What is the SPPI test?

The what is the 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?

Ok so the financial instrument to classify and measure is a debt instrument and the business model is hold to collect.

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: solely payments of principal and interest

  • The business model within which the asset is held (the business model test), and What is the SPPI test? the business model and SPPI tests
  • The contractual cash flows of the asset (the SPPI test). What is the SPPI test?

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. What is the SPPI test?

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.

The decision model you are going to guided through is as follows:

What is the SPPI test

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 What is the SPPI test?
  • 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. What is the SPPI test? solely payments of principal and interest

 

Which financial assets are likely to fail the SPPI test? the business model and SPPI tests

Common examples of financial assets that will fail the SPPI test are:

  • All equity investments because their contractual terms give rise to equity risk What is the SPPI test?
  • All derivatives because they are leveraged in nature What is the SPPI test?
  • 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. What is the SPPI test? solely payments of principal and interest

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.

Amortized Cost or FVOCI possible

FVPL mandatory

Bank deposits repayable on demand, where interest, if payable, is at a fixed or floating market rate

Investments in common shares where the holder does not designate the asset as FVOCI

Trade receivables requiring payment only of fixed amounts on fixed dates

Investments in mandatorily redeemable preferred shares and puttable instruments (or instruments issued by entities having a limited life) such as mutual fund units where non-payment of dividends is not a breach of contract or the holder has no claim for a fixed amount in bankruptcy

Full recourse loans or investments in debt securities that require only fixed payments on fixed dates

Self-standing derivative financial assets such as purchased options, swaps and forward contracts

Full recourse floating rate loans requiring fixed payments on fixed dates of principal and bearing interest at a floating market rate (such as the BA rate) where the interest rate is for a period that is the same as the interest rate reset period (e.g., the interest rate is reset every three months based on the 3 month BA rate)

Floating rate loans where the interest rate is for a period that does not correspond to the interest reset period (e.g., interest is reset every 3 months based on the 6 month BA rate) and the impact on cash flows is significant

Non-recourse loans (i.e., those where recourse is limited to specific assets) where at initial recognition the lender has an economic exposure to the underlying asset’s value and cash flows that is consistent with a basic lending arrangement

Non-recourse loans where at initial recognition the lender has an economic exposure to the underlying asset’s value and cash flows greater than that of a basic lender

Trade receivables, loans and investments in debt securities, having the attributes described above but that can be prepaid, subject to meeting certain criteria

Fixed or floating rate loans including terms where payments are based on factors such as equity or commodity prices, unless the terms are not genuine or their effect is de minimis

The question is: Are the contractual cash flows solely payments of principal and interest on the principal amounts outstanding?

Yes / No

See also: The IFRS Foundation

What is the SPPI test? solely payments of principal and interest

likely to meet the SPPI test