Review a loss-making contract using its unavoidable costs

A project margin turning negative is a reason to investigate the contract, but it is not a completed provision calculation. Gather the enforceable remaining promises, customer consideration, termination rights and consequences of nonperformance. Have legal and accounting reviewers address uncertain terms before the team treats a commercial negotiation as an available exit.

IAS 37's onerous-contract assessment compares the economic benefits expected from a contract with its unavoidable costs. Those costs reflect the lower of fulfilling the obligation and the compensation or penalties associated with failing to fulfill it. The review is contract-specific; a general forecast of future operating losses follows a different accounting analysis.

Prepare the remaining work by deliverable, expected timing and source of cost. Under IAS 37, fulfillment costs include incremental costs and an allocation of other costs directly related to fulfilling contracts. A contribution-margin report that includes only purchased materials and subcontractors may therefore omit relevant costs.

Ask the reviewer which allocations are appropriate and retain the supporting basis. Separate sunk costs already recognized, future obligations and costs that do not belong to the contract. Reconcile the forecast to procurement commitments and delivery plans, marking assumptions that depend on unapproved staffing or supplier changes.

Obtain support for the cost and availability of each contractual alternative. An exit estimate should include the applicable settlement terms and required approvals. A proposal sent to the customer is not an accepted release. Record whether the company can act on the alternative at the reporting date and what uncertainty remains.

Suppose an illustrative contract has $80,000 of remaining benefits and supported fulfillment costs of $110,000. The company is also examining a $20,000 release payment. Those figures identify questions for the accountant; they do not justify automatically booking either $30,000 or $20,000 until the contractual position, measurement requirements and relevant asset assessments are resolved.

Identify assets used in fulfilling the contract and provide their carrying amounts and recoverability evidence. IAS 37 requires relevant impairment losses on such assets to be recognized before a separate onerous-contract provision is established. Coordinate the calculations so the same economic shortfall is not included twice without a supported accounting basis.

Give the final workpaper a clear boundary between the asset assessment and the remaining contract obligation. Show the approved entries, accounts and review dates. If the forecast includes assets shared with other contracts, have the accountant determine the appropriate assessment scope rather than allocating an arbitrary share of the total carrying value.

Refresh remaining costs and benefits when change orders, supplier settlements or delivery facts change. Preserve the earlier approved assessment and explain new information separately. Reconcile actual spending and settlement against the relevant provision movements, with release decisions approved rather than used to smooth a later project's margin.