Provisions, onerous contracts and contingencies

Retailers regularly face situations that look similar on the surface - a lease that has become loss-making, a supply contract that no longer makes economic sense, a pending legal claim - but that require careful analysis under different IFRS standards to reach the correct answer, and conflating them is one of the more consequential errors retail preparers make. IAS 37 governs provisions, onerous contracts, and contingent liabilities, but since IFRS 16 brought almost all leases onto the balance sheet, a lease that becomes loss-making is primarily an IAS 36 impairment question (because the lease liability and right-of-use asset are already recognized), not a fresh IAS 37 onerous contract provision - recognizing both would effectively double-count the loss. Getting this wrong either overstates liabilities (double-counting a lease loss as both an impaired ROU asset and a separate onerous contract provision) or understates them (failing to test a genuinely onerous non-lease contract, such as a supply agreement, at all). Legal claims and warranty obligations require their own probability and reliability-of-estimate assessment distinct from lease economics entirely. Because restructuring and store-closure decisions are common in a competitive retail environment, management and auditors need a clear, standard-by-standard decision framework rather than a single generic 'provision' reflex.

Is the arrangement a lease already recognized under IFRS 16, or a non-lease executory contract that falls under IAS 37? For a loss-making store lease, have the unavoidable costs of the remaining lease term been compared to expected economic benefits to test for an onerous contract? Has a restructuring plan been formally approved and either announced or started, as required before a restructuring provision can be recognized?

1. First classify the arrangement: is it a lease within IFRS 16's scope that is already recognized on the balance sheet (lease liability and right-of-use asset), or is it a non-lease contract (e.g., a supply agreement), or a short-term/low-value lease for which the recognition exemption was applied?
2. For a store lease already on-balance-sheet under IFRS 16 that has become loss-making (e.g., due to declining footfall or a closure decision), the correct primary treatment is an IAS 36 impairment test of the store's cash-generating unit (CGU), which includes the right-of-use asset, fixtures, and equipment - compare the CGU's carrying amount to its recoverable amount and recognize an impairment loss if the carrying amount is higher; do NOT separately recognize an IAS 37 onerous contract provision for the same lease on top of the lease liability already recognized.
3. For a contract that is NOT a recognized lease (e.g., a non-lease supply or service agreement, or a short-term/low-value lease outside the IFRS 16 recognition exemption where no lease liability sits on the balance sheet), assess whether it is onerous: the unavoidable costs of meeting the contractual obligations exceed the economic benefits expected to be received under it.
4. If a contract is onerous under step 3, recognize a provision for the present obligation at the lower of the cost of fulfilling the contract and the cost of exiting it (e.g., penalty for termination), net of any recoveries.
5. Separately, for legal claims, warranty obligations, or other disputes, recognize a provision only when there is a present obligation (legal or constructive) as a result of a past event, an outflow of economic resources is probable, and the amount can be estimated reliably; if any of these three conditions is not met, assess for contingent liability disclosure instead.
6. Reassess restructuring costs against the specific IAS 37 recognition criteria for restructuring provisions - a provision is only recognized once a detailed formal plan exists and has been announced or has begun implementation, creating a valid expectation in those affected; a mere management decision or board intention is not sufficient.

For an IAS 36 impairment of a loss-making leased store CGU, measure recoverable amount as the higher of fair value less costs of disposal and value in use using store-specific cash flow forecasts (see RETAIL-008 for the full CGU impairment mechanics); the resulting impairment loss is allocated across the CGU's assets including the right-of-use asset. For a genuine IAS 37 onerous contract provision (non-lease contract, or a short-term/low-value lease not on-balance-sheet), measure the provision at the lower of the unavoidable cost of fulfilling the contract and any compensation or penalties from failing to fulfill it, net of expected recoveries (e.g., resale value of goods the entity is committed to purchase); discount to present value where the effect of the time value of money is material, such as multi-year unavoidable commitments. For legal claims and warranty provisions, measure at the best estimate of the expenditure required to settle the obligation at the reporting date - using the expected value (probability-weighted) approach for a large population of similar items (e.g., warranty claims) or the most likely outcome for a single large obligation (e.g., one significant lawsuit), and discount long-dated obligations where material.

For IAS 36 store impairments: cross-refer to the CGU impairment disclosures (events/circumstances triggering impairment, recoverable amount basis, key assumptions, sensitivity); for IAS 37 items: nature of each material provision and the reporting line it sits within; a reconciliation of the provision's opening balance, additions, amounts used, unused amounts reversed, unwinding of discount, and closing balance; the estimated timing of expected outflows and the major uncertainties affecting timing/amount; for onerous contracts specifically, the nature of the contract and the basis for the unavoidable cost/exit cost comparison; contingent liabilities not recognized as provisions, with an estimate of financial effect unless impracticable, disclosed unless the possibility of an outflow is remote; disclosure explicitly distinguishing which loss-making arrangements were addressed via ROU asset impairment (IAS 36) versus onerous contract provisions (IAS 37), so users can see the two are not overlapping.

• Treating a loss-making store lease that is already recognized under IFRS 16 as a fresh IAS 37 onerous contract provision instead of performing an IAS 36 impairment test of the store CGU (including the ROU asset) - this is the single most consequential and common error, since it can double-count the loss (an impaired ROU asset plus a separate provision for the same unavoidable lease payments)
• recognizing a general reserve for possible future losses that is not linked to a specific present obligation
• failing to test genuinely onerous non-lease contracts (e.g., a fixed-volume supply agreement that has become loss-making) for an IAS 37 provision at all because attention is focused only on leases
• recognizing a restructuring provision based on a board decision or announcement to the media without a sufficiently detailed formal plan communicated to those affected
• disclosing a contingent liability as if it were a recognized provision when settlement is only possible (not probable)
• failing to discount long-dated onerous contract or legal claim provisions where the time value of money is material.