A contract is onerous when the unavoidable costs of meeting its obligations exceed the economic benefits expected from it. FRS 102 requires the present obligation under an onerous contract to be recognised as a provision under Section 21, measured at the least net cost of exiting: the lower of the net cost of fulfilling the contract and any compensation or penalties for walking away from it.

What makes a contract onerous?

The definition sits in Example 2 of the appendix to Section 21 (paragraph 21A.2) and in the FRS 102 glossary: a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. Paragraph 21.11A then requires the present obligation under that contract to be recognised and measured as a provision.

Most contracts are executory, meaning neither party has yet performed, or both have performed to an equal extent. Paragraph 21.1B(c) keeps executory contracts outside Section 21 unless they are onerous, so an ordinary loss of profit on an unperformed contract is not recognised until it turns into an unavoidable net cost. Paragraph 21.1 also makes Section 21 the default for onerous contracts wherever another section of FRS 102 contains no specific requirement. The general recognition and measurement rules are explained in FRS 102 Section 21: provisions and contingencies.

How is an onerous contract different from expected future losses?

Paragraph 21.11B prohibits provisions for future operating losses. The appendix example of a loss making segment concludes that there is no past event obliging the business to pay out resources, so no provision is made, although the expected losses may indicate that assets are impaired under Section 27.

The difference is the contract. With an onerous contract, the business is already contractually bound to pay out resources for which it will not receive commensurate benefits. A shop that expects to trade at a loss next year has no onerous contract simply because of that forecast; a supplier bound to deliver goods at a fixed price below what they will now cost to make may have one.

How do you spot one in practice?

Typical triggers at a year end review include:

  • fixed price customer contracts where material, labour or energy costs have risen since the price was agreed;
  • purchase commitments at fixed prices or volumes for goods that are no longer needed or can only be sold at a loss;
  • service or licence agreements the business cannot cancel but no longer uses;
  • a cancelled project with non refundable commitments still running.

Leases need separate thought from 2026. For periods beginning on or after 1 January 2026, a lessee recognises a right of use asset for most leases, and paragraph 20.59 requires Section 27 to be applied to decide whether that asset is impaired. A vacated property therefore usually shows up as an impairment of the right of use asset, with the lease liability remaining on the balance sheet. On transition, paragraph 1.53(b) let lessees rely on their previous onerous lease assessment and reduce the right of use asset by any onerous lease provision held immediately beforehand. A lease kept off the balance sheet under the short term or low value exemption in paragraph 20.6 has no right of use asset to impair; see short term and low value lease exemptions.

How is the provision measured?

Paragraph 21A.2 sets out three linked ideas:

Unavoidable costs
The least net cost of exiting from the contract, which is the lower of the cost of fulfilling it and any compensation or penalties arising from failure to fulfil it.
Cost of fulfilling
The incremental costs of fulfilling that contract plus an allocation of other costs that relate directly to fulfilling contracts. Costs that do not relate directly to fulfilling contracts are left out.
Economic benefits
What the business expects to receive under the contract, such as the contract price.

The provision is then measured under the normal Section 21 rules: the best estimate at the reporting date, discounted where the time value of money is material, reviewed at each reporting date, with the unwinding of any discount shown as a finance cost (paragraphs 21.7 and 21.11).

What does the calculation look like?

Illustration only. A manufacturer has agreed to supply 10,000 units at £50 each, a total of £500,000, and cannot change the price. Since signing, costs have risen. At the year end the figures for the undelivered contract are:

Item Amount
Contract revenue still to be received £500,000
Incremental costs of making the units £480,000
Allocation of other costs directly related to fulfilling contracts £40,000
Cost of fulfilling £520,000
Net cost of fulfilling (£520,000 less £500,000) £20,000
Penalty for cancelling the contract £30,000

The least net cost of exiting is £20,000, because carrying on costs less than paying the £30,000 penalty, so a provision of £20,000 is recognised. If the penalty had been £15,000, the least net cost would be £15,000 and that would be the provision, whether or not management actually intends to cancel. If costs later fall back so the contract breaks even, the provision is reversed through profit or loss at the next review.

Is an onerous contract provision deductible for tax?

HMRC accepts at BIM46540 that Section 21 requires provision for onerous contracts as soon as a net loss is foreseen, giving rent on vacated property as an example and citing Herbert Smith v Honour. Following that case, the old non anticipation principle has no effect where the accounting treatment is required by GAAP. HMRC adds that the decision does not let through provisions for expenditure that would otherwise be disallowed, such as capital expenditure, and that the provision must be computed with sufficient accuracy (BIM46555).

For leases on the balance sheet, HMRC’s Business Leasing Manual at BLM51020 says an impairment of a right of use asset that is GAAP compliant should be accepted, for example where a property is vacated with no prospect of future benefit, while significant impairments of assets still in use should be referred to an advisory accountant. Remember also the general conditions at BIM46510 covered in capital or revenue expenditure.

What needs to be disclosed?

An onerous contract provision is a class of provision, so paragraph 21.14 applies: a reconciliation of the opening and closing balance, a description of the obligation and the expected timing of payments, the uncertainties involved and any expected reimbursement. Small entities applying Section 1A must give these disclosures under paragraph 1AC.31C. Where a large provision raises doubt about the business’s finances, the directors should also consider the going concern assessment.

What mistakes come up?

  • Providing for a forecast trading loss with no binding contract behind it, which paragraph 21.11B forbids.
  • Providing for the full contract cost instead of the net loss, or ignoring a cheaper exit route.
  • Loading the cost of fulfilling with general overheads that do not relate directly to fulfilling contracts.
  • Continuing to hold an onerous lease provision for a lease now on the balance sheet, instead of testing the right of use asset for impairment.
  • Failing to revisit the provision when prices or volumes change.
  • Treating the whole provision as tax deductible when part relates to capital items.

For repairs and reinstatement on leased premises, see dilapidations provisions.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.