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ACCA Applied Knowledge · Financial Accounting · Provisions and contingencies

Brandt plc signed a non-cancellable contract to rent a warehouse for $90,000 a year for the next 3 years. It has now ceased using the warehouse and can sublet it for $50,000 a year for the 3 years. Ignoring discounting, what provision should be recognised for the onerous contract?

The provision is $120,000. The net unavoidable cost is annual rent of $90,000 less sublet income of $50,000, which is $40,000 a year, and over the three remaining years this totals $120,000 when discounting is ignored.

  1. A$40,000
  2. B$270,000
  3. C$120,000Correct
  4. D$150,000

Explanation

The unavoidable cost of the contract is the lower of the cost of fulfilling it and any compensation from failure to fulfil it. Here the net cost is the rent of $90,000 less sublet income of $50,000 = $40,000 a year, over 3 years = $120,000. Providing $270,000 ignores sublet income.

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