An onerous contract is a contract in which the aggregate cost required to fulfill the agreement is higher than the economic benefit to be obtained from it. Such a contract can represent a major financial burden for an organization.
When an onerous contract is identified, an organization should recognize the net obligation associated with it as an accrued liability and offsetting expense in the financial statements. This should be done as soon as the loss is anticipated.
An onerous contract may arise in relation to the sale of commodities, when the market price declines below the cost required to obtain, mine, or produce a commodity. Another example of an onerous contract is when a lessee is still obligated to make payments under the terms of an operating lease, but is no longer using the asset. The amount of the remaining lease payments, less any offsetting sublease income, is considered the amount of the obligation to be recognized as a loss.