(2)
(2)
(14)
At 31st December
46
8
17
52
108
32
263
Non-current
– 1 11 45 84
10
151
Current
46 7 6 7 24
22
112
46
8
17
52
108
32
263
[...]
Provisions are made for obligations under onerous operating leases when the properties are not used by the Group
and the net costs of exiting from the leases exceed the economic benefits expected to be received.
6.2.1.B Recognition
of
provisions for occupied leasehold property
As discussed at 6.2.1 above, the guidance in this section is mainly relevant to entities not
yet applying IFRS 16. For entities applying IFRS 16, the recognition of a provision for
vacant leasehold property would be appropriate only in respect of property leases that
become onerous before the commencement date of the lease, and short-term property
leases (as defined in IFRS 16) that are accounted for in accordance with paragraph 6 of
IFRS 16. For entities applying IFRS 16, IAS 37 applies also to leases for which the
1916 Chapter 27
underlying asset is of a low value and which are accounted for in accordance with
paragraph 6 of IFRS 16, but we would not expect leases of property to qualify as leases
for which the underlying asset is of a low value.
The discussion at 6.2.1.A above deals with situations where the leasehold property
becomes vacant. However, it does not address the case where an entity is occupying
leasehold property, which it has no current intention to vacate, and the lease becomes
onerous. As noted above, IAS 37 defines an onerous contract as ‘a contract in which the
unavoidable costs of meeting the obligations under the contract exceed the economic
benefits expected to be received under it’. [IAS 37.10]. In practice, it will often be where
business performance declines that an entity will assess whether a lease over an
occupied property has become onerous. The definition of an onerous contract requires
that the contract is onerous to the point of being directly loss-making, not simply
uneconomic by reference to current prices. Thus, if the entity still expects to operate
profitably from the leased property, despite rental payments that come to exceed
market rates, or a decline in business performance, no provision should be made. If the
business operated out of the leased property has become loss-making, and the entity
does not expect to be able to improve its operating results to recover the rental
payments, then a provision may be necessary. However, before a separate provision for
an onerous contract is established, IAS 37 requires that an entity should first recognise
any impairment loss that has occurred on assets dedicated to the contract. [IAS 37.69]. As
discussed at 6.2 above, IAS 37 considers the unavoidable costs under a contract to
reflect the least net cost of exiting from the contract, which is the lower of the cost of
fulfilling it and any compensation or penalties arising from failure to fulfil it. [IAS 37.68].
Therefore, where the business operated out of a leased property has become loss-
making, an onerous lease provision cannot be recognised to the extent that the lessee
could reasonably expect to recover its own remaining lease commitment by subletting
the property (see 6.2.1.A above) or from projected future trading income.
Tesco plc included in its property provisions an amount for leases on unprofitable
stores, and vacant properties.
Extract 27.3: Tesco plc (2018)
Notes to the Group financial statements [extract]
Note 25 Provisions [extract]
Property provisions [extract]
Property provisions comprise onerous lease provisions, including leases on unprofitable stores and vacant properties,
dilapidations provisions and asset retirement obligation provisions. These provisions are based on the least net cost
of fulfilling or exiting the contract.
The calculation of the value in use of the leased properties to the Group is based on the same assumptions for growth
rates and expected changes to future cash flows as those for Group owned properties, as discussed in detail in Note 11,
discounted at the appropriate risk free rate. The cost of exiting lease contracts is estimated as the present value of
expected surrender premiums or deficits from subletting at market rents, assuming that the Group can sublet
properties at market rents, based on discounting at the appropriate risk adjusted rate.
Provisions, contingent liabilities and contingent assets 1917
6.2.1.C
When an entity ceases to occupy part of a leased property
As discussed at 6.2.1 above, the guidance in this section is mainly relevant to entities not
yet applying IFRS 16. For entities applying IFRS 16, the recognition of a provision for
vacant leasehold property would be appropriate only in respect of property leases that
become onerous before the commencement date of the lease, and short-term property
leases (as defined in IFRS 16) that are accounted for in accordance with paragraph 6 of
IFRS 16. For entities applying IFRS 16, IAS 37 applies also to leases for which the
underlying asset is of a low value and which are accounted for in accordance with
paragraph 6 of IFRS 16, but we would not expect leases of property to qualify as leases
for which the underlying asset is of a low value.
A further complication arises in the case of a leased property when only part of the
building under lease is vacated. In our view, the existence of a single lease contract does
not prevent the entity from regarding each floor as a separate unit of account if this
appropriately reflects the facts and circumstances. Accordingly, it could be appropriate
to regard physically separable parts of a building in isolation when determining whether
the lease (or in this case part of it) is onerous. This would appear reasonable in the case
of an office block with a number of floors, where it is customary for individual floors to
be sub-let to other occupants.
Nevertheless, a distinction needs to be made between physically separable areas of a
property that have been vacated (i.e. taken out of use by the lessee) and areas of a
property that are being used inefficiently. Inefficient use does not justify the recognition
of a liability, due to the prohibition in IAS 37 against provisions for future operating
losses. [IAS 37.63]. As noted above, an entity should consider whether it is appropriate to
regard each floor as a separate unit of account and therefore to recognise a provision
for the rental costs related to a single floor of an office block that has been vacated.
However, it is not appropriate to recognise a provision in respect of a lease or a separate
unit of account within a lease (i.e. a floor) that is still partly-occupied, albeit at less than
its full capacity unless the unavoidable costs of meeting the obligations under that lease,
or separate unit of account within the lease, exceed the economic benefits expected to
be received under the lease (see 6.2.1.B above).
6.2.2
Contracts with customers that are, or have become, onerous
As IFRS 15 contains no specific requirements to address contracts with customers that
are, or have become, onerous, IAS 37 applies to such contracts. [IAS 37.5(g)]. In assessing
whether a contract is onerous, an entity should compare the unavoidable costs of
meeting the obligations under the contract to the economic benefits expected to be
received under it. The unavoidable costs under the contract are the lower of the cost
of fulfilling the contract and any compensation or penalties arising from failure to fulfil
the contract. [IAS 37.68]. As discussed at
6.2 above, in November 2017, the
Interpretations Committee decided to add a narrow-scope standard-setting project to
its agenda to clarify the meaning of the term ‘unavoidable costs’ in the definition of an
onerous contract. At the time of writing, an exposure draft was expected in the last
quarter of 2018.19
One question that may arise, is how an entity should account for an onerous contract
with a customer when the contract includes several ‘over time’ performance
1918 Chapter 27
obligations that are satisfied consecutively. Since the requirements for onerous
contracts are outside the scope of IFRS 15, an entity’s accounting for onerous
contracts does not affect the accounting for its revenue from contracts with customers
in accordance with IFRS 15. Therefore, an entity must use an ‘overlay’ approach,
which consists of two steps:
(a) apply the requirements of IFRS 15 to measure progress in satisfying each
performance obligation, and account for the related costs when incurred in
accordance with the applicable standards; and
(b) at the end of each reporting period, apply IAS 37 to determine if the remaining
contract as a whole is onerous. If the entity concludes that the remaining contract
as a whole is onerous, it recognises a provision only to the extent that the amount
of the remaining unavoidable costs under the contract exceed the remaining
economic benefits to be received under it.
This approach is illustrated below.
Example 27.16: Onerous contract with several ‘over time’ performance
obligations that are satisfied consecutively
Entity A enters into a contract that consists of two distinct performance obligations, which are satisfied
consecutively. Revenue is recognised over time for both performance obligations. Entity A expects to satisfy
the first performance obligation (PO1) during Years 1-4 and the second performance obligation (PO2) in
Years 5-6. Entity A measures progress towards the satisfaction of both performance obligations based on
costs incurred compared to the total expected costs (i.e. it applies an input method under IFRS 15).
If Entity A terminates the contract, a penalty of €100,000 is payable.
The expected revenues and costs at the inception of the contract and the updated expectations at the beginning
of Year 2 are as follows:
At contract inception
Update in Year 2
Expected
Expected
Expected
Expected
Expected
PO1
costs
revenue
costs
revenue
progress
Year 1
24,000
30,000
24,000
30,000
25%
Year 2
24,000
30,000
24,000
30,000
25%
Year 3
24,000
30,000
24,000
30,000
25%
Year 4
24,000
30,000
24,000
30,000
25%
Total PO1
96,000
120,000
96,000
120,000
PO2
Year 5
10,000
15,000
32,000
15,000
50%
Year 6
10,000
15,000
32,000
15,000
50%
Total PO2
20,000
30,000
64,000
30,000
Total contract 116,000
150,000
160,000
150,000
Gross profit (loss)
34,000
(10,000)
At contract inception, Entity A expects a positive margin for both performance obligations. At the beginning
of Year 2, its estimates of the cost to fulfil the second performance obligation are increased by €44,000.
Therefore, Entity A now expects to incur a loss of €34,000 for the second performance obligation, resulting
in a negative margin for the entire contract of €10,000.
Provisions, contingent liabilities and contingent assets 1919
The contract as a whole is only onerous to the extent that the remaining costs to be incurred exceed the
remaining benefits to be recognised. This is not the €34,000 loss relating to the second performance
obligation, because at the beginning of Year 2, Entity A has yet to recognise profits of €18,000 for the
completion of the first performance obligation. As a result, the net cost of fulfilling the contract at Year 2 is
€16,000. This cost is less than the termination penalty of €100,000 and therefore, applying the ‘overlay’
approach explained above, Entity A recognises a provision under IAS 37 of €16,000 in Year 2.
In Years 2 to 4, as the first performance obligation is being completed, the provision increases to reflect the
higher net cost of satisfying the remaining performance obligations in the contract. As at the end of Year 4,
only the revenues and costs relating to the second performance obligation remain, such that the provision now
stands at €34,000 and is utilised in Years 5 and 6 as the related losses are incurred.
The table below illustrates the effect of this accounting treatment (assuming that the actual outcome of the contract
is the same as the updated estimates). This example ignores the time value of money for simplicity reasons.
Provision
Profit or
Additions/
loss for
Costs
Revenue
Utilisations
Balance
the period
Year 1
24,000
30,000
–
– 6,000
Year 2 (change in
–
–
16,000
16,000 (16,000)
estimated total costs)
Year 2
24,000
30,000
6,000
22,000
–
Year 3
24,000
30,000
6,000
28,000
–
Year 4
24,000
30,000
6,000
34,000
–
Year 5
32,000
15,000
(17,000)
17,000
–
Year 6
32,000
15,000
(17,000)
–
–
Total 160,000
150,000
–
– (10,000)
The effect of an onerous contract provision, or a change in the provision, is recognised
as an expense in profit or loss and not as an adjustment to revenue. [IAS 37.59].
As provisions for onerous contracts with customers are in the scope of IAS 37, they
should be classified as provisions in the balance sheet and disclosed in accordance with
IAS 37 (see 7.1 below). Onerous contract provisions are outside the scope of IFRS 15 and
should not be included within contract liabilities.
Since the definition of an onerous contract in IAS 37 refers only to a contract, the unit of
account to determine whether an onerous contract exists is the contract itself, rather than
the performance obligations identified in accordance with IFRS 15. [IAS 37.10]. As a result,
the entity must consider the entire remaining contract, including remaining revenue to be
recognised for unsatisfied, or partially unsatisfied, performance obligations and the
remaining costs to fulfil those performance obligations.
As discussed at 6.2 above, there is diversity in practice in how entities determine the
economic benefits expected to be received under a contract for the purposes of
assessing whether a contract is onerous. Where a contract with a customer contains
an element of variable consideration, it is likely that judgement will be required in
assessing the economic benefits expected to be received under a contract. This may
particularly be the case where an entity is required to constrain the estimate of
variable consideration to be included in the transaction price for revenue recognition
purposes under IFRS 15. Variable consideration under IFRS 15 is discussed further in
Chapter 28 at 6.2.
1920 Chapter 27
6.3 Decommissioning
provisions
Decommissioning costs arise when an entity is required to dismantle or remove an asset
at the end of its useful life and to restore the site on which it has been located, for
example, when an oil rig or nuclear power station reaches the end of its economic life.
Rather than allowing an entity to build up a provision for the required costs over the life
of the facility, IAS 37 requires that the liability is recognised as soon as the obligation
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 378