Solely Payments of Principal and Interest (SPPI) Test: An entity should assess whether contractual cash flows are Solely Payments of Principal and Interest (SPPI) on the principal amount outstanding for the currency in which the financial asset is denominated.

Principal is the fair value of the financial asset at initial recognition. However, principal may change over time – e.g. if there are repayments of principal. Principal is not the amount due but the fair value of financial asset. This meaning reflects the economics of the financial asset from the perspective of the holder. An entity should evaluate the contractual cash flows to the amount that it invested.

Interest is consideration for the time value of money, the credit risk associated with the principal amount outstanding during a particular period of time, consideration for other basic lending risks (e.g. liquidity risk) and costs (e.g. administrative costs) and a profit margin.

Principal is not the amount due but the fair value of the financial instrument at initial recognition. Transaction price is generally a good measure of the fair value at initial recognition, as there is nothing like ‘free lunch’ in business. If not, then the difference is recognized in PL immediately (both gain or loss as the case may be).