IFRS 9 Best long-read SPPI Test

The SPPI Test

If an asset is in a hold-to-collect or hold-to-collect or sell business model, an entity assesses whether the cash flows from the financial asset meet the ‘solely payments of principal and interest’ (SPPI Test) benchmark – i.e. whether the contractual terms of the financial asset give rise, on specified dates, to cash flows that are solely payments of principal and interest.

  • Principal’ is the fair value of the financial asset on initial recognition. The principal may change over time – e.g. if there are repayments of principal.
  • Interest’ is consideration for the time value of money and credit risk. Interest can also include consideration for other basic lending risks and costs, and a profit margin.

A financial asset that does not meet the SPPI Test is always measured at FVPL, unless it is a non-trading equity instrument and the entity makes an irrevocable election to measure it at FVOCI. Here is the decision tree to put the narrative in context:

SPPI Test

Contractual cash flows that meet the SPPI Test are consistent with a basic lending arrangement in the banking industry.

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1 Best Complete Read – Financial Instruments

Financial Instruments is a summary of the current (Financial Statements preparation for 2020 on wards) IFRS reporting requirements relating to the combination of IAS 32 Financial Instruments: Presentation, IFRS 7 Financial instruments: Disclosure and IFRS 9 Financial Instruments, into one overall narrative.

IFRS standards for Financial Instruments have a complicated history. It was originally intended that IFRS 9 would replace IAS 39 in its entirety. However, in response to requests from interested parties that the accounting for financial instruments be improved quickly, the project to replace IAS 39 was divided into three main phases.

The three main phases of the project to replace IAS 39 were:

  1. Phase 1: classification and measurement of financial assets and financial liabilities.
  2. Phase
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9 Best practical Impairment related company loans

9 Best practical Impairment related company loans – What are related company loans?

Technically not the most difficult question one would think, BUT………

Entities must first consider whether the loan is within the scope of IFRS 9 or another standard. This is because IFRS 9: 2.1(a) scopes out ‘interests in subsidiaries, associates and joint ventures’ that are accounted for in accordance with IAS 27 Separate Financial Statements or IAS 28 Investments in Associates and Joint Ventures i.e. at cost less impairment or using the equity method.

In many cases, it will be clear that the loan is a debt instrument that falls within the scope of IFRS 9 but some scenarios may require a more detailed analysis.

IFRS 9 replaced Read more

IFRS 9 Proper accounting for Related Company Loans

IFRS 9 Proper accounting for Related Company Loans – IFRS 9 Financial Instruments makes no distinction between unrelated third party and related party transactions. Entities that prepare stand-alone financial statements are required to apply the full provisions of the standard to all transactions within its scope.

This means related company loan receivables must be classified and measured in accordance with the requirements of IFRS 9, including where relevant, applying the Expected Credit Loss (ECL) model for impairment. IFRS 9 Proper accounting for Related Company Loans

Applying IFRS 9 to related company loans can present a number of application challenges as they are often advanced on terms that are not arms-length or sometimes advanced on an informal basis without any terms … Read more

What is a Business Model?

What is a Business Model? The business model test is about whether the asset is part of a group or portfolio that is being managed within a business model whose objective is to collect contractual cash flows from the non-equity financial asset (Amortised Cost), or to both collect contractual cash flows from the non-equity financial asset and sell the non-equity financial asset (FVOCI). Otherwise, the asset is measured at FVPL (see summary schedule below). What is a Business Model?

An entity’s business model for managing financial assets:

  • reflects how financial assets are managed to generate cash flows
  • is determined by the entity’s key management personnel
  • does not depend on management’s intentions for individual instruments but is based
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IFRS 9 The Business Model Test

IFRS 9 The Business Model Test is a necessary condition (see IFRS 9 Classification and Measurement of Financial Instruments) for classifying a loan or receivable at Amortized Cost or FVOCI. The test is about whether the asset is part of a group or portfolio that is being managed within a business model whose objective is to collect contractual cash flows from the non-equity financial asset (Amortized Cost), or to both collect contractual cash flows from the non-equity financial asset and sell the non-equity financial asset (FVOCI). Otherwise, the asset is measured at FVPL. The key elements of this test are listed below.

Observe: IFRS 9 recommends applying the Business Model test before applying the SPPI test because this

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Do the SPPI contractual cash flow characteristics test

Do the SPPI contractual cash flow characteristics test summarises the classification of financial assets. A typical example of an instrument where the contractual cash flows would not meet SPPI would be a debt instrument with an interest rate that is linked to the issuer’s share price. Similarly, a debt instrument with an equity conversion feature, under which the holder has an option to convert the debt instrument into a fixed number of the issuer’s equity shares on maturity, would not meet the SPPI test. Do the SPPI contractual cash flow characteristics test

However, if an issuer uses its own shares as a ‘currency’ to settle a convertible debt instrument, then this might meet the SPPI test. This could … Read more

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.

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Instruments that may fail the SPPI test

Instruments that may fail the SPPI test – Careful consideration and a documented decision regarding the Solely Payment of Principal and Interest test is needed in the following cases:Instruments that may fail the SPPI test

[IFRS 9 B4.1.13, IFRS 9 BC4.186, IFRS 9 BC4.190]

Instruments that may fail the SPPI test

Instruments that may fail the SPPI test

Instruments that may fail the SPPI test

Contract description

Considerations

A bond with a stated maturity and payments of principal and interest linked to an unleveraged inflation index of the currency in which the instrument is issued. The principal amount is protected. This linkage resets the time value of money to the current level.

Linking payments of principal and interest to an unleveraged inflation index resets

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Contractually linked instruments

Contractually linked instruments - IFRS 9 provides guidance when an entity prioritises payments for linked instruments that create concentrations of credit risk