Onerous Contract

What Is an Onerous Contract?

An onerous contract is an accounting term that alludes to a contract that will cost a company more to satisfy than what the company will receive in return.

The term is utilized in numerous countries worldwide, where international regulators have determined that such contracts must be accounted for on balance sheets. The United States has a different system, in light of generally accepted accounting principles, or GAAP, as set forward by the U.S.- based Financial Accounting Standards Board.

Grasping Onerous Contracts

The International Accounting Standards (IAS) characterizes an onerous contract as "a contract wherein the undeniable costs of meeting the obligations under the contract surpass the economic benefits expected to be received under it."

The term "undeniable costs" likewise has a specific significance for the end goal of accounting. The IAS characterizes it as "the lower of the cost of satisfying the contract and any compensation or punishments emerging from inability to satisfy it."

Onerous Contract Example

An illustration of an onerous contract may be an agreement to rent a property that is not generally required or that can at this point not be utilized productively. For example, assume a company consents to a long term arrangement to rent office space, then moves or cuts back while the agreement is still in effect, leaving the office space, which it currently has no need for, empty. Or on the other hand consider a mining company that has marked a lease to dig for coal or another commodity on a land parcel, yet sooner or later during the term of the contract, the price of that commodity tumbles to a level that makes extricating it and putting up it for sale to the public unrewarding.

Special Considerations

The rules for how onerous contracts ought to be treated in a company's financial statements are part of the International Financial Reporting Standards (IFRS), for which the IAS Board is the independent standard-setting body. The overseeing body, the IFRS Foundation, is a not-for-benefit organization situated in London.

International Accounting Standard 37 (IAS 37), "Provisions, Contingent Liabilities, and Contingent Assets," characterizes onerous contracts as "provisions," meaning liabilities or obligations that will accrue at a dubious time or in an obscure amount. Provisions are estimated utilizing the best estimate of the expenses required to fulfill the current obligation.

Under IAS 37, any business or company that distinguishes a contract as onerous is required to perceive the current obligation as a liability and to list that liability on its balance sheet. This interaction is intended to be embraced at the main indication that the company anticipates a loss from the contract.

The IFRS and IASB standards are involved by companies in numerous countries all through the world, albeit not in the United States. The U.S. expects companies to follow one more set of standards under GAAP. Under GAAP, losses, obligations, and obligations on committed onerous contracts commonly are not recognized or managed. Be that as it may, the FASB has been working with the IASB to lay out viable standards worldwide.

Features

• In the United States, companies ordinarily follow a different set of accounting standards and generally don't need to account for their onerous contracts.
• An onerous contract is an accounting term defined under the International Financial Reporting Standards (IFRS), utilized in numerous countries around the world.
• Companies that follow those standards are required to report any onerous contracts they're committed to on their balance sheets.