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The revised Reporting Standard IFRS-9 (and new converged standard in India i.e. Ind AS 109) has introduced two fresh paradigms or say, two new bones to the accounting systems for financial instruments viz. SPPI Test and Three-stage Expected Credit Loss Model. Although it has been more than a year since the IFRS-9 has been revised, it is still a riddle for banks and other industries having financial assets on the face of their financial statements.
Here we will understand about SPPI Test, It's evolution, How is this useful? What difference it will make to the accounting systems?

Occurrences that brought in SPPI Test

When the global financial crisis happened around 2007-08 leading to great recession and  European sovereign-debt crisis spoiling financial institutions in the world economy, increasing liquidity and credit adversities around the globe, concerns have been raised about delay in practice of loss provisioning on loans and other financial instruments. The less provisioning of losses used to provide less impact on the Profit or Loss of the banks, but alongside did not show the current financial position.

To deal with such concerns IASB stepped for these major changes, accurate loss provisioning has been standardised through covering recognition of some future expected losses along with already incurred losses in impairment mechanism. And to convey the fair balance sheet view, preventing to even look for impairment at first, the changes to classification of financial instruments included SPPI Test.

SPPI Test and its utility

SPPI Test is basically the assessment of contractual cash flow features contained in a financial asset. The standard says that the contractual cash flows need to be Solely Payments of Principal and Interest (SPPI), so that the financial asset’s classification qualifies as either Amortised Cost or Fair Value through Other Comprehensive Income (FVOCI). If it fails to meet SPPI test criterion above, such financial asset will be classified as Fair Value through Profit or Loss (FVTPL). This testing is required on the contractual cash flow characteristics of each instrument, instead of overall portfolio or business.

It is to note that cash flows from equity instruments and derivatives do not contain principal or interest elements. Mostly such assets will be classified as FVTPL, though equity instruments not held for trading may initially opt for FVOCI which will be an irreversible option. So the only utility of SPPI Test is with respect to such financial assets which are debt instruments.

The difference this Test will bring

For instance, if the loan involves contractual terms like prepayment before maturity which may change the timing, risk associated or amount of contractual cash flows in future, then both the cash flows ‘before change’ and ‘after change’ have to satisfy the SPPI test criterion to qualify loan for Amortised Cost classification. Such ‘after change’ cash flows may include additional compensation which should be reasonable to set off the loss from such change.

Proceeding with the same instance, suppose there is no penalty or premium to compensate for premature termination of the loan contract, prepayment will become significant and encouraged feature of the loan changing the fair value as soon as the market rates of interest fluctuate, and thus failing SPPI Test the loan will be classified at fair value. Therefore it is necessary to carefully assess the features of contractual cash flows to avoid extravagant SPPI Test failures, because such failures could lead to higher profit or loss volatility and could thereby influence the financial position and regulatory capital levels of the organization.

Closing Thoughts

IFRS-9 (Ind AS 109 in India) aims to provide fair reporting of financial instruments through Amortised Cost as long as the contractual cash flows have limited credit or lending risk, and are in consistent with a basic lending arrangement. A basic lending arrangement primarily looks for earning to cover time value of money invested and lending risk associated.

Henceforth, SPPI Test completes this aim by screening out financial assets with high variability and risk features and routing such variation to P&L Statement using FVTPL, which was earlier missing. Possibly a useful obligation, future will reveal more!

The author can also be reached at


Published by

CA. Akhil Maheshwari, CMA, MBA
(CA,CMA(USA),MBA,CS Professional,S.IAI)
Category Professional Resource   Report

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