IAS 37 Onerous Contract Provision: Costs and Entries

When do you need an IAS 37 onerous contract provision?

An IAS 37 onerous contract provision becomes relevant when a binding contract leaves a business facing an unavoidable loss. Picture a Saudi maintenance company that agreed a fixed customer price, then discovers that labour and materials will cost more than expected. The accountant needs a contract calculation before deciding what to record.

Start with the agreement, the work still outstanding, and the evidence available at the reporting date. A weak sales forecast alone does not create a [provision](/glossary#provision). The [IFRS Foundation's IAS 37 overview](https://www.ifrs.org/issued-standards/list-of-standards/ias-37-provisions-contingent-liabilities-and-contingent-assets/) distinguishes an onerous contractual obligation from future operating losses, for which no provision is recognised.

For an introductory explanation of recognition versus disclosure, read our [guide to provisions and contingent liabilities](/learn/provisions-contingent-liabilities-ias-37). Here, we concentrate on a narrower task: preparing a defensible loss calculation, comparing fulfilment with cancellation, and translating the result into entries.

The two businesses below are fictional. Their contracts concern ordinary services or supplies assessed under full IFRS Accounting Standards. All amounts are in Saudi riyals, taxes are outside the examples, and no customer advances have been received. Settlement is near enough that discounting is assumed immaterial. These assumptions keep the numerical exercise focused; they are not conclusions about every Saudi contract.

Keep a blank worksheet beside you as you read. Give it five boxes: remaining benefits, remaining fulfilment costs, exit payments, asset review, and required provision. The final number is easier to explain when another person can follow those boxes without reconstructing your thinking.

Which costs belong in an IAS 37 onerous contract provision assessment?

Begin with the work the business must still deliver. Identify materials, labour and other resources that this work will consume. Then check for costs shared across contracts that directly support delivery. A project report showing only extra cash purchases can miss part of the resource cost.

The IASB's [completed cost-of-fulfilment amendment](https://www.ifrs.org/projects/completed-projects/2020/onerous-contracts-cost-of-fulfilling-a-contract/) clarified this assessment. IAS 37 paragraph 68A includes incremental costs and an allocation of other directly related costs. One example is [depreciation](/glossary#depreciation) of equipment used to fulfil the contract. The amendments apply to annual reporting periods beginning on or after 1 January 2022, with earlier application permitted.

For your worksheet, make the allocation explainable. If a maintenance team uses the same testing equipment on several jobs, document the time or usage assigned to this job. A round percentage chosen to produce a preferred profit is poor evidence. Equally, do not import every head-office expense from a management report without checking its connection to fulfilment.

• Trace each direct item: connect quantities to the remaining work and rates to current quotations or staffing records.
• Explain shared resources: show the allocation basis and confirm that another schedule has not counted the same cost again.
• Separate unrelated items: keep general corporate expenditure outside this calculation when it has no direct connection to delivery.
• Keep dates consistent: benefits and costs must describe the same outstanding obligations at the same reporting date.

Ask the operations manager to explain the physical work behind each line. A documented change in required hours is much more useful than an unexplained increase in a project percentage.

Worked example 1: fulfilling a Riyadh maintenance contract

Assume Sahl Maintenance in Riyadh has signed a fixed-price service contract for SAR 240,000. At its reporting date, all the services remain to be performed during the following three months. The customer will pay on completion. The contract is enforceable, the estimates are reliable, and cancelling would require a payment of SAR 40,000 with no other exit costs.

The team prepares this remaining-cost schedule. Equipment has already been checked for impairment, with no loss identified. The depreciation allocation is based on the equipment's current carrying amount and expected contract usage. No inventory or contract-cost asset needs a separate write-down.

Fulfilling the contract gives a net loss of SAR 10,000, calculated as SAR 250,000 less SAR 240,000. Cancellation would cost SAR 40,000. Under these assumptions, the lower unavoidable net loss is SAR 10,000, so this is the initial provision.

The [journal entry](/glossary#journal-entry) at the reporting date is:

Notice how the equipment allocation changes the answer. Labour and materials alone total SAR 225,000, suggesting a SAR 15,000 surplus. Including the SAR 25,000 of directly related depreciation reveals the loss. No cash leaves the bank when this initial provision entry is posted.

The management report also allocates SAR 15,000 of unrelated head-office expenditure to this customer. Our facts establish that it does not relate directly to fulfilling the contract. It stays outside this assessment; including it would incorrectly increase the calculated loss to SAR 25,000.

As a sensitivity exercise, increase materials by SAR 20,000 while leaving every other assumption unchanged. Fulfilment costs become SAR 270,000 and the net loss becomes SAR 30,000, still below the cancellation payment. This alternative is a separate scenario, not another entry to post alongside the original case.

How do you compare completion with cancellation?

The comparison is between net economic outcomes. In a straightforward unperformed customer contract, calculate the remaining fulfilment cost less the remaining customer benefits. Compare that loss with the compensation or penalty needed to exit. Establish what the exit payment actually releases the business from before relying on it.

IAS 37 paragraphs 66–69 address this assessment. The publicly accessible [2021 issued standard, including the 2020 amendments](https://www.ifrs.org/content/dam/ifrs/publications/pdf-standards/english/2021/issued/part-a/ias-37-provisions-contingent-liabilities-and-contingent-assets.pdf) provides the paragraph text. This is a historical edition, cross-checked here against the Foundation's current overview and completed amendment page.

For the simplified cases in this article, the worksheet is: provision = the lower of the positive fulfilment loss and the full exit payment. That shortcut assumes no unresolved asset impairment, advances, reimbursements, additional obligations or material discounting. If your facts contain those features, rebuild the comparison around them rather than forcing them into this simple formula.

Read the cancellation clause with the person responsible for the contract. Confirm whether the stated amount is the whole settlement, whether notice must be given by a deadline, and whether existing commitments survive termination. A price quoted in an informal conversation is not automatically an available exit route.

Also keep commercial preferences separate from contractual rights. Management may prefer completion to preserve a relationship. Record that preference in the decision memo, but support the accounting amount using the actual obligation and available alternatives. Conversely, do not invent a cheap cancellation option merely because continuing feels unattractive.

The worksheet should let a reviewer answer a plain question: after allowing for what the business receives under each route, how much is it still unable to avoid losing?

Worked example 2: cancelling a Jeddah display order

Rawasi Displays in Jeddah has an unperformed order for exhibition stands. The customer price is SAR 180,000, and current quotations show remaining delivery costs of SAR 230,000. Those costs are all incremental in this example. No inventory, dedicated equipment, customer advance or contract-cost asset exists, and there is no impairment adjustment to make.

The signed agreement permits full cancellation for SAR 30,000. Assume this option is available at the reporting date, releases Rawasi from all remaining delivery obligations, and leaves no supplier commitments or other compensation. The estimates incorporate the relevant uncertainty, and discounting is immaterial.

The provision is SAR 30,000. Do not subtract the customer price from the cancellation payment: Rawasi will not deliver the stands or earn that consideration if it cancels. Comparing the two routes already accounts for this difference.

Assume Rawasi subsequently exercises that cancellation right and pays exactly SAR 30,000, with no intervening change in the estimate. The settlement entry debits the onerous contract provision and credits cash for SAR 30,000. Charging the payment to expense again would duplicate the loss already recognised.

Now change only the cancellation payment to SAR 80,000. Completion still loses SAR 50,000, so the lower unavoidable net loss becomes SAR 50,000. This variation shows why a penalty is an input to the comparison rather than an automatic answer.

Before accepting either version, explain it aloud without account names. In the original, the business can settle the problem for less by cancelling. In the variation, delivery produces the smaller net loss. Once that explanation is clear, the entry follows the supported amount.

Why review assets before recording the contract loss?

A contract calculation can contain costs associated with assets already recognised. IAS 37 paragraph 69 requires relevant impairment losses to be recognised before establishing a separate onerous-contract provision. This sequence prevents the same economic shortfall from being captured twice.

Our [practical IAS 36 impairment guide](/learn/impairment-of-assets-ias-36) explains the asset calculation. The [IFRS Foundation's IAS 36 overview](https://www.ifrs.org/issued-standards/list-of-standards/ias-36-impairment-of-assets/) describes recoverable amount and when an asset or cash-generating unit needs assessment. Use the standard applicable to the particular asset; the words “contract loss” do not make every asset subject to IAS 36.

Prepare an asset list beside the contract schedule. Record the carrying amount, the applicable measurement rule, the review performed, and any adjustment. Then update the contract calculation for the resulting amounts. For equipment, check whether the depreciation allocation needs to change after the asset review.

Avoid treating an impairment charge as a universal deduction from the initial contract loss. The relationship depends on which assets and cash flows were included in each assessment. Subtracting a number mechanically can hide a missing cost just as easily as leaving it unchanged can duplicate a loss.

In the Sahl example, we explicitly assumed that the equipment review found no impairment and that the depreciation allocation was current. In the Rawasi example, there were no relevant recognised assets. These are purposeful facts that allow the provision calculations to stand on their own.

In practice, ask the preparer of the asset schedule to review the contract worksheet with you. Agree which loss appears in which schedule and document the link. That short reconciliation often catches errors that neither schedule reveals in isolation.

What common mistakes distort the provision and later review?

Mixing gross costs with net losses. The Sahl provision is SAR 10,000. Using its SAR 250,000 fulfilment cost as the loss would ignore the customer's SAR 240,000 consideration. Label the final line “net loss” so the calculation stays understandable.

Treating a payment as a second expense. Rawasi's SAR 30,000 settlement uses the liability previously recognised. Keep the original posting reference with the payment support. Otherwise, a later accountant may record the same contract loss twice.

Leaving the estimate unchanged without checking the facts. At each reporting date, update the remaining work, prices and exit options. Separate changes in estimates from amounts used to settle the original obligation. The [XRB publication of IAS 37's equivalent requirements](https://standards.xrb.govt.nz/standards-navigator/nz-ias-37/) includes the review, use and disclosure rules in paragraphs 59, 61 and 84–85; it is a New Zealand standard-setter publication, not Saudi-specific guidance.

Posting an illustrative alternative as an additional liability. The changed materials amount and changed cancellation penalty above are separate learning scenarios. In a real ledger there is one supported closing requirement for the obligation, reconciled with its existing balance.

Keeping a number without an explanation. Prepare a movement schedule showing the opening balance, additions, usage, reversals and closing balance, with discount effects where relevant. Describe the obligation, expected settlement timing and material estimation uncertainty in the disclosure workpaper.

Finally, label draft standard-setting material correctly. The Foundation's [Provisions—Targeted Improvements project](https://www.ifrs.org/projects/work-plan/provisions/) still identifies final amendments as its next milestone when checked on 15 September 2026. This article does not treat exposure-draft proposals as requirements already in force.

How can you practise the decision and the entries?

Rebuild both examples on a blank page before looking at the solutions. Begin with a sentence identifying what remains binding. Add the remaining benefits, explain each included cost, and compare the two net outcomes. Finish with the initial entry and a short note on the asset-review assumption.

On your next attempt, change one fact at a time. Remove the cancellation right, change a supplier quotation, or introduce equipment that needs an impairment review. State which part of the worksheet must be rebuilt before calculating. Changing several facts together makes it harder to identify the reason your answer moved.

Review your work in this order:

• Contract: did you use an available exit route and the correct remaining obligations?
• Cost: can you support every included amount and allocation?
• Measurement: did you compare net losses and deal with relevant assets first?
• Posting: does the initial entry record the liability, and does settlement avoid duplicating expense?
• Explanation: can someone trace the conclusion back to the facts without asking what a spreadsheet cell means?

Use [Accountery's accounting practice exercises](/practice) to strengthen classification, balanced entries and review of mistakes. Choose relevant exercises from the available catalogue, then apply the worksheet to the fictional cases here on paper. The aim is to build a repeatable reasoning habit: read the obligation, calculate the supported amount, and explain why that amount belongs in the accounts.