Onerous Contracts

An onerous contract is a contract in which the unavoidable costs of meeting the obligations outweigh the economic benefits that the company expects to receive. This can occur when the costs of fulfilling a contract increase unexpectedly or when market conditions change, making the contract unprofitable. Under accounting standards, companies must recognize a provision for the loss associated with an onerous contract as soon as it is identified.

Example

A construction company has an onerous contract to build a facility, but due to rising material costs, the expenses to complete the project exceed the payment they will receive, making it a financial loss.