Accounting for an onerous lease splits cleanly along framework lines. Under IFRS, IAS 37 requires you to recognize a separate provision for the net loss on the contract once unavoidable costs exceed the economic benefits you expect from the lease. Under US GAAP, there is no equivalent onerous contract provision for leases; you instead test the right-of-use asset for impairment under ASC 360 and keep paying down the lease liability on its original schedule. The onerous lease provision under IFRS versus US GAAP is the first question to settle, because the mechanics, the balance sheet result, and even the ability to reverse the charge later all turn on which framework you report under.
When a Lease Becomes Onerous
A lease is onerous when the unavoidable costs of meeting your obligations under it exceed the economic benefits you expect to receive. The common patterns are a company locked into a long-term office or retail lease after relocating, downsizing, or losing the revenue that justified the space, and specialized equipment leases where the underlying technology has become obsolete mid-term.
Unavoidable costs include remaining lease payments, maintenance you are contractually obligated to perform, and any penalties or compensation owed to the landlord. Expected benefits include revenue from continued use, cost savings, and realistic sublease income. If the costs exceed the benefits, the lease is onerous, and the trigger event matters less than the math.
The IFRS Path: An IAS 37 Provision
IAS 37 defines an onerous contract as one where the unavoidable costs of meeting the obligations exceed the economic benefits expected under it. Three conditions must all be met before you recognize a provision: a present obligation exists from a past event, an outflow of resources is probable, and you can make a reliable estimate of the amount. When they are met, the full estimated loss is recognized immediately rather than spread across future periods.
Measuring the Provision
The provision equals the least net cost of exiting the contract. In practice you calculate two figures and record the lower one. The first is the net cost of fulfilling the lease through its remaining term. The second is the cost of terminating early.
Fulfillment cost starts with all remaining lease payments and directly related costs, then subtracts realistic sublease income. A 2022 amendment to IAS 37 clarified that costs of fulfilling a contract include both incremental costs, such as direct labor and materials, and an allocation of other costs that relate directly to fulfilling the contract, including depreciation on equipment used in performance. Companies that previously counted only incremental costs were understating their provisions.
Exit cost is whatever penalty, compensation, or termination payment the lease specifies for early termination. Many commercial leases fix this as a percentage of remaining rent or a lump sum. If the termination payment is structured over time, discount those future payments as well.
Discount Rate
When the time value of money is material, IAS 37 requires discounting the provision to present value. The rate must be a pre-tax rate reflecting current market assessments of the time value of money and the risks specific to the liability. It is not the incremental borrowing rate used for the lease liability under IFRS 16, which reflects the lessee’s credit risk when borrowing. Using the IFRS 16 rate in place of the IAS 37 rate will misstate the provision.
Worked Example
A company has 48 months remaining on an office lease at $10,000 per month, and the space sits empty after a headquarters relocation. After discounting the remaining payments and subtracting realistic sublease income of $2,000 per month from a partial sublet, the present value of fulfilling the lease is $340,000. The landlord offers early termination for a one-time $300,000 payment. The provision is $300,000, because the exit path is cheaper.
Impairment Comes First
Before recording the IAS 37 provision, assess whether the right-of-use asset is impaired under IAS 36. IFRS 16 explicitly subjects ROU assets to IAS 36 impairment testing. Reduce the ROU asset first, then determine whether the remaining net cost still warrants an onerous contract provision. Skipping the impairment step and jumping straight to the provision can double-count the loss.
The US GAAP Path: Impairing the Right-of-Use Asset
US GAAP has no general onerous contract provision for leases. The proper treatment when a lease turns bad is an impairment analysis of the ROU asset under ASC 360.
When a triggering event occurs, such as vacating leased space, committing to a plan to abandon the asset, or a sustained drop in cash flows associated with the asset, test the ROU asset or the asset group containing it for recoverability. ASC 360-10-35-21 lists indicators including a significant adverse change in how the asset is being used, a current-period operating loss combined with a history of losses, or a current expectation that the asset will be disposed of well before the end of its useful life.
The recoverability test compares the carrying amount of the ROU asset or asset group to the sum of undiscounted future cash flows expected from its use and eventual disposition. If undiscounted cash flows fall below carrying amount, the asset is not recoverable, and the impairment loss equals the difference between carrying amount and fair value.
Abandonment
When a company commits to abandoning leased space before the term ends, the decision itself is an impairment indicator. Test the ROU asset immediately. An abandoned ROU asset is reduced to its salvage value, typically zero or close to it, as of the cease-use date.
The lease liability does not change. Absent a modification or termination agreement with the landlord, you continue making lease payments and reducing the lease liability on its original amortization schedule. The impairment hits the asset side of the balance sheet, not the liability side. After impairment, the ROU asset is measured at its post-impairment carrying amount less accumulated amortization, and amortized over the shorter of the asset’s remaining useful life or the remaining lease term.
Journal Entries
IFRS Entries
The initial entry debits an expense account, often labeled Onerous Lease Expense or Restructuring Expense, and credits a Provision for Onerous Contract. The full estimated loss hits the income statement in the period the lease becomes onerous. As lease payments or the termination penalty are paid, debit the provision and credit cash. Any unwinding of the discount over time is recognized as a finance cost.
US GAAP Entries
Debit Impairment Loss and credit the Right-of-Use Asset for the difference between carrying amount and fair value. No separate provision or liability is created. The lease liability entries continue unchanged: each payment debits the Lease Liability, with interest expense for finance leases, and credits cash on the original schedule.
How Subleasing Affects the Calculation
Sublease income sits at the center of measuring an onerous lease because it directly reduces the net cost of fulfillment. Under both frameworks, expected sublease income can offset the burden, but only to the extent it is realistic and legally available.
Check the lease for restrictions before assuming any sublease income. Many commercial leases contain recapture clauses that let the landlord terminate the lease entirely when a tenant tries to sublease, sometimes accelerating remaining payments. Leases that permit assignment may still include profit-sharing provisions or consent requirements that limit the financial benefit. If subleasing is prohibited outright, you cannot include sublease income in the measurement at all.
Under US GAAP, ASC 842-20-35-14 specifies that when lease cost for the sublease term exceeds anticipated sublease income, that excess is an impairment indicator for the ROU asset. If you cannot sublease for enough to cover your own payments, you likely have an impairment to test.
Reviewing and Reversing the Charge
The frameworks diverge sharply here. Under IFRS, IAS 37 requires reviewing provisions at the end of each reporting period and adjusting them to reflect the current best estimate. If a sublease is secured at a better rate than assumed, or the landlord agrees to reduce remaining payments, the provision is reduced and the reduction is recognized as a gain. If an outflow is no longer probable, the provision is reversed entirely. Reversals cannot exceed the original amount recognized.
Under US GAAP, impairment losses on long-lived assets are not reversible. Once the ROU asset is written down, the reduction is permanent. If circumstances improve, such as re-occupying the space or entering a favorable sublease, the adjustment flows through future depreciation or amortization rather than reversing the impairment. This asymmetry can produce meaningfully different results when conditions improve after the initial charge.
Disclosure Requirements
Under IFRS
IAS 37 requires detailed disclosures for each class of provision: the carrying amount at the beginning and end of the period, additional provisions made, amounts used, unused amounts reversed, and the increase from the passage of time. Beyond the numerical reconciliation, you disclose the nature of the obligation, the expected timing of outflows, and the uncertainties affecting amount or timing. If expected reimbursement exists, such as a subtenant’s committed payments, disclose that amount and any asset recognized for it.
Under US GAAP and SEC Rules
ROU asset impairment losses are disclosed under ASC 360, covering the amount of the loss, the facts and circumstances leading to impairment, the method used to determine fair value, and the segment affected. For SEC registrants, Regulation S-K Item 303 requires disclosure of material cash requirements from known contractual obligations and any known trends or uncertainties reasonably likely to have a material impact on continuing operations. An onerous lease situation that will trigger significant impairment or restructuring charges often falls within the early-warning disclosure requirements, meaning the potential for future charges should be discussed before they are recorded.
Federal Income Tax Implications
Book and tax treatment diverge for onerous leases, creating temporary differences that affect the tax provision. Under 26 U.S.C. ยง 461(h), the all-events test for deducting a liability is not met any earlier than when economic performance occurs. For liabilities arising from the use of property, economic performance occurs as the taxpayer actually uses the property, not when the liability is recognized for accounting purposes.
The IFRS provision or the US GAAP impairment loss hits the income statement immediately, but the tax deduction comes only as lease payments are made. That gap creates a deductible temporary difference, which typically supports a deferred tax asset. Recognize the deferred tax asset only to the extent it is probable under IFRS, or more likely than not under US GAAP, that sufficient future taxable income will be available to realize the benefit.
Provision Versus Impairment as Distinct Concepts
The onerous lease provision and the ROU asset impairment address different sides of the balance sheet, even when they arise from the same business event. Impairment asks whether the carrying amount of the right-of-use asset has become unrecoverable. The IAS 37 provision asks whether the remaining contract obligation still produces a net loss beyond what impairment already captured.
Under IFRS, both analyses typically run. Test the ROU asset for impairment under IAS 36 and write it down if necessary, then determine whether the remaining contract still produces a net loss requiring an IAS 37 provision. Under US GAAP, the ROU impairment is the entire response; there is no second-step provision for the remaining contract loss. IFRS reporters may end up showing both a reduced ROU asset and a separate onerous contract provision for the same lease, while US GAAP reporters show only the impaired ROU asset alongside an unchanged lease liability. Neither framework lets the problem go unrecorded, but the mechanics and presentation differ enough that identifying the reporting framework is the first step before any entry is posted.