International Accounting Standards Board (IASB) has issued a decree regarding Onerous Contract-Cost of Fulfilling a Contract- Amendments to IAS 37 on May 14, 2020 after previously submitting an Exposure Draft on this decree on December 13, 2018. This amendment specifically describes the costs that must be included by the company in determining the cost of fulfilling a contract to assess whether the contract is onerous or not.
International Accounting Standards (IAS) Number 37 defines a single contract as a contract in which the cost of fulfilling the obligations contained in the contract exceeds the economic benefits that are expected. IAS 37 also states that the unavoidable costs of a contract represent the least net cost of the contract, which is lower than the cost of fulfilling and any compensation or penalties arising from failure to fulfill the contract. However, before this amendment was proposed, IAS 37 did not specify which costs should be included in determining contract fulfillment costs.
The classification of which costs must be incurred in determining the actual contract fulfillment costs is specific to the construction contract that was previously contained in IAS 11 concerning construction contracts that have been withdrawn since January 1, 2018. The amendment provides benefits to assess whether a contract is burdensome. Differences in views regarding which costs should be included in contract costs in the IAS 37 application may cause material differences in the entity’s financial statements entering into certain types of contracts.
Amendments to IAS Number 37 are scheduled to be implemented since January 1, 2022, however, the amendments can be carried out as soon as possible by companies that are ready and understand the changes contained in this amendment. In this project, the IASB developed an amendment to IAS 37 to clarify that for purposes of assessing whether a contract is onerous, the costs of contract fulfilment including both the incremental costs of fulfilling the contract and the allocation of other costs must be directly related to fulfilling the contract.
Based on the Exposure Draft ED/2018/2 concerning Onerous Contracts-Cost of Fulfilling a Contract which is a proposed amendment to IAS Number 37, the cost of contract fulfilment is a cost that directly related to the contract (compared to only incremental costs of the contract). The amendments also specify the classification of costs that are directly and indirectly related to the contract.
Below are the costs that are directly related to goods or services provision contract:
- Direct labor (such as salaries and wages for employees who process and deliver goods or provide services directly to other parties)
- Direct raw materials (such as equipment used to fulfill contracts)
- Cost allocation that is directly related to contractual activities (such as costs of management and supervision contracts, insurance, tools depreciation, equipment, and right-to-use assets to fulfill contracts)
- Costs that can be explicitly charged to the other party in a contract
- Other costs incurred simply because an entity is involved in the contract (for example, payments to subcontractors)
Meanwhile, costs that are not directly related to the contract are general and administrative costs, unless these costs are explicitly charged to other parties.
Adopting Amendments to IAS 37 Provisions, Contingent Liabilities and Contingent Assets: Onerous Contracts - Cost of Fulfilling the Contracts, the Indonesian Financial Accounting Standards Board (DSAK) has also compiled and issued a Draft Exposure Amendment to Indonesian Financial Accounting Standards 57. Responses to the Exposure Draft have been closed and ended on 30 November 2020.
In line with the application of IAS 37, the Amendments to PSAK 57: Provisions, Contingent Liabilities and Contingent Assets regarding Aggravating Contracts- Fulfilling Costs Contract are proposed to be effective in the annual reporting period starting on or after January 1, 2022, and allowing for earlier adoption. Based on the Exposure Draft, DSAK proposes additional classifications in determining the costs of contract fulfillment, which consists of:
- Allocation of incremental costs (such as direct and material labor)
- Other direct costs (such as the allocation of depreciation expense on the fixed assets used in contract fulfillment).
Also, DE Amendments to PSAK 57 propose an entity to apply these amendments to contracts that have not fulfilled all of their obligations at the beginning of the annual reporting period of the first application of the amendments by the entity (initial application date). Nor does the entity need to restate comparative information. Instead, an entity needs to make adjustments to the opening balance of retained earnings or other components of equity to recognize the cumulative effect of amendments’ initial application on the date of initial application.
Provisions, contingent liabilities and contingent assets generally have an amount and time that is not completely certain but must still be recognized because one of the accounting principles is conservatism, which is simply defined as the principle of prudence in financial reporting where the company does not immediately recognize the additional assets and profits but immediately recognizes any possible losses and liabilities. This contradicts taxation which has an aggressive principle, which recognizes transactions for actual events and does not allow the recognition of reserves as stated in Article 9 paragraph (1) letter c of the Income Tax Law:
To determine the amount of Taxable Income for domestic Taxpayers and permanent establishments, it may not be deducted:
c. Establishment or accumulation of reserve funds, except:
- Reserve for uncollectible accounts for banks and other business entities that extend credit, leasing with option rights, consumer finance companies, and factoring companies;
- Reserves for insurance businesses include reserves for social assistance established by the Health Social Security Agency;
- Guarantee reserves for the Deposit Insurance Corporation;
- Reserve for reclamation costs for mining businesses;
- Reserve for replanting costs for forestry businesses; and
- Reserve for closing and maintaining industrial waste disposal sites for industrial waste treatment businesses.
Due to differences in principles, it is necessary to have a positive fiscal correction in the financial statements for tax purposes.
This article is written based on the Draft Exposure of the Amendment to PSAK 57. Follow up the latest discussion in the next article after the issuance of the ratification of the Amendment to PSAK 57 in Indonesia.
References:
[1] DE Amendments to PSAK 57
[2] DE Amendments to IAS 37
