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Annual Reporting

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Menu
 * IFRS Topics A – Z
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   * IFRS vs US GAAP Financial Statement presentation
   * IFRS vs US GAAP Revenue recognition
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   * IFRS vs US GAAP Financial assets
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WHAT IS THE SPPI TEST? – IFRS 9 BEST COMPLETE READ

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:

 * 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:



Topics hide
Which financial assets are likely to meet the SPPI test?
Which financial assets are likely to fail the SPPI test?
What is the SPPI test? solely payments of principal and interest


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?

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


WHAT IS THE SPPI TEST? SOLELY PAYMENTS OF PRINCIPAL AND INTEREST




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