SPPI test & business model objective test
Which criteria should be applied first – SPPI test or business model test?
SPPI test refers to the evaluation of contractual cash flows that analyses if such cash flows represent solely payments of principal and interest on the principal amount outstanding.
Business model is in fact not a test. An entity should examine its business model to arrive at whether the financial assets are held with the sole purpose of generating contractual cash flows or buying and selling of such financial assets or both.
There is no specific order in which the two above-mentioned criteria are to be examined. An entity should classify a financial asset on the basis of its contractual cash flow characteristics if the financial asset is held within a business model whose objective is to hold assets to collect contractual cash flows or within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets. To do so, an entity should determine whether the asset’s contractual cash flows are solely payments of principal and interest on the principal amount outstanding.
Contractual cash flows that are solely payments of principal and interest on the principal amount outstanding are consistent with a basic lending arrangement. In a basic lending arrangement, consideration for the time value of money and credit risk are typically the most significant elements of interest. However, in such an arrangement, interest can also include consideration for other basic lending risks (for example, liquidity risk) and costs (for example, administrative costs) associated with holding the financial asset for a particular period of time. In addition, interest can include a profit margin that is consistent with a basic lending arrangement. In extreme economic circumstances, interest can be negative if, for example, the holder of a financial asset either explicitly or implicitly pays for the deposit of its money for a particular period of time (and that fee includes the consideration that the holder receives for the time value of money, credit risk and other basic lending risks and costs). However, contractual terms that introduce exposure to risks or volatility in the contractual cash flows that is unrelated to a basic lending arrangement, such as exposure to changes in equity prices or commodity prices, do not give rise to contractual cash flows that are solely payments of principal and interest on the principal amount outstanding. An originated or a purchased financial asset can be a basic lending arrangement irrespective of whether it is a loan in its legal form.
