Instruments that failed the SPPI test

Instruments that failed the SPPI test – The following financial instruments in IFRS 9 have be carefully judged by the IASB and fail(ed) the Solely Payment of Principal and Interest test.

[IFRS 9 B4.1.9D, IFRS 9 B4.1.14] Instruments that fail(ed) the SPPI test

Contract description

Considerations

A bond that is convertible into a fixed number of equity instruments of the issuer.

The SPPI test is not met because the return on the bond is not just consideration for the time value of money and credit risk, but also reflects the value of the issuer’s equity.

An inverse floating interest rate loan – e.g. the interest rate on the loan increases if an interest rate index decreases.

The SPPI test is not met because interest has an inverse relationship to market rates and so does not represent consideration for the time value of money and credit risk.

A perpetual instrument that is callable at any time by the issuer at par plus accrued interest, but for which interest is only payable if the issuer remains solvent after payment and any deferred interest does not accrue additional interest.

The SPPI test is not met because the issuer may defer payments and additional interest does not accrue on the amounts deferred. As a result, the holder is not entitled to consideration for the time value of money and credit risk. However, the fact that an instrument is perpetual does not preclude it from meeting the SPPI test.

Financial instruments failing the SPPI test are valued at fair value through profit or loss (Reference is made to Classification of financial assets).Instruments that failed the SPPI test

Fair value through profit or loss means:  Instruments that failed the SPPI test Instruments that fail(ed) the SPPI test

IFRS 9: Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Why is the SPPI test important? Instruments that failed the SPPI test I

The classification decision for non-equity financial assets under IFRS 9, is dependent on two key criteria: Instruments that failed the SPPI test I

Consequently, determining whether a financial asset meets the SPPI test is necessary in order to determine the appropriate classification category under IFRS 9.

If a non-equity financial asset fails the SPPI test, it must be classified at Fair Value Through Profit or Loss (FVTPL) in its entirety. Unlike IAS 39, it is no longer possible to separate a financial asset into a ‘host’ contract (often measured at amortised cost) and an ‘embedded derivative’ component (measured at FVTPL). If a non-equity financial asset passes the SPPI test, then it will either be classified at amortised cost if the ‘hold to collectbusiness model test is met, or at Fair Value Through Other Comprehensive Income (FVTOCI) if the ‘hold to collect and sellbusiness model test is met.

What is the SPPI test?

The 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.

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.

Instruments that failed the SPPI test

Instruments that failed the SPPI test

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