Companies currently applying the ‘incremental cost’ approach will need to recognise bigger and potentially more provisions for onerous contracts. This follows recent amendments to IAS 37 Provisions, Contingent Liabilities and Contingent Assets, which clarify the types of costs a company includes as the ‘costs of fulfilling a contract’ when assessing whether a contract is onerous. 

What’s the issue?

Following the withdrawal of IAS 11 Construction Contracts, companies apply the requirements in IAS 37 when determining whether a contract is onerous. These requirements specify that a contract is ‘onerous’ when the unavoidable costs of meeting the contractual obligations – i.e. the lower of the costs of fulfilling the contract and the costs of terminating it – outweigh the economic benefits. 

What’s the issue?

Many lessees are seeking rent concessions from lessors. The rent concessions could be in various forms and may include one-off rent reductions, rent waivers or deferrals of lease payments. For example, a number of retailers are seeking reductions in real estate rents, and similar issues may arise in other leases.

Under IFRS 16, rent concessions often meet the definition of a lease modification, unless they were envisaged in the original lease agreement. The accounting for lease modifications can be complex. For example, the lessee may be required to recalculate lease assets and liabilities using a revised discount rate.

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