Corporate Accounting and Auditing · Provisions, Contingent Liabilities and Contingent Assets (Ind AS 37)

Onerous Contracts and Restructuring Provisions under Ind AS 37

Updated 10 October 2026 · Fact-checked

An onerous contract is one where the unavoidable cost of meeting the obligations exceeds the economic benefits expected. The unavoidable cost is the lower of the net cost of fulfilling (cost less benefits) and the penalty or compensation for exit, and that amount is the provision. A restructuring provision needs a detailed formal plan and a valid expectation in those affected, and covers only direct restructuring costs.

Understand Onerous Contracts and Restructuring Provisions

Ind AS 37 says a provision is made only when there is a present obligation from a past event, an outflow is probable, and the amount can be estimated reliably. Onerous contracts and restructuring are two special cases of this rule.

A contract is onerous when the unavoidable costs of meeting its obligations exceed the economic benefits you expect to receive under it. Example: you must buy goods at a fixed price and can only sell them at a loss. The contract itself is the past event. You do not wait for the loss to happen. You recognise the expected loss now, as a provision.

The unavoidable cost is the lower of two things: the net cost of fulfilling the contract (cost of fulfilling less the economic benefits you expect from it), and any compensation or penalty for failing to fulfil it. If you exit, you receive no benefits, so benefits are not deducted from the penalty. Under the current Ind AS 37, the cost of fulfilling includes incremental costs (direct labour, materials) and an allocation of other costs directly related to the contract (for example, depreciation of equipment used on it). General administrative costs that are not directly related are excluded. Before you make a separate provision, you first 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 the way it is conducted. Examples are sale or termination of a line of business, closure of a location, or a major reorganisation of management. A restructuring gives rise to a constructive obligation only when two conditions are both met: the entity has a detailed formal plan, and it has raised a valid expectation in those affected that it will carry out the restructuring, either by starting to implement the plan or by announcing its main features to them. A board decision alone is not enough.

Only direct expenditure arising from the restructuring is provided for. That means costs both necessarily entailed by the restructuring and not associated with ongoing activities. Costs like retraining staff, relocating continuing staff, marketing, and investment in new systems are not provided for. Future operating losses are never provided for. If a restructuring involves the sale of an operation, no obligation arises until there is a binding sale agreement.

Key rules to remember

Onerous contract provision: Provision = Lower of (Cost of fulfilling − Economic benefits expected, Penalty or compensation for exit); Applies only when the result is a loss. Benefits are not deducted from the penalty, as they are not received on exit. Recognise impairment of assets dedicated to the contract first.
Cost of fulfilling a contract: Incremental costs + Allocation of other costs directly related to the contract; Excludes general overheads not directly related to the contract.
Restructuring obligation test: Detailed formal plan + Valid expectation in those affected (by starting implementation or announcing main features); Both conditions are needed. Without them, no provision exists.
Restructuring provision amount: Direct expenditure = Necessarily entailed by restructuring AND not associated with ongoing activities; Typical items: employee termination payments, penalties on cancelling contracts. Exclude retraining, relocation, marketing, new systems and future operating losses.

How to solve Onerous Contracts and Restructuring Provisions questions

Use this order for any question on onerous contracts or restructuring. It keeps you from adding costs that the Standard does not allow.

1Identify the type: onerous contract or restructuring. Check the date of the event against the reporting date.
2For an onerous contract, list the expected economic benefits (revenue or savings) under the contract.
3List the cost of fulfilling: incremental costs plus directly related allocated costs. Leave out general overheads.
4Compute the net cost of fulfilling = cost of fulfilling − expected benefits. If it is zero or negative, the contract is not onerous and no provision is made.
5Find the exit cost: penalty or compensation payable for cancelling. The unavoidable cost is the lower of the net cost of fulfilling and the exit penalty. That amount is the provision. Note any impairment of dedicated assets to be recognised first.
6For restructuring, test the two conditions: detailed formal plan and valid expectation by the reporting date. If either is missing, provision is nil (disclose a contingent liability if relevant).
7If conditions are met, include only direct expenditure such as termination payments and contract cancellation penalties. Exclude retraining, relocation, marketing, new systems and future operating losses.
8Pass the journal entry (Profit and Loss Dr, Provision Cr) and state the disclosure in one line.

Quickest way: Two-question filter

When to use it: Use in MCQs and in short numerical parts when time is tight.

Onerous contract: ask 'What is the net loss if I stay in (cost less benefits), and what is the penalty if I exit?' Provide the smaller of the two.
Restructuring: ask 'Was the plan detailed and formal, and were affected people told or action started before the reporting date?' If no, answer nil.
Scan the cost list and strike out anything linked to the future running of the business: retraining, relocation, marketing, new systems, future losses.
Add the remaining items and write the total as the provision.

Common mistakes in Onerous Contracts and Restructuring Provisions

Providing for restructuring because the board approved it before year end.
Students treat a management decision as the obligating event.
Fix: Check for a detailed formal plan and a valid expectation raised in those affected (announcement or start of implementation) by the reporting date.
Including retraining, relocation and marketing costs in the restructuring provision.
These costs look connected to the restructuring.
Fix: Include only direct expenditure that is necessarily entailed and not tied to ongoing activities. Strike out costs of running the future business.
Providing for future operating losses of a business being closed.
Students think expected losses are a present liability.
Fix: Future operating losses are never provided for. Only an onerous contract or direct restructuring cost qualifies.
Using the net cost of fulfilling the contract even when the penalty to exit is lower.
Students forget that the unavoidable cost is the lower of the two.
Fix: Always compute both the net loss of fulfilling and the exit penalty, and take the lower.
Ignoring benefits expected under the contract, so the whole cost becomes the provision.
Students read the provision as the cost, not the net loss.
Fix: Deduct expected economic benefits from the cost of fulfilling to get the net cost. Do not deduct them from the exit penalty.
Providing for the loss before checking impairment of assets dedicated to the contract.
The order of recognition is not remembered.
Fix: Recognise impairment on those assets first, then provide for any remaining onerous loss.

Worked examples

Example 1

Bharat Fabrics Ltd has a contract to supply 10,000 metres of cloth at ₹300 per metre. At the reporting date, cost of fulfilling is ₹340 per metre (incremental costs only). The customer allows cancellation on payment of a penalty of ₹20,00,000. Compute the provision, if any.

Show the solution

Expected benefit = 10,000 × ₹300 = ₹30,00,000.
Cost of fulfilling = 10,000 × ₹340 = ₹34,00,000.
Net cost of fulfilling = ₹34,00,000 − ₹30,00,000 = ₹4,00,000. This is positive, so the contract is onerous.
Exit cost = penalty of ₹20,00,000. No benefit is received on exit, so nothing is deducted from it.
Provision = lower of (₹4,00,000, ₹20,00,000) = ₹4,00,000.
Fulfilling is the cheaper route, so provide ₹4,00,000.

Answer: Provision for onerous contract = ₹4,00,000. Debit Statement of Profit and Loss, credit Provision for Onerous Contract.

Example 2

Sundaram Industries Ltd decided on 15 March 2027 to close its Coimbatore plant. The detailed formal plan was approved by the board on 20 March 2027, and the main features were announced to employees on 25 March 2027. The year ends on 31 March 2027. Estimated costs: employee termination payments ₹80,00,000; retraining of staff moving to other plants ₹12,00,000; relocation of those staff ₹6,00,000; penalty for cancelling a supply contract ₹9,00,000; marketing campaign for new products ₹15,00,000; expected operating losses until closure ₹20,00,000. Compute the restructuring provision.

Show the solution

Test the conditions: a detailed formal plan existed and the main features were announced on 25 March 2027, before the reporting date. A valid expectation exists, so a constructive obligation exists.
Include direct costs only: termination payments ₹80,00,000 and contract cancellation penalty ₹9,00,000.
Exclude retraining ₹12,00,000 and relocation ₹6,00,000, as they relate to continuing staff and ongoing activities.
Exclude marketing ₹15,00,000, which relates to the future business.
Exclude operating losses ₹20,00,000, as future operating losses are not provided for.
Provision = ₹80,00,000 + ₹9,00,000 = ₹89,00,000.

Answer: Restructuring provision = ₹89,00,000. The other costs are recognised as and when incurred.

Exam tips

In theory answers, always name both conditions for a restructuring constructive obligation. Marks usually sit on 'detailed formal plan' and 'valid expectation'.
Read the dates carefully. An announcement after the reporting date means no provision at year end, even if the board decided earlier.
In numericals, show a two-column list of included and excluded costs with a reason for each exclusion. This earns step marks even if the total is wrong.
For onerous contracts, show the net cost of fulfilling and the exit penalty separately before picking the lower one.
In MCQs, any option that provides for future operating losses is wrong.

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

Onerous Contracts and Restructuring Provisions in other exams

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

Onerous Contracts and Restructuring Provisions: frequently asked questions

What is an onerous contract under Ind AS 37?

It is a contract in which the unavoidable costs of meeting your obligations exceed the economic benefits you expect to receive. You recognise the present obligation under it as a provision. The amount is the lower of the net cost of fulfilling (cost less benefits) and the penalty for exit.

What costs are included in a restructuring provision?

Only direct expenditure that is necessarily entailed by the restructuring and not associated with ongoing activities. Typical examples are employee termination payments and penalties for cancelling contracts. Retraining, relocation, marketing, investment in new systems and future operating losses are excluded.

When does a restructuring create a constructive obligation?

When you have a detailed formal plan and have raised a valid expectation in those affected. You do this by starting to implement the plan or announcing its main features to them. Both conditions must be met by the reporting date.

Can I provide for a restructuring that involves selling a business?

Not until there is a binding sale agreement. Until then, no obligation arises for the sale. Once the agreement is signed, the obligation exists only for the direct costs that qualify.