What is Onerous Contract?
An onerous contract is a contract in which the unavoidable costs of meeting the obligations exceed the economic benefits expected to be received. Under IAS 37, the entity must recognize a provision for the net loss measured at the lower of the cost of fulfilling the contract and any penalty for terminating it.
How It Works
- Estimate unavoidable costs (direct costs plus an allocation of overhead).
- Estimate expected benefits from the contract.
- If costs exceed benefits, recognize a provision for the difference.
- Update each reporting period until the contract is performed or terminated.
Saudi Context
Saudi construction contractors facing sharp input cost increases on fixed-price contracts often recognize onerous contract provisions before completion.
Example
A fixed-price construction contract priced at SAR 30 million now expected to cost SAR 35 million to complete results in a SAR 5 million onerous contract provision.