Implementation matters — Onerous contracts

Date recorded:

Feedback summary (Agenda Paper 12)


The purpose of this paper was to provide the Board with a summary of the feedback received on the Exposure Draft Onerous Contracts—Cost of Fulfilling a Contract (ED) (please refer to our IFRS in Focus for the contents of the ED). The staff asked the Board for any comments or questions on the feedback. No decisions were asked of the Board.

Analysis of feedback

The paper was split between the key views on each of the two questions below, and an analysis of other matters.

The ED asked respondents:

  1. Whether they agree that IAS 37 should specify that the cost of fulfilling a contract comprises the costs that relate directly to the contract rather than only the incremental costs (Question 1)
  2. Whether they have any comments on the proposed examples of costs that do, and do not, relate directly to a contract (Question 2)

Question 1:

A significant majority of respondents agreed that the cost should comprise the directly related costs in addition to those incremental to the contract.

Respondents noted that this would be in line with the requirements of IAS 37, and that from a user’s perspective recognition of provisions for onerous contracts is important.

Six respondents disagreed with the proposed amendments for the following reasons:

  • It would impose additional costs on entities to measure costs using an incremental approach, and that the cost of the proposals may outweigh the expected benefits
  • Provisions would not provide useful information if an entity prices contracts considering only incremental costs, and that in these situations the outcome would be inconsistent with commercial reality
  • Conflict with the other requirements of IAS 37 (paragraph 63) which prohibits an entity from recognising future operating losses

Question 2:

Many respondents agreed with the Board’s proposals to include costs that do (and do not) relate directly to a contract. However, many respondents had questions or expressed concerns. These are described below.

  • Principle underpinning the examples:
    • Some respondents suggested the Board clarify the principle that underpins the proposed examples and include it as a requirement in IAS 37, for example ‘the directly related cost approach—includes all the costs an entity cannot avoid because it has the contract. Such costs include both the incremental costs of the contract and an allocation of other costs incurred on activities required to fulfil the contract’
  • Examples in the proposed paragraph:
    • Respondents asked for clarity on costs included in fulfilling a contract
    • In relation to salaries and wages respondents questioned if costs under IAS 19 Employee Benefits, such as pension costs should be considered in applying the proposed amendments
    • In relation to production costs, some respondents suggest basing the examples on those within IAS 2 Inventories as opposed to IFRS 15 Revenue from Contracts with Customers, as IAS 2 refers to fixed and variable production overheads and indirect costs
    • Deloitte said, in its view IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets have a different concept of “directly attributable” costs than IAS 2, but that IAS 2’s requirement more directly links to the Board’s proposals
  • General and administrative costs:
    • Many respondents suggested clarifying the treatment of general and administrative costs in order to better distinguish between costs that relate directly to a contract and general costs of operating
    • Some respondents said general and administrative costs can never relate directly to a contract, even if the costs are explicitly chargeable to the counterparty under the contract

Other matters:

  • Scope of proposed amendments:
    • The Board decided not to extend the scope of the amendments to include measurement and the meaning of the term “economic benefits”, as this was not prompted by withdrawal of IAS 11 Construction Contracts and expanding the scope would cause delay. Some respondents felt that it was not be beneficial to consider the cost of fulfilling a contract without also considering the meaning of economic benefits
    • Respondents suggested clarifying whether an entity is required to measure an onerous contract provision using the same costs it used to identify the contract as onerous. Other respondents asked for clarity as to whether and how the proposals would affect the measurement of liabilities with the scope of IAS 37 that are not onerous contracts
    • Respondents suggested clarifying the definition of a “contract”. IFRS 15 requires some contracts to be combined, respondents asked if IAS 37 would apply to the combined contract as defined by IFRS 15 or to each legally separate contract
    • Respondents also questioned the interaction of IAS 37 with IAS 36 Impairment of Assets.
  • Transition requirements
    • The Board proposed that entities would be required to apply a modified retrospective approach on transition
    • Respondents had mixed views on the proposed transition requirements, some respondents said that entities should be permitted to apply the requirements retrospectively in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

Board discussion

A Board member asked for confirmation of the logic of Vodafone’s response to the ED. It was detailed that the response from Vodafone suggests that when an asset is used to service many contracts, the cost of using that asset should not be included within the calculation of the onerous provision against any contract. The Board noted that the ED suggests instead that these costs would be attributed to the relevant contracts. The Board also noted that there could be a unit of account issue to consider, and how, when there are multiple contracts of a homogenous nature, the attribution of shared costs should be applied.

A number of respondents disagreed with the proposed amendments, on the basis of the outcome expected if an entity assesses contracts on the basis of incremental costs. The Board discussed that when an asset is idle, a provision/impairment may not be required. However, when subsequently the entity enters into a contract that requires the use of the idle asset, a new assessment would be required, which might lead to the potential recognition of a provision. Had the entity not entered into a contract, the onerous provision would not have been required.

Another Board member noted that the majority of responses appear to be views on practical application of the proposed changes in the ED, focusing on the simplicity of using the incremental cost approach, against the difficulty of using the directly attributable cost approach. The Board member generally disagreed with those respondents on the basis that well managed companies understand the cost base of their business to a high degree and that calculating the incremental or direct cost would not be a difficult exercise.

Another Board member highlighted the comment from EY that the definition of direct cost should be included within the proposed amendment to the Standard, as opposed to the Basis for Conclusions as currently suggested. The Board discussed that using an incremental cost approach leads to fewer instances of having to recognise provisions and also leads to smaller amounts being provided for. A Board member noted that the longer a contract spans post year-end the closer the definition of incremental and direct costs become aligned. Another Board member wanted to clarify the reason behind the diversity seen in practice in application of IAS 37. Some preparers used IAS 11 Construction Contracts criteria which match up closely with the proposed approach in the ED. Others looked to IAS 37 in isolation and said that incremental cost is an established practice. One member suggested the scope of the changes to IAS 37 should be limited to those construction contracts which were in the scope of IAS 11.

No decisions were made.

Related Topics

Correction list for hyphenation

These words serve as exceptions. Once entered, they are only hyphenated at the specified hyphenation points. Each word should be on a separate line.