If a financial asset would otherwise meet the SPPI test, but fails to do so only as a result of a contractual term that permits or requires prepayment before maturity, or permits or requires the holder to put the instrument back to the issuer, then the asset can be measured at amortised cost or FVOCI if:
- the relevant business model test is satisfied;
- the entity acquired or originated the financial asset at a premium or discount to the contractual par amount;
- the prepayment amount substantially represents the contractual par amount and accrued (but unpaid) contractual interest, which may include reasonable compensation for early termination; and
- on initial recognition of the financial asset, the fair value of the prepayment feature is insignificant. [IFRS 9 B4.1.12]
Reasoning behind the par prepayment exception
The IASB decided to provide this narrow-scope exception because it was persuaded by the feedback that amortised cost would provide useful and relevant information for certain financial assets that would otherwise fail the SPPI test. The Board gives the following examples:
- purchased credit-impaired assets acquired at a deep discount to par; and
- financial assets originated at below-market rates – e.g. a loan provided to a customer as a marketing incentive such that the loan’s fair value at initial recognition is significantly below the contractual par amount advanced.
In these cases, the borrower may have the contractual ability to prepay at par, but the contractual prepayment feature would have an insignificant fair value as it is very unlikely that a prepayment will occur. In the first example, the prepayment is very unlikely because the financial asset is impaired and so the borrower is unlikely to have funds from which it could prepay the asset. In the second example, it is very unlikely that the customer will choose to prepay, because the interest rate is below-market and the financing is advantageous. Consequently, the amount at which the loan can be prepaid does not introduce variability that is inconsistent with a basic lending arrangement. [IFRS 9 BC4 193–194]
These examples discuss circumstances in which a financial asset is originated or purchased at a discount to the par amount. However, the IASB noted that its rationale for the exception is equally relevant for assets that are originated or purchased at a premium. Possible examples might include:
- a fixed-rate bond that is acquired at a substantial premium to par, but which is prepayable at par only at the option of the holder;
- a bond that is acquired at a substantial premium to par but which is prepayable at the option of the issuer only in the event of a specified change in tax law that is considered very unlikely.