Sequencing of expected contract losses, the onerous contract test, and impairment of contract-related assets · IFRS 15 / IAS 37 / IAS 36

Why it matters

When a contract turns loss-making, IFRS 15, IAS 37 and IAS 36 interact in a specific mandatory sequence that is easy to apply out of order: skipping the impairment-first step, or netting the onerous provision against unrelated CGU cash flows, both produce a materially wrong loss recognition pattern and can either double-count or understate the total loss actually facing the entity on that contract.

Diagnostic questions

Has the total expected outcome at completion (total contract revenue including highly probable variable consideration, less total estimated costs to complete) been recomputed at this reporting date using the latest information? If the recomputation shows an overall expected loss, has any related contract asset, fulfilment cost asset, or dedicated uninstalled material been tested for and reduced by impairment before any separate onerous contract provision is measured? Is any residual IAS 37 provision limited to the unavoidable costs of the remaining obligations that exceed the expected economic benefits, net of the impairments and losses already recognized? Has the sequencing of IFRS 15, then asset impairment under IAS 36, then IAS 37 been followed rather than applied out of order or netted against unrelated cash-generating unit cash flows?

Recognition

Recompute total expected outcome at completion (total contract revenue including highly probable variable consideration, less total estimated costs to complete) at each reporting date, using the same estimation process as the ordinary progress and cost-to-complete update.
If the recomputation shows the contract will be loss-making, follow the mandatory sequence: first, impair any contract-related assets specifically associated with that contract (contract fulfilment cost assets, contract assets, capitalized costs to obtain the contract) to their recoverable amount under the applicable standard for each asset type.
Second, if a loss remains after asset impairment, recognize an IAS 37 onerous contract provision for the unavoidable net cost of the remaining obligations.
Third and separately, assess whether broader non-financial assets used on the contract (e.g. dedicated equipment) within their own cash-generating unit require an IAS 36 impairment test, which is a distinct assessment from the contract-specific onerous provision and should not be conflated with it or omitted because an onerous provision was already booked.
Reassess the full sequence each period as facts change; do not net a loss on one contract against unrelated profitable contracts or unrelated CGUs.

Measurement

Measure the total expected loss based on the latest estimate at completion (total contract revenue less total estimated costs); measure any residual onerous contract provision (after asset impairment) at the lower of the cost of fulfilling the remaining contract and any compensation/penalties for not fulfilling it; measure any separate CGU-level impairment under IAS 36 as the excess of carrying amount over the higher of fair value less costs of disposal and value in use for that CGU, which may include assets beyond the specific contract. Ensure the same cost-to-complete estimate feeds consistently into all three assessments rather than using divergent figures for each.

Presentation & disclosure

Disclose: (1) the sequence applied and amounts recognized at each step (asset impairment, onerous provision, separate CGU impairment) for material loss-making contracts; (2) the contracts or CGUs affected and the reasons; (3) key assumptions in the underlying cost-to-complete estimate common to all three assessments; (4) movements in the onerous provision and any impairment losses/reversals during the period; (5) sensitivity disclosure where the loss determination is finely balanced or highly estimation-dependent.

Common mistakes

Jumping directly to recognizing an IAS 37 onerous provision for the full expected loss without first writing down any related contract asset or fulfilment cost asset to its recoverable amount, double counting part of the loss
recognizing the onerous provision but never separately testing dedicated equipment or other CGU assets under IAS 36, missing a further impairment that the onerous test does not capture
netting the loss on one onerous contract against healthy margins on unrelated contracts within the same reported segment
using inconsistent cost-to-complete figures across the three assessments performed by different teams (commercial, finance, asset management) without reconciliation.

Simple example

A contract has total expected revenue of SAR 100,000,000 and, following a cost overrun, total expected costs at completion of SAR 112,000,000, an overall expected loss of SAR 12,000,000. At the reassessment date, the contract has a contract asset of SAR 4,000,000 (unbilled revenue) related specifically to this contract, and dedicated equipment used solely on this contract has a carrying amount of SAR 3,000,000 within its own CGU, with a recoverable amount assessed at SAR 2,000,000 due to the contract's deteriorated outlook.
Step 1 - impair the contract asset first:
Dr Impairment loss - contract asset (P&L) 4,000,000
Cr Contract asset 4,000,000
Step 2 - recognize the residual onerous contract provision for the remaining SAR 8,000,000 of the SAR 12,000,000 total loss (12,000,000 - 4,000,000 already absorbed by the contract asset write-down):
Dr Onerous contract loss (P&L) 8,000,000
Cr Provision for onerous contract 8,000,000
Step 3 - separately test and impair the dedicated equipment under IAS 36:
Dr Impairment loss - equipment (P&L) 1,000,000
Cr Accumulated impairment - equipment 1,000,000
(3,000,000 - 2,000,000 = 1,000,000; this is a distinct, additional loss beyond the SAR 12,000,000 contract-level loss, since it relates to a separate CGU-level recoverability test)

Professional judgment

Ensuring the same underlying cost-to-complete and revenue forecast feeds consistently into the IFRS 15 progress calculation, the IAS 37 onerous test, and the IAS 36 impairment assessment requires cross-functional governance (commercial, finance, asset management working from one approved forecast) that many organizations lack, leading to inconsistent loss figures across the three analyses performed by different teams at different times. Determining the appropriate cash-generating unit for the IAS 36 step (dedicated project equipment alone, or a broader unit including shared resources) requires judgment about the level at which cash inflows are actually independent, and can differ from the contract-specific unit of account used for the IFRS 15/IAS 37 steps, which is a genuine complexity rather than an inconsistency to be simplified away.

Source basis

IFRS 15 / IAS 37 / IAS 36 · Revenue from Contracts with Customers / Provisions, Contingent Liabilities and Contingent Assets / Impairment of Assets

Paragraph references

IAS 37.68AIAS 37.69IFRS 15.101–102

Verified against the official standard texts used in the IFRS Expert skill.

IFRS 15 Revenue from Contracts with Customers

Issued: 28 May 2014 · Effective: 1 January 2018

IAS 37 Provisions, Contingent Liabilities and Contingent Assets

Issued: September 1998 · Effective: 1 July 1999

IAS 36 Impairment of Assets

Issued: March 2004 · Effective: 31 March 2004

Related issues

Educational and navigation content only. Not professional advice. Does not reproduce official IFRS/IAS text. Consult the authoritative standards and qualified professionals; professional judgment may still be required.