A company holds a contract that has become onerous. Under IAS 37, as clarified by the IASB's amendment on the costs of fulfilling a contract, what amount should the unavoidable cost of the contract be measured at?
- The total remaining contractual revenue the company would have received had it continued to perform the contract in full
- The lower of the cost of fulfilling the contract and any compensation or penalties arising from failure to fulfil it, representing the least net cost of exiting the contract
- The higher of the cost of fulfilling the contract and any compensation or penalties arising from failure to fulfil it, so as to be prudent
- The historical cost of any assets dedicated to the contract, without regard to any compensation or penalties for non-performance
Why B? And why not the others?
Correct answer: B. The lower of the cost of fulfilling the contract and any compensation or penalties arising from failure to fulfil it, representing the least net cost of exiting the contract
IAS 37 measures the unavoidable costs under an onerous contract as the lower of the cost of fulfilling the contract and any compensation or penalties arising from failing to fulfil it, which together represent the least net cost of exiting the contract; a provision is recognised for that amount after any related assets have first been tested for impairment under IAS 36. The option pointing to the total remaining contractual revenue is wrong because revenue forgone is not what the standard measures at all — the test compares costs of performance against the cost of walking away, not what income would have been received. The option using the higher of the two figures inverts the actual rule: picking the larger amount would systematically overstate the provision, and deliberately inflating a provision beyond the standard's specified measure is not what IAS 37 means by a faithful or prudent estimate. The option relying on historical cost of dedicated assets, ignoring compensation or penalties, addresses a different question — impairment of the contract's related assets under IAS 36 — rather than the onerous-contract provision itself, which specifically requires comparing fulfilment cost against exit compensation or penalties.
Source: IAS 37 Provisions, Contingent Liabilities and Contingent Assets, paragraph 68 and Onerous Contracts—Cost of Fulfilling a Contract (Amendments to IAS 37, 2020)