What is the primary characteristic of an onerous contract?

An onerous contract is defined primarily by the relationship between unavoidable costs and expected economic benefits. In this context, the essential characteristic is that the costs that an entity cannot avoid when fulfilling its contractual obligations exceed the benefits expected to be derived from the contract. This situation often arises in scenarios where continuing with the contract would lead to losses, making it unfavorable for the entity to maintain.

Identifying an onerous contract is critical for financial reporting, as it requires the recognition of a provision for the losses expected to be incurred. By understanding that the hallmark of an onerous contract is when the unavoidable costs exceed the expected economic benefits, entities can appropriately manage and report such contracts, thus providing accurate financial information to stakeholders.

The other choices do not accurately capture the essence of an onerous contract. The potential for profit is not a characteristic, as a hallmark of an onerous contract is the lack of profit. Similarly, simply considering the net cost of exiting the contract does not address the ongoing relationship with the cost versus benefit while the contract is still active. Finally, contracts that guarantee economic advantages would not be onerous; rather, they would generally be classified as favorable and beneficial to the entity.