This Contractual cash flows SPPI? test is part of the decision model for the classification and measurement of financial assets, that started in the IFRS 9 Framework for financial assets. But you can also read it without doing the test …. off course?
What is the SPPI test is about the classification of non-equity instruments (financial assets) under IFRS 9, that is dependent on two key criteria:
- The business model within which the asset is held (the business model test), and Contractual cash flows SPPI
- The contractual cash flows of the asset (the SPPI test). Contractual cash flows SPPI
The solely payments of principal and interest (SPPI) test requires that the contractual terms of the financial asset (as a whole) give rise to cash flows that are solely payments of principal and interest on the principal amounts outstanding ie cash flows that are consistent with a basic lending arrangement. Unlike the business model test, this assessment must be carried out on an instrument by instrument basis. Contractual cash flows SPPI
Principal is defined as being the fair value of the financial asset at initial recognition. Interest is defined narrowly as being compensation for the time value of money and credit risk although it can also include compensation for other lending risks such as liquidity, administrative costs and a profit margin. Cash flows that provide compensation for other risks such as equity or commodity risk will fail the SPPI test because they are inconsistent with a basic lending arrangement.
Which financial assets are likely to meet the SPPI test?
Common examples of financial assets that will meet the SPPI test are: What is the SPPI test?
- A bond repayable in 3 years and paying variable or fixed market rate of interest What is the SPPI test?
- A fixed rate loan repayable in 10 years but allows the borrower to prepay at an amount equal to unpaid amounts of principal and interest on the principal amount outstanding
- An interest free loan by a parent to a subsidiary that is repayable in 5 years – this is because the principal amount (i.e. fair value at initial recognition) would be accreted back to par using the effective interest rate method.
Which financial assets are likely to fail the SPPI test?
Common examples of financial assets that will fail the SPPI test are:
- All equity investments because their contractual terms give rise to equity risk
- All derivatives because they are leveraged in nature
- A bond with interest payments linked to the EBITDA or revenue of the issuer or contingent consideration linked to profits generated by a business that has been sold – this is because these features introduce exposures to equity like risks.
Both the business model test and the SPPI test have to be met in order to account for an instrument at Amortized Cost or FVOCI. On this page, when we talk of passing or meeting one of these tests, we mean the asset can be measured at Amortized Cost or FVOCI as appropriate, assuming that the other test is met.
When we talk of failing the test, we mean that the asset must be measured at FVPL. Applying the Business Model and SPPI tests is not necessarily straightforward and their outcomes sometimes can be surprising. Consider, for example, the following table, which illustrates how the tests can affect the classification and measurement of common types of financial assets.
The question is: Are the contractual cash flows solely payments of principal and interest on the principal amounts outstanding?
Contractual cash flows SPPI
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