Why it matters
Contracts priced in local currency but with significant FX-denominated inputs (imported steel, MEP equipment, subcontracts) carry margin risk that only shows up through remeasurement of monetary FX balances and updated cost-to-complete estimates, so a single devaluation event can turn several previously profitable contracts loss-making in one quarter and force onerous contract provisions.
Diagnostic questions
What share of remaining cost-to-complete on each contract is denominated in or linked to a foreign currency (imported materials, equipment, subcontracts)? Is the cost-to-complete estimate updated immediately (not with a lag) when FX movements increase the local-currency cost of remaining inputs? Do any contracts include currency escalation or pass-through clauses that shift FX risk back to the customer? When updated cost-to-complete causes total expected costs to exceed revenue on a specific contract, is the full onerous loss recognized immediately?
Recognition
1) For each contract, map the currency composition of the remaining cost-to-complete (local currency labor/overhead versus FX-denominated imported materials, equipment and subcontracts). 2) Remeasure monetary assets and liabilities denominated in foreign currency (payables to foreign subcontractors/suppliers, FX-denominated loan drawdowns) at the closing rate at each reporting date, recognizing the exchange difference in profit or loss. 3) When FX movements increase the local-currency cost of remaining FX-denominated inputs, update the total estimated contract costs (cost-to-complete) used in the percentage-of-completion revenue and margin calculation immediately, not with a lag. 4) Where the updated cost-to-complete causes total expected contract costs to exceed total contract revenue, recognize the full expected loss immediately as an onerous contract provision, not spread over the remaining life. 5) Determine the appropriate exchange rate to use where multiple official/parallel rates or capital transfer restrictions exist, based on the rate at which the entity realistically expects to settle the transaction, and apply it consistently. 6) Assess whether any contractual currency escalation or pass-through clauses shift some of the FX risk back to the customer, which would reduce (but rarely eliminate) the contractor's exposure.
Measurement
Monetary FX balances (payables, receivables, loan balances denominated in foreign currency) are remeasured at each reporting date using the closing spot rate (or the realistic settlement rate under restrictions), with the difference recognized in profit or loss; non-monetary items (e.g., inventory already purchased and paid for) are not remeasured for subsequent FX movements. Cost-to-complete used in revenue/margin recognition should reflect updated FX assumptions for the remaining unincurred FX-denominated costs, using a rate consistent with realistic settlement expectations, updated at least each reporting period or when a significant FX movement occurs.
Presentation & disclosure
Disclose the entity's FX risk management policy for contracts, concentration of exposure by currency, sensitivity of contract margins to reasonably possible FX movements, the amount of FX gains/losses recognized in profit or loss, and any onerous contract provisions with the events (including FX) that triggered them.
Common mistakes
1) Excluding FX-driven cost inflation from the cost-to-complete estimate used in percentage-of-completion accounting, effectively deferring recognition of a known cost increase. 2) Capitalizing devaluation losses into contract costs after the fact instead of recognizing them as incurred and updating the forecast immediately. 3) Ignoring FX exposure embedded in advance payment guarantees, performance bonds or retention balances denominated in foreign currency. 4) Using a stale or official rate that does not reflect the realistic settlement rate when parallel market or transfer restrictions exist. 5) Netting FX gains on one contract against FX losses on another instead of assessing each contract's onerous status separately.
Simple example
Facts: An Egyptian contractor has a fixed-price EGP contract with EUR 4,000,000 of remaining MEP subcontract costs. At the start of the year the rate was EGP 50 = EUR 1 (EGP 200,000,000 equivalent); after a EGP devaluation the closing rate is EGP 60 = EUR 1 (EGP 240,000,000 equivalent), increasing remaining costs by EGP 40,000,000. This update pushes total estimated contract costs above total contract revenue by EGP 15,000,000 for this specific contract (SAR-equivalent figures used here for illustration: assume SAR-equivalent loss of SAR 15,000,000, i.e. treating EGP amounts as translated into the group's SAR reporting currency at the relevant rate for this example). Journal entry to remeasure the EUR-denominated subcontract payable already incurred (assume EUR 500,000 already payable, revalued from SAR-equivalent 1,250,000 to 1,500,000 at closing rates): Dr Foreign exchange loss (P&L) 250,000 Cr Trade payables (EUR subcontractor) 250,000 Journal entry to recognize the resulting onerous contract loss once updated cost-to-complete shows total costs exceeding total revenue: Dr Onerous contract loss (P&L) 15,000,000 Cr Provision for onerous contract 15,000,000
Professional judgment
The central judgments are selecting the realistic settlement exchange rate when multiple official and parallel rates coexist or capital controls restrict conversion, and disciplining the feed of FX-driven cost changes into cost-to-complete forecasts promptly rather than waiting for actual cash payments. Management must also judge how much of the FX risk is contractually passed to the customer via escalation clauses versus retained by the contractor, and whether devaluation expectations already priced into a contract's original budget should temper the immediate loss recognition (they generally should not - actual rate movements are recognized as they occur).
Source basis
IAS 21 · The Effects of Changes in Foreign Exchange Rates
Paragraph references
Verified against the official standard texts used in the IFRS Expert skill.
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.