of the time was spent debating whether the IC should explore undertaking a narrow scope exercise to clarify what constitutes ‘unavoidable costs’.

The members who supported doing further work, however, struggled to formulate a scope that would be narrow yet meaningful. These members were aware that it might not be meaningful to work on just the unavoidable costs aspect of the requirements without also assessing what is meant by economic benefits as they both relate to the unit of account of the contract, how to distinguish unavoidable costs from accruing for future operating losses, and whether it would be feasible to address recognition and not the measurement of an onerous contract provision.

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