The contractual cash flow test (SPPI)

Learning objectives

• Determine whether the contractual cash flows of an asset are solely payments of principal and interest on the principal amount outstanding (time value of money, credit risk, other basic lending risks).L1, L2, L3, L4
• Prepare a workpaper documenting the contractual cash flow characteristics test (SPPI).L1, L2, L3, L4
• Support in writing, from the facts of the case, the judgement made on the contractual cash flow characteristics test (SPPI).L1, L2, L3, L4

Normative references

• IFRS 9 §4.1.3For the contractual cash flow characteristics test, principal is the fair value of the asset at initial recognition (it may change, for example with repayments), and interest consists of consideration for the time value of money and for the credit risk associated with the principal amount outstanding, as well as for other basic lending risks and costs (liquidity, administrative costs) and a profit margin.
• IFRS 9 §B4.1.7BUnder para. 4.1.3(a), principal is the fair value of the financial asset at initial recognition; that amount may change over the life of the asset, for example if there are repayments of principal. The exclusion of contractual terms that introduce exposure to risks unrelated to a basic lending arrangement, such as equity prices, is addressed in para. B4.1.7A.
• IFRS 9 §B4.1.7ASPPI cash flows are consistent with a basic lending arrangement: the time value of money and credit risk are typically the most significant elements of interest, which may also include consideration for other basic lending risks (for example, liquidity risk) and costs (for example, administrative costs) and a profit margin, and may even be negative in extreme circumstances; by contrast, contractual terms that introduce exposure to risks or volatility unrelated to a basic lending arrangement, such as changes in equity prices or commodity prices, do not give rise to SPPI cash flows.

Original summaries of the paragraphs (reference register), never a quotation of the standard.

3 questions

• For the contractual cash flow test, what does the principal of a financial asset represent?L1
• A training handout presents four statements about the contractual cash flow (SPPI) test. Which one is wrong?L2
• Vega SA has acquired a bond whose redemption is indexed to the price of an equity index. It holds this portfolio to collect its contractual cash flows. Which measurement category applies?L3