IFRS 9-The SPPI test explained by example!!!

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. Here are some examples to obtain an understanding for the IFRS reasoning:

Loan with zero interest and no fixed repayment terms

Relevant IFRS paragraphs [IFRS9.B4.1.7] – [IFRS 9.B4.1.9]

Parent A provides a loan to Subsidiary B. The loan is classified as a current liability in Subsidiary B’s financial statements and has the following terms:

  • No interest;
  • Repayable on demand of Parent A.

Question: Does the loan meet the SPPI contractual cash flows characteristic test?

Answer: Yes.

The terms provide for the repayment of the principal amount of the loan on demand.

Loan with zero interest repayable in 5 years

Parent A provides a loan of CU10 million to Subsidiary B. The loan has the following terms:

  • No interest;
  • Repayable in five years.

Question:

Does the loan meet the SPPI contractual cash flows characteristic test?

Answer: Yes.

The principal (fair value) is CU10 million discounted to its present value using the market interest rate at initial recognition. The final repayment of CU10 million represents a payment of principal and accrued interest.

Loan with interest rate cap

Entity B lends Entity C CU5 million for five years, subject to the following terms:

  • Interest is based on the prevailing variable market interest rate;
  • Variable interest rate is capped at 8%;
  • Repayable in five years.

Question: Does the loan meet the SPPI contractual cash flows characteristic test?

Answer: Yes.

Contractual cash flows of both a fixed rate instrument and a floating rate instrument are payments of principal and interest as long as the interest reflects consideration for the time value of money and credit risk. Therefore, a loan that contains a combination of a fixed and variable interest rate meets the contractual cash flow characteristics test.

Loan with profit linked element

Entity D lends Entity E CU500 million for five years at an interest rate of 5%.

Entity E is a property developer that will use the funds to buy a piece of land and construct residential apartments for sale. In addition to the 5% interest, Entity D will be entitled to an additional 10% of the final net profits from the project.

Question: Does the loan meet the SPPI contractual cash flows characteristic test?

Answer: No.

The profit linked element means that the contractual cash flows do not reflect only payments of principal and interest that consist of only the time value of money and credit risk. Therefore, the loan will fail the requirements for amortised cost classification. Entity D will account for the loan at fair value through profit or loss.

Leave a Comment

Your email address will not be published. Required fields are marked *