Financial Reporting · Ind AS 37 Provisions, Contingent Liabilities and Contingent Assets

Ind AS 37: Onerous Contracts and Restructuring Provisions

Updated 5 October 2026 · Fact-checked

Apply the three Ind AS 37 recognition tests (present obligation from a past event, probable outflow, reliable estimate) to each case. An onerous contract gets a provision for the lower of the cost of exiting and the cost of fulfilling it. A restructuring needs a detailed formal plan and a valid expectation in those affected. Future operating losses never get a provision.

Understand Application of Recognition Rules: Onerous Contracts and Restructuring

Ind AS 37 gives general rules. The exam tests whether you can apply them to a situation. The rules are the same every time. Recognise a provision only if there is a present obligation (legal or constructive) from a past event, an outflow is probable (more likely than not), and you can make a reliable estimate.

The key phrase is past event. The obligating event must have already happened. A future intention or a management decision alone is not enough. This is why you cannot provide for future operating losses. No obligation exists for them yet. Expecting to lose money next year is a sign to test assets for impairment, not a reason for a provision.

An onerous contract is one where the unavoidable costs of meeting the obligations exceed the economic benefits expected from it. The contract itself is the past event. The unavoidable cost is the lower of the net cost of continuing with the contract (the unavoidable cost of fulfilling it, less the economic benefits expected from it) and any compensation or penalty for failing to fulfil it. When you work out the unavoidable cost of fulfilling, include the costs directly related to the contract: incremental costs (such as direct labour and materials) and an allocation of other costs directly related to contract activities (such as depreciation of equipment used for it). General administrative costs are not included unless the contract makes them chargeable to the counterparty. Before you make a separate provision, recognise any impairment loss on assets dedicated to that contract.

A restructuring is a programme planned and controlled by management that materially changes the scope of the business or how it is conducted. A constructive obligation arises only when the entity has a detailed formal plan and has raised a valid expectation in those affected, by starting to implement the plan or by announcing its main features to them. A board decision alone is not enough. The provision includes only the direct expenditure arising from the restructuring: necessarily entailed by it and not associated with the ongoing activities of the entity. So include employee termination costs. Exclude retraining, relocating continuing staff, marketing and investment in new systems.

Other cases follow the same logic. Warranties: the sale is the past event. Estimate the cost across the whole population of sales using expected values. Refunds: if a published policy creates a valid expectation of refunds, a provision is needed for expected returns. Decommissioning: the obligation arises when the facility is installed or the damage is caused. Provide for the present value of the cost. The matching debit is added to the asset cost under Ind AS 16, as the obligation is a cost of the asset.

Key rules to remember

Recognition test for a provision: Present obligation from a past event + Probable outflow (more likely than not) + Reliable estimate = Recognise; If any one condition fails, do not recognise. Consider a contingent liability disclosure instead, unless the outflow is remote.
Onerous contract provision: Provision = Lower of (Net cost of continuing = Unavoidable cost of fulfilling − Economic benefits expected) and (Penalty or compensation for exit); Compare the net cost of continuing with the exit penalty or compensation, and provide the lower. Recognise impairment on dedicated assets first.
Cost of fulfilling a contract: Incremental costs + Allocation of other costs directly related to the contract; This is the gross unavoidable cost used in the net cost of continuing above. Excludes general administrative costs not chargeable to the counterparty.
Restructuring provision: Provision = Direct expenditure necessarily entailed by the restructuring and not associated with ongoing activities; Include termination payments. Exclude retraining, relocation of continuing staff, marketing and new systems. Exclude future operating losses. Gains on expected asset sales are ignored.
Future operating losses: No past event → No present obligation → No provision; Always a no-provision answer. Check for asset impairment.
Warranty provision: Expected cost = Σ (Probability × Cost of each outcome) across the population of warranties; Use expected value for a large population of similar items. Discount if the time value of money is material.

How to solve Application of Recognition Rules: Onerous Contracts and Restructuring questions

Use the same sequence for every Ind AS 37 application question. Write each step briefly in the answer, since marks follow the logic.

1Identify the event the question describes. Ask: has the obligating event already happened by the reporting date?
2Check for a present obligation, legal or constructive. For restructuring, look for a detailed formal plan and a valid expectation (implementation started or main features announced).
3Test probability of outflow (more likely than not) and reliability of the estimate.
4If the contract is loss-making, compute the net cost of continuing (unavoidable cost of fulfilling less expected economic benefits) and the cost of exit (penalty or compensation). Take the lower as the unavoidable cost. Check for impairment of dedicated assets first.
5Measure the provision as the best estimate. Use expected value for large populations and the most likely outcome for a single item. Discount if the effect is material.
6Remove items that do not qualify: future operating losses, retraining, relocation, marketing, and anticipated gains on asset disposals.
7State the conclusion in provision-facts-conclusion form: the Ind AS 37 rule, the case facts, then the amount or the reason for no provision. Add a disclosure note if the item is a contingent liability.

Quickest way: Four-question filter

When to use it: Use this when the question is a short case MCQ or you have little time on a written part.

Question 1: Did the obligating event happen on or before the reporting date? If not, no provision.
Question 2: Is there a legal or constructive obligation? For restructuring, was the plan announced or started before the reporting date?
Question 3: For a loss-making contract, compare the penalty or compensation for exit with the net cost of continuing (unavoidable fulfilment cost less expected benefits). Provide the lower amount.
Question 4: Count only direct, necessary costs. Drop future losses, retraining, relocation and marketing, then write the figure.

Common mistakes in Application of Recognition Rules: Onerous Contracts and Restructuring

Providing for future operating losses because the business is expected to lose money.
Prudence feels like a reason to book the loss early.
Fix: No past event means no obligation. Say that no provision is made, and test the related assets for impairment under Ind AS 36.
Recognising a restructuring provision on the date the board approves the plan.
Students treat a decision as an obligation.
Fix: A board decision alone does not create a constructive obligation. You need a detailed formal plan plus a valid expectation in those affected through announcement or implementation before the reporting date.
Including retraining, relocation of continuing staff or marketing in the restructuring provision.
These costs are caused by the restructuring, so they look relevant.
Fix: Include only costs necessarily entailed by the restructuring and not associated with the ongoing activities of the entity. Those costs relate to future operations, so exclude them.
Measuring an onerous contract at the full fulfilment loss when exit is cheaper.
Students compute only one route.
Fix: Compute both the net fulfilment loss and the exit penalty. The provision is the lower of the two.
Skipping impairment of assets dedicated to the onerous contract.
The provision looks like the whole answer.
Fix: Recognise any impairment loss on those assets first. Then provide for the remaining unavoidable loss.
Netting expected gains on selling assets against a restructuring provision.
Students want the net cash effect.
Fix: Gains from expected disposal of assets are not taken into account when measuring a provision. Account for the disposal under the relevant standard.

Worked examples

Example 1

Case: Meru Ltd has a five-year supply contract to supply components at ₹400 per unit. The contract can be terminated on payment of a ₹5,00,000 penalty. On the reporting date, the unavoidable cost to make each unit has risen to ₹480 and 10,000 units remain to be supplied. No assets are dedicated to the contract. How much provision should Meru recognise?

Show the solution

Rule: a contract is onerous when unavoidable costs exceed expected benefits. The provision is the lower of the net cost of continuing with the contract and the penalty for exit.
The contract is the past event. Meru is already bound, so a present obligation exists.
Unavoidable cost of fulfilling: ₹480 × 10,000 = ₹48,00,000. Expected economic benefits: ₹400 × 10,000 = ₹40,00,000.
Net cost of continuing: ₹48,00,000 − ₹40,00,000 = ₹8,00,000.
Cost of exit: penalty of ₹5,00,000.
The lower amount is ₹5,00,000. No dedicated assets exist, so no impairment arises first.

Answer: Meru recognises a provision of ₹5,00,000, because the exit penalty is lower than the net cost of continuing of ₹8,00,000.

Example 2

Case: On 15 March 2027 the board of Tara Ltd decided to close its Pune plant. A detailed formal plan was approved. On 20 March 2027 the main features were announced to the plant's employees. Expected costs: employee termination payments ₹60 lakh; retraining of staff moving to other plants ₹15 lakh; relocation of equipment to continuing plants ₹10 lakh; expected operating losses of the plant until closure ₹25 lakh. The reporting date is 31 March 2027. What provision is required?

Show the solution

Rule: a restructuring provision needs a detailed formal plan and a valid expectation in those affected, through announcement or implementation, by the reporting date.
Facts: the plan was approved and the main features were announced to employees on 20 March 2027, before the reporting date. A constructive obligation exists.
Include only direct expenditure necessarily entailed by the restructuring and not associated with ongoing activities.
Termination payments of ₹60 lakh qualify.
Retraining of ₹15 lakh and relocation of equipment of ₹10 lakh relate to continuing operations, so exclude them.
Operating losses of ₹25 lakh up to closure are future operating losses, so exclude them.

Answer: Tara Ltd recognises a restructuring provision of ₹60 lakh. The other costs are charged to profit or loss as incurred.

Exam tips

Start every answer with the three recognition conditions. Then apply them to the facts. Examiners award marks for the logic.
In restructuring questions, check the dates. The announcement or start of implementation must fall on or before the reporting date.
Sort cost lists into 'include' and 'exclude' columns before computing. Many questions are built around that split.
For onerous contracts, always show both the fulfilment loss and the exit cost, then pick the lower.
In MCQs, 'future operating losses' and 'board decision only' are common wrong-option traps. Both lead to no provision.

Practice questions from Ind AS 37 Provisions, Contingent Liabilities and Contingent Assets

Application of Recognition Rules: Onerous Contracts and Restructuring in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Application of Recognition Rules: Onerous Contracts and Restructuring: frequently asked questions

Can I create a provision for future operating losses under Ind AS 37?

No. Future operating losses do not arise from a past event, so there is no present obligation. Instead, consider whether the expected losses indicate that related assets are impaired under Ind AS 36.

What is an onerous contract in Ind AS 37?

It is a contract where the unavoidable costs of meeting its obligations exceed the economic benefits expected from it. You recognise and measure the present obligation under the contract as a provision.

When does a restructuring create a constructive obligation?

When the entity has a detailed formal plan and has raised a valid expectation in those affected. This happens by starting to implement the plan or by announcing its main features to them.

How are warranty provisions measured?

For a large population of similar warranties, use the expected value: weight each possible outcome by its probability and add them. If the time value of money is material, discount the amount to present value.