Onerous contracts

Rising costs and fixed-price contracts turn profitable deals into loss-making ones, and IAS 37 requires the loss to be recognised as soon as it becomes unavoidable. This guide explains what counts as an onerous contract, how to measure unavoidable costs after the 2022 amendments, and works through an example.

By Mirza Fahad Baig, Chartered Accountant. Reviewed by Hamza Fida, Chartered Accountant. Checked against official sources on . 3 minute read.

Short answer

Onerous contracts under IAS 37 are contracts in which the unavoidable costs of meeting the obligations exceed the economic benefits expected under them. IAS 37 requires a provision for the present obligation. Unavoidable costs are the lower of the cost of fulfilling the contract and any compensation or penalties for failing to fulfil it. Since the 2022 amendments, the cost of fulfilling includes both incremental costs and an allocation of other costs that relate directly to the contract, such as depreciation of equipment used. Assets dedicated to the contract are tested for impairment first.

At a glance

Onerous when
Unavoidable costs exceed benefits
Unavoidable costs
Lower of fulfilling and exit cost
Cost of fulfilling
Incremental plus directly related costs
Amendments
Effective 1 January 2022
First
Impair dedicated assets
Not for
Future operating losses generally
Onerous contractsOnerous when: Unavoidable costs exceed benefits; Unavoidable costs: Lower of fulfilling and exit cost; Cost of fulfilling: Incremental plus directly related costs; Amendments: Effective 1 January 2022; First: Impair dedicated assets; Not for: Future operating losses generally.KEY FACTS AT A GLANCEOnerous contractsOnerous whenUnavoidable costs exceedbenefitsUnavoidable costsLower of fulfilling andexit costCost of fulfillingIncremental plus directlyrelated costsAmendmentsEffective 1 January 2022FirstImpair dedicated assetsNot forFuture operating lossesgenerallyChecked against official sourcesTax BakersOnerous contractsOnerous when: Unavoidable costs exceed benefits; Unavoidable costs: Lower of fulfilling and exit cost; Cost of fulfilling: Incremental plus directly related costs; Amendments: Effective 1 January 2022; First: Impair dedicated assets; Not for: Future operating losses generally.KEY FACTS AT A GLANCEOnerous contractsOnerous whenUnavoidable costs exceed benefitsUnavoidable costsLower of fulfilling and exit costCost of fulfillingIncremental plus directly related costsAmendmentsEffective 1 January 2022FirstImpair dedicated assetsNot forFuture operating losses generallyChecked against official sourcesTax Bakers
Key facts at a glance, as set out in this guide.

What is an onerous contract?

A contract in which the unavoidable costs of meeting the obligations exceed the economic benefits expected to be received. Contracts that can be cancelled without paying compensation are not onerous, because no obligation exists. Fixed-price supply contracts, long-term leases of space no longer needed and service contracts priced below cost are typical examples.

What are the unavoidable costs?

The lower of:

  • the cost of fulfilling the contract, and
  • any compensation or penalties arising from failure to fulfil it.

The amendments effective from 1 January 2022 clarified that the cost of fulfilling comprises the costs that relate directly to the contract: the incremental costs, such as direct labour and materials, and an allocation of other costs that relate directly to fulfilling contracts, such as depreciation of an item of equipment used in fulfilling it. General and administrative costs that do not relate directly to the contract are excluded.

A worked onerous contract example

Is the contract onerous? (CU)Is the contract onerous? (CU)50,000Revenue-45,000Incrementalcosts-8,000Allocateddepreciation-3,000Loss toprovide
Including directly related costs, the contract makes a loss of 3,000.

A manufacturer has a fixed-price contract to supply 1,000 units at 50 each, revenue of 50,000. Since signing, material costs have risen: incremental costs are now 45 per unit, and depreciation of the production line allocated to the contract is 8 per unit. Cancelling the contract would cost a penalty of 5,000.

CU
Cost of fulfilling: 1,000 x (45 + 8)53,000
Less economic benefits: revenue(50,000)
Net cost of fulfilling3,000
Cost of exiting: penalty5,000
Provision: the lower3,000

Before the 2022 amendments, some companies counted only incremental costs, 45 per unit, and would have found no onerous contract: 45,000 is below 50,000. Including the allocated depreciation reveals the loss and the provision required.

Onerous contract examples by industry

IndustryTypical onerous contract
Construction and engineeringFixed-price project where cost estimates have risen above the price
ManufacturingLong-term supply agreement at a price below current production cost
EnergyPurchase commitment for fuel or power above expected selling prices
Outsourcing and IT servicesMulti-year service contract priced below the cost of delivery
TelecomCapacity commitments for network or satellite capacity no longer needed

Why test assets for impairment first?

Before recognising a provision, the company recognises any impairment loss on assets dedicated to the contract, such as the production line or inventory held for it. Otherwise the same loss could be counted twice. See IAS 36 explained.

Are leases onerous contracts?

Under IFRS 16, most leases are on the balance sheet, so a lease of an unused office is dealt with by impairing the right-of-use asset, not by an onerous contract provision. Onerous contract provisions remain relevant for non-lease costs such as service charges, and for short-term or low-value leases kept off the balance sheet.

What must be disclosed?

For each class of provision: the carrying amounts at the start and end of the period, additions, amounts used and reversed, and the unwinding of the discount; a description of the obligation and the expected timing; and the uncertainties about amount and timing, including the major assumptions about future events.

How does this interact with IFRS 15?

IFRS 15 has no separate onerous test for contracts with customers; loss-making customer contracts are measured under IAS 37. A provision is recognised for the expected loss, and costs incurred are recognised as performed. See revenue over time and IAS 37 explained.

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Questions people ask

What is an onerous contract under IAS 37?

A contract in which the unavoidable costs of meeting the obligations exceed the economic benefits expected under it.

What are unavoidable costs?

The lower of the cost of fulfilling the contract and any compensation or penalties for failing to fulfil it.

What did the 2022 amendments to IAS 37 change?

They clarified that the cost of fulfilling a contract includes incremental costs and an allocation of other costs that relate directly to the contract.

Are dedicated assets tested for impairment first?

Yes. Any impairment of assets dedicated to the contract is recognised before an onerous contract provision.

Sources

Every fee, date and rule on this page was taken from these official and primary sources.

  1. IFRS Foundation: IAS 37 Provisions, Contingent Liabilities and Contingent Assets

Rules and fees change. If you are reading this long after October 4, 2026, confirm the figures with the source before you rely on them.

IAS 37IAS 37 provisions explainedIAS 36IAS 36 impairment of assets explainedIFRS 15Revenue over time or at a point in time under IFRS 15

More in IAS 37

TopicAll 2 guides in IAS 37

This guide is general information. It is not tax or legal advice for your situation.