Do The SPPI Contractual Cash Flow Characteristics Test – FAQ | IFRS

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 be in circumstances in which the equity conversion feature is for a variable number of the issuer’s equity shares that have a fair value equal to the unpaid principal and interest, and the equity shares are quoted on a public market. However, if the issuer was a private company then it is likely that the SPPI test would be failed because of liquidity risk.

See the table below to obtain an overview of the decision process this test is part of:

Do the SPPI contractual cash flow characteristics test

Here are some examples of the SPPI test for certain financial instruments and its outcome:


SPPI test for loan with zero interest and no fixed repayment terms

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; Do the SPPI contractual cash flow characteristics test
  • Repayable on demand of Parent A. Do the SPPI contractual cash flow characteristics test

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

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


SPPI test for loan with zero interest repayable in five years

Parent A provides a loan of CU10 million to Subsidiary B. The loan has the following terms:

  • No interest; Do the SPPI contractual cash flow characteristics test
  • Repayable in five years.  Do the SPPI contractual cash flow characteristics test

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

Answer: Yes. The principal (fair value) is CU10 million discounted to its present value using the market interest rate at initial recognition. The final repayment of CU10 million represents a payment of principal and accrued interest.


SPPI test for a loan with interest rate cap

Entity B lends Entity C CU5 million for five years, subject to the following terms:Do the SPPI contractual cash flow characteristics test

  • Interest is based on the prevailing variable market interest rate;  Do the SPPI contractual cash flow characteristics test
  • Variable interest rate is capped at 8%;  Do the SPPI contractual cash flow characteristics test
  • Repayable in five years. Do the SPPI contractual cash flow characteristics test

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

Answer: 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.


SPPI test for loan with profit linked element Do the SPPI contractual cash flow characteristics test

Entity D lends Entity E CU500 million for five years at an interest rate of 5%. Do the SPPI contractual cash flow characteristics test

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 5% interest, Entity D will be entitled to an additional 10% of the final net profits from the project.

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

Answer: Yes. The prepayment option is not contingent on any future event. Do the SPPI contractual cash flow characteristics test

The prepayment penalty is considered to be reasonable additional compensation for early contract termination.


SPPI test for convertible note Do the SPPI contractual cash flow characteristics test

Question: Does an investment in a convertible note that converts into equity instruments of the issuer meet the SPPI contractual cash flows characteristic test?

Answer: No. IFRS 9 requires analysis of the terms of the convertible note in its entirety. The interest rate in a convertible note does not reflect the consideration for the time value of money and the credit risk (except when the shares are used as a currency, with a variable number of shares being issued that are equal in value to the unpaid principal and interest). Do the SPPI contractual cash flow characteristics test

The interest rate is usually set lower than the market interest rate. The overall return is also linked to the value of the equity of the issuer such that the conversion feature would potentially enhance the overall return. Do the SPPI contractual cash flow characteristics test


SPPI test for commodity-linked note Do the SPPI contractual cash flow characteristics test

Question: Does an investment in a bond with contractual interest payments linked to a commodity price (e.g. the price of gold, copper etc.) meet the SPPI contractual cash flows characteristic test? Do the SPPI contractual cash flow characteristics test

Answer: No, because the interest rate reflects the changes in the specified commodity price and not compensation for the time value of money and credit risk.


SPPI test for deferred consideration receivable in a business combination

Company O sold one of its subsidiaries to Company P. The purchase consideration consists of a deferred payment of CU10 million payable in two years.

Question: Does the receivable meet the SPPI contractual cash flows characteristic test? Do the SPPI contractual cash flow characteristics test

Answer: Yes, the initial principal amount (fair value) is CU10 million discounted at the market interest rate for two years. The payment of CU10 million represents principal and accrued interest.

See also: The IFRS Foundation

Do the SPPI contractual cash flow characteristics test

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