②There is no obligation to a third party. The loss-making business could be closed and the losses avoided.

　　2. Onerous contracts

　　An onerous contract is a contract in which the unavoidable costs of meeting the contract exceed the economic benefits expected to be received under it.

　　A common example of an onerous contract is a lease on a surplus factory. The leaseholder is legally obliged to carry on paying the rent on the factory， but they will not get any benefit from using the factory.

　　The least net cost of an onerous contract should be recognized as a provision. The least net cost is the lower of the cost of fulfilling the contract or of terminating it and suffering any penalty payments.

　　Some assets may have been bought specifically for the onerous contract. These should be reviewed for impairment before any separate provision is made for the contract itself.

　　1Demo

　　Droopers has recently bought all of the trade， assets and liabilities of Dolittle， an unincorporatd business. As part of the take-over all of the combined business’s activities have been relocated at Droopers main site. As a result Dolittle’s premises are now empty and surplus to requirements.

　　However， just before the acquisition Dolittle had signed a three year lease for their premises at $6000 per calendar month. At 31 December 2003 this lease ad 32 months left to run and the landlord had refused to terminate the lease. A sub-tenant had taken over part of the premises for the rest of the lease at a rent of $2500 per calendar month.

　　Required

　　(a) Should Droopers recognized a provision for an onerous contract in respect of this lease?

　　(b) Show how this information will be presented in the financial statements for 2003 and 2004. Ignore the time value of money.

　　Solution：

　　Droopers has a legal obligation to pay a further $192000 to the landlord， as a result of a lease signed before the year end. Therefore an onerous contract exists and must be provided for.

　　There is also an amount recoverable form the sub-tenant of $80000(32×2500). This will be shown separately in the balance sheet as an asset.

　　The $192000 payable and the $80000 recoverable can be netted off in the income statement.

　　income statements　　2003　2004

　　$　$

　　provision for onerous lease contract

　　(net)112000 Dr.

　　net rental payable on lease (72-30)　-42000 Dr

　　release of provision　42000 Cr

　　112000 Dr.

　　balance sheets

　　receivalbes

　　amounts recoverable from sub-tenants80000 Dr.50000 Dr

　　liabilities

　　amounts payable on onerous contracts192000 Cr120000 Cr

　　3. Restructuring

　　A restructuring is a programme that is planned and controlled by management and has a material effect on：

　　①The scope of a business undertaken by the reporting entity in terms of the products or services it provides; or

　　②The manner in which a business undertaken by the reporting entity is conducted;

　　Restructuring includes terminating a line of business， closure of business locations， changes in management structure， and refocusing a business’s operations.

　　Restructuring provisions have always been quite common， and have often been misused. IAS37 restricts the recognition of restructuring provisions to situations where an entity has a constructive obligation to restructure.

　　A constructive obligation will only arise if：

　　①There is a detailed formal plan for restructuring. This must identify the businesses， locations and employees affected; and

　　②Those affected have a valid expectation that the restructuring will be carried out. This can be by starting to implement the plan or by announcing it to those affected.

　　The constructive obligation must exist at the year-end.(Any obligation arising after the year end may require disclosure under IAS10)

　　A board decision alone will not create a constructive obligation unless：

　　①The plan is already being implemented. For example， assets are being sold， redundancy negotiations have begun; or