Page 9 - 13. COMPILER QB - INDAS 37

QUESTIONS FROM PAST EXAM PAPERS

Q8. (Nov. 18 – 4 Marks)

Sun Limited has entered into a binding agreement with Moon Limited to buy a custom-made machine for
Rs4,00,000. At the end of 2017-18, before delivery of the machine, Sun Limited had to change its method of
production. The new method will not require the machine ordered which is to be scrapped after delivery. The
expected scrap value is nil. Given that the asset is yet to be delivered, should any liability be recognized for

the potential loss? If so, give reasons for the same, the amount of liability as well as the accounting entry.
SOLUTION
As per Ind AS 37, Executory contracts are contracts under which

❖ neither party has performed any of its obligations; or
❖ both parties have partially performed their obligations to an equal extent.
The contract entered by Sun Ltd. is an executory contract, since the delivery has not yet taken place.
Ind AS 37 is applied to executory contracts only if they are onerous.

Ind AS 37 defines an onerous contract as a contract in which the unavoidable costs of meeting the obligations
under the contract exceed the economic benefits expected to be received under it.

As per the facts given in the question, Sun Ltd. will not require the machine ordered. However, since it is a
binding agreement, the entity cannot exit / cancel the agreement. Further, Sun Ltd. has to scrap the machine
after delivery at nil scrap value.

These circumstances do indicate that the agreement/ contract is an onerous contract. Therefore, a provision
should be made for the onerous element of Rs 4,00,000 i.e. the full cost of the machine.

Rs Rs
Onerous Contract Provision Expense A/c Dr. 4,00,000
To Provision for Onerous Contract Liability A/c 4,00,000
(Being asset to be received due to binding agreement recognized)

Profit and Loss Account (Loss due to onerous contract) Dr. 4,00,000
To Onerous Contract Provision Expense A/c 4,00,000
(Being loss due to onerous contract recognized and asset
derecognsied)

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