Onerous contracts and purchase commitments

When unavoidable costs of meeting a contract exceed the benefits expected, a provision is recognized based on the cheaper way out. Volatile commodity prices make this recurring for regional manufacturers; failing to provide understates liabilities and overstates profit, risking sudden large charges later.

Are there fixed-price purchase or sales commitments where current market prices or production costs have moved unfavorably relative to the contracted terms? Has the unavoidable net cost (cost to fulfil less economic benefit, or exit penalty if lower) been quantified as a provision? Have any assets dedicated to the contract been tested for impairment first, before recognizing the onerous-contract provision?

1. Screen all significant purchase and sales commitments at each reporting date for fixed-price terms that are now unfavorable relative to current market prices or production costs.
2. For a candidate contract, compare the unavoidable costs of fulfilling it against the economic benefits expected to be received under it.
3. If unavoidable costs exceed expected benefits, the contract is onerous - first test whether any assets dedicated to the contract are impaired, and write those down first under the applicable asset standard.
4. After any asset impairment, recognize a provision for the remaining unavoidable net loss on the contract.
5. Where the loss arises from linked contracts, assess the combined unavoidable net loss across the linked contracts if genuinely interdependent.
6. Do not provide for expected future losses on contracts that are merely loss-making without being onerous.
7. Reassess the onerous contract provision at each reporting date as commodity prices, volumes and exit terms change.

Measurement basis: the provision equals the unavoidable net cost, the lower of the cost to fulfil net of expected benefit and any exit compensation. Included: incremental directly related costs. Excluded: costs incurred regardless of fulfilment. Remeasurement triggers: reassess each reporting date as prices or volumes change; release if no longer onerous.

Nature of the onerous contract(s) and circumstances giving rise to the provision; amount and expected timing of outflow; roll-forward of the provision balance; impairment losses on dedicated assets; major assumptions used; contingent liabilities for possible but not probable losses.

• Ignoring loss-making fixed-price deals with major retailers
• recognizing a provision for general future losses rather than genuinely onerous contracts
• failing to impair dedicated assets first
• overlooking interdependency between linked contracts
• not updating the provision as prices partially recover.