IFRS 9 – The ‘SPPI’ test

Under IFRS 9, one important condition for a financial asset to qualify for amortized cost classification is that the financial asset must meet the “SPPI” contractual cash flow characteristics test.

Contractual cash flows are considered to be SPPI, if the contractual terms of the financial asset only give rise to cash flows that are solely payments of principal and interest on the principal amount outstanding on specified dates. The interest must be significantly linked to time value of money and credit risk.

Therefore, if the contractual cash flows are linked to features such as changes in equity or commodity prices, they would not pass the SPPI test because they introduce exposure to risks or volatility that is unrelated to a basic lending arrangement.

In effect, the SPPI contractual cash flow test means that only debt instruments can qualify to be measured at amortized cost, since the terms of an equity instrument are never capable of giving rise to solely payments of principal and interest.


Example 1

Parent A provides a loan to Subsidiary B. The loan is classified as a current liability in Subsidiary B’s financial statements and has the following terms:

  • No interest
  • No fixed repayment terms
  • Repayable on demand of Parent A.

Question:  Does the loan meet the ‘SPPI’ contractual cash flows characteristic test?

Solution 1

Yes. The terms provide for the repayment of the principal amount of the loan on demand.


Example 2

Parent A provides a loan of $20 million to Subsidiary B. The loan has the following terms:

  • No interest
  • Repayable in six years.

Question: Does the loan meet the ‘SPPI’ contractual cash flows characteristic test?

Solution 2

Yes. The principal (fair value) is $20 million discounted to its present value using the market interest rate at initial recognition.

The final repayment of $20 million represents a payment of principal and accrued interest.


Example 3

Entity B lends Entity C $8 million for five years, subject to the following terms:

  • Interest is based on the prevailing variable market interest rate
  • Variable interest rate is capped at 7%
  • Repayable in five years.

Question: Does the loan meet the SPPI contractual cash flows characteristic test?

Solution 3

Yes. Contractual cash flows of both a fixed rate instrument and a floating rate instrument are payments of principal and interest as long as the interest reflects consideration for the time value of money and credit risk.

Therefore, a loan that contains a combination of a fixed and variable interest rate meets the contractual cash flow characteristics test.


Example 4

Entity D lends Entity E $14 million for five years at an interest rates of 6%.

Entity E is a property developer that will use the funds to buy a piece of land and construct residential apartments for sale.

In addition to the 6% interest, Entity D will be entitled to an additional 11% of the final net profits from the project.

Question: Does the loan meet the ‘SPPI’ contractual cash flows characteristic test?

Solution 4

No. The profit linked element means that the contractual cash flows do not reflect only payments of principal and interest that consist of only the time value of money and credit risk.

Therefore, the loan will fail the requirements for amortized cost classification. Entity D will account for the loan at fair value through profit or loss.


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