# Understanding Onerous Contracts: Definition, Examples, and Accounting Rules

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## What Is an Onerous Contract?

An onerous contract is an agreement that costs a company more to fulfill than it will earn from it. Under international accounting standards, these contracts must be listed as liabilities on the balance sheet.

The United States has a different system, based on [generally accepted accounting principles](https://www.investopedia.com/terms/g/gaap.asp), or GAAP, as set forth by the U.S.-based Financial Accounting Standards Board. Under GAAP rules, companies do not specifically have to specify the losses from onerous contracts.

Common examples of onerous contracts include multi-year leases for property that the company is unable to use.

### Key Takeaways

*   Onerous contracts occur when the costs of fulfilling a contract surpass the economic benefits received, making them a financial burden for companies.  
    
*   According to the International Financial Reporting Standards (IFRS), businesses must report onerous contracts as liabilities on their balance sheets to reflect potential financial losses accurately.  
    
*   The definition of onerous contracts and the requirement for their accounting is primarily governed by International Accounting Standard 37 (IAS 37), which classifies them as provisions due to their uncertain costs and timing.  
    
*   Despite IFRS's global reach, U.S. companies typically follow Generally Accepted Accounting Principles (GAAP), which do not mandate the recognition of onerous contracts in the same way, highlighting differences in international accounting practices.  
    
*   Businesses must monitor for indications of future losses from contracts and recognize them promptly to comply with IFRS standards, ensuring transparency and financial accuracy.

## Detailed Breakdown of Onerous Contracts in Accounting

The International Accounting Standards (IAS) defines an onerous contract as "a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it."﻿﻿

The term "unavoidable costs" also has a specific meaning for accounting purposes. The IAS defines it as "the lower of the cost of fulfilling the contract and any compensation or penalties arising from failure to fulfill it."﻿﻿

## Real-World Examples of Onerous Contracts

An example of an onerous contract might be an agreement to rent a property that is no longer needed or that can no longer be made use of profitably. For instance, suppose a company signs a multiyear agreement to rent office space, then moves or downsizes while the agreement is still in effect, leaving the office space, which it now has no use for, vacant. Or consider a mining company that has signed a lease to mine for coal or some other commodity on a piece of land, but at some point during the term of the contract, the price of that commodity falls to a level that makes extracting it and bringing it to market unprofitable.

## Key Considerations for Accounting Onerous Contracts

The rules for how onerous contracts should be treated in a company's financial statements are part of the [International Financial Reporting Standards](https://www.investopedia.com/terms/i/ifrs.asp) (IFRS), for which the IAS Board is the independent standard-setting body. The IFRS Foundation, a not-for-profit group, is based in London.

International Accounting Standard 37 (IAS 37), "Provisions, Contingent Liabilities, and Contingent Assets," classifies onerous contracts as "provisions," meaning liabilities or debts that will accrue at an uncertain time or in an unknown amount. Provisions are measured using the best estimate of the expenses required to satisfy the current obligation.

Under IAS 37, any business or company that identifies a contract as onerous is required to recognize the current obligation as a liability and to list that liability on its balance sheet. This process is meant to be undertaken at the first indication that the company expects a loss from the contract.

Companies in many countries use the IFRS and IASB standards, but not in the United States. The U.S. requires companies to follow another set of standards under GAAP. Under GAAP, losses, obligations, and debts on committed onerous contracts typically are not recognized or dealt with. However, the FASB has been working with the IASB to establish compatible standards worldwide.

> **Article Sources**
>
> 1.  IFRS Foundation. "[Onerous Contracts](https://www.ifrs.org/-/media/project/onerous-contracts-cost-of-fulfilling-a-contract-amendments-to-ias-37/ed-onerous-contracts-factsheet-dec-2018.pdf)," Page 1. Accessed Sept. 4, 2020.
>     
> 2.  IFRS Foundation. "[About Us](https://www.ifrs.org/about-us/)." Accessed Sept. 4, 2020.
>     
> 3.  IFRS Foundation. "[IAS 37 Provisions, Contingent Liabilities and Contingent Assets](https://www.ifrs.org/issued-standards/list-of-standards/ias-37-provisions-contingent-liabilities-and-contingent-assets/)." Accessed Sept. 4, 2020.