Onerous freight and charter contracts

When the unavoidable costs of fulfilling a long-term freight or vessel charter contract exceed the economic benefits expected from it, a provision for the resulting loss must be recognized rather than deferring recognition until the loss is actually incurred. Failing to identify an onerous contract lets losses trickle into future periods' income statements instead of being recognized upfront, distorting trend analysis and hiding a known future cash drain from investors and lenders.

Do any fixed-rate, multi-year freight or charter contracts now have unavoidable costs (fuel, crewing, vessel/vehicle depreciation and maintenance) that exceed the economic benefits (contracted revenue) expected to be received under them? Is there a realistic option to exit the contract at a lower cost (a penalty or buyout) than continuing to fulfil it, and if so, is the provision measured at the lower of the two amounts? Are all directly attributable costs, and only those, included in the unavoidable-cost calculation?

1) Monitor fixed-rate multi-year freight/charter contracts against current and forecast fuel, crewing, and vessel/vehicle operating costs. 2) Identify when the unavoidable costs of meeting the contract's obligations exceed the economic benefits expected to be received under it (the contract is 'onerous' as a whole). 3) Confirm there is no realistic ability to exit the contract at lower cost than fulfilling it (the lower of fulfillment cost and exit cost governs the provision). 4) Recognize a provision for the best estimate of the unavoidable net cost as soon as the contract meets the onerous threshold, do not wait for actual losses to appear in the income statement. 5) Reassess the provision each period as fuel prices, freight rates, or remaining contract volumes change.

Measure the provision using the lower of the cost of fulfilling the contract (unavoidable costs net of expected economic benefits) and any compensation or penalty payable from exiting the contract. Include all directly related costs (e.g. fuel, crewing, vessel/vehicle depreciation and maintenance allocable to the contract) in the fulfillment cost estimate, and reassess as market fuel prices or freight rates move.

Disclose: (1) the existence, nature, and amount of onerous contract provisions; (2) the key assumptions (fuel price, cost escalation, remaining volume) used to determine them; (3) a reconciliation of the provision's movement during the period; (4) the expected timing of the outflow; (5) sensitivity of the provision to key assumptions where material.

• Failing to identify an onerous contract until actual losses appear voyage-by-voyage in the income statement, instead of recognizing the full expected loss upfront
• measuring the provision using only incremental costs rather than all unavoidable costs of fulfilling the contract
• ignoring the exit-cost alternative when it would actually be cheaper than fulfillment
• not reassessing the provision as fuel/crewing costs or remaining contract volume change.