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Steve Scott paper F7 Financial Reporting

Main points of presentation

Overview of the F7 papers and performance to date Candidates strengths and weaknesses Tips for improvement in examinations Marginal candidates Syllabus issues How the exam emphasis might change

An overview of the three recent F7 papers will reveal candidates strengths and weaknesses. From this I will identify how examination performance can be improved with special reference to marginal candidates. This will be followed by discussing the some issues of the syllabus and how the emphasis of some questions may change in future examinations.

REVIEW OF PAST EXAMS

(Dec 07 to Dec 08)
The main focus of this years Teachers Conference is to build on the more general guidance given at the 2006 conference by relating it to the actual performance of candidates in the examinations from Dec 07 to Dec08. This is three papers in total. [click]

How the questions scored

Dec 07 June 08 Dec 08

Question 1 - consolidation Question 2 - company reporting Question 3

- interpretation

51% 52% 45% 35% 29% 40.3%

52 % 43% 42% 38% 21% 32.6%

60% 52% 40% 27% 40% 42.5%

Question 4
- remaining syllabus

Question 5 - remaining syllabus Percentage passing

Average mark expressed as a percentage of marks available

Before going into detailed issues, I thought a review of the average mark gained by candidates on each of the questions may prove informative. The table gives the average mark for each question expressed as a percentage of the total marks available for that question. The topics of the first three questions are broadly the same each diet. As we can see questions one and two are the best scoring questions for candidates. Question three is not quite as good, mainly because of mixed abilities with regard to the interpretation of financial statements. The two remaining questions covering the broader syllabus areas tend to achieve rather disappointing scores. [click]

WHAT WAS DONE WELL?

Looking at candidates performance in more depth[click]

Consolidated Accounts Financial Statements Performance Appraisal

What are often described as the core topics of question 1, 2 and 3 are generally done well. Looking at question one on consolidations. Although there is a great variety of material within this subject, candidates have a good understanding of most of the basic principles of this subject and have adopted an appropriate methodical approach to answers. [click] Question two requires candidates to produce or redraft the financial statements of a single entity company. Typically this will be an income statement, a statement of financial position and a statement of changes in equity, although it may be that not all of these are tested in every examination. Most candidates have mastered the approach of taking figures from a trial balance, making appropriate adjustments, and preparing the required statements. [click] Question three builds on candidates proficiency at producing financial statements by testing their ability to interpret or appraise the performance of a company from such statements. Questions normally ask candidates to prepare a statement of cash flows or calculate some accounting ratios prior to their interpretation. Answers to the required calculations are generally well done, the interpretation of them is another matter. [click]

WHAT WASNT DONE WELL?

Now for the bad news [click]

Consolidated accounts
Basics well understood, but - cannot discount or unwind deferred consideration - confusion over pre and post acquisition adjustment - a downward fair value adjustment was badly answered - ignoring calculation of non-controlling interest - significant number not time apportioning (when required) - still seeing the use of proportionate consolidation

I want to approach the issue of what candidates find difficult from two perspectives. Firstly, those aspects of the core topics that are not well understood and secondly problems in the remainder of syllabus. For consolidations it is the more complex adjustments that, not surprisingly, cause problems. [click] For example where an acquisition involves deferred consideration, candidates are weak at discounting the consideration to its present value and even weaker at being able to unwind the finance cost related to the deferred consideration. [click] There are many examples of confusion between what are pre acquisition adjustment and those that should be post acquisition. The elimination of unrealised profits (on inventories and non-current assets) are often treated as pre acquisition adjustments. In the June 08 paper it was a common error for all of the intra group sales (and profits) to be eliminated from the consolidated figures. It should only the post acquisition sales that are eliminated. [click] On a similar theme, a downward revaluation of a property required as part of the fair value exercise had been accounted for by the subsidiary in the post acquisition period. The effect of this was that the loss should have been treated as an adjustment between the subsidiary's pre and post acquisition profits. Many candidates ignored this treatment and instead accounted for the write down again effectively double counting the fall in value. [click] Other common mistakes are to completely ignore the calculation of non-controlling interest, particularly in the income statement Dec 08[click] .and I am still seeing the use of proportionate consolidation for subsidiaries and associates, though thankfully this is on a lesser scale than it used to be. The use of proportionate consolidation, particularly for subsidiaries is, in my view, guesswork. It is a rare technique in practice and is not in the F7 syllabus. I find it hard to imagine that a candidate attempting to employ this technique has worked any of the relevant past examination questions. [click]

Single entity financial statements

Revaluations and related subsequent depreciation Financial instruments: - use of nominal the interest rate instead of the effective rate - gains on investments at fair value through profit or loss taken to reserves Careless reading of the question ? Even basic deferred tax is not understood Statement of changes in equity

The preparation of financial statements for single company, often called a published accounts question, is usually from a trial balance, but may be tested as a restatement of draft accounts. Although both approaches essentially test the same body of knowledge, restatement questions are answered less well. June 08 was a restatement type question and scored an average of 43% compared to over 50% in both Dec 07 and 08. These questions contain adjustments that test the principles of many accounting standards, and it is these areas that are not well answered. [click] A perennial problem seems to be the revaluation of non-current assets. The timing of the revaluation is often misinterpreted by candidates as is the future depreciation charge. If the revaluation occurs at the end of the year then depreciation for the year, based on the assets previous value, must be accounted for before calculating the gain to the revaluation reserve or alternatively the impairment loss dependent upon the valuation. [click] There will usually be a financial instrument to deal with and candidates often use the nominal interest rate rather than the effective rate to calculate the finance cost. This confusion often carries over into the carrying value of the instrument in the statement of financial position. Another surprising problem, given their description, is that the gain relating to financial instruments described at fair value through profit of loss is frequently taken to reserves. [click] The June 08 paper required an adjustment to profit for some goods made on a sale or return basis. Many candidates adjusted for the whole of the sales rather than the amount covered by the right to return, and many deducted the sales revenue as the adjustment rather than just the profit element. I often attribute this type of error as careless reading of the question. [click] Relatively few candidates can get to grips with deferred tax. Common errors are candidates inability to distinguish between temporary differences the deferred tax provision and for the whole of the deferred tax provision to be charged to income statement (rather than the movement in the provision). Few candidate realise that deferred tax relating to a revaluation of non-current asset should be debited to the revaluation reserve (via other comprehensive income). [click] It is surprisingly common for candidates to make no attempt at a required SOCIE. This is surprising as it is an area where there are relatively easy marks to be gained. Though this was not as prevalent in the Dec 08 paper [click]

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Performance appraisal
Weak interpretation of ratios - general lack of commercial awareness - cannot spot clues in the question - rote learned approach, answer not related to scenario Poor format knowledge of statement of cash flows - cannot distinguish cash flows from non-cash flows - incorrect movement in cash flow; outflows shown as inflows

In performance appraisal questions, I find candidates have the most difficulty with the interpretation of cash flow information and calculated ratios. [click] The main issue seems to be the lack of intention on the part of candidates to actually consider what the ratios are telling them, possibly because a lack of commercial awareness. Far too often the analysis merely reiterates the information in the cash flow e.g. spending on non-current assets has increased by $430,000, or the current ratio has decreased from 2.5 to 1.4. I would stress that this kind of approach is not analysing or interpreting the data, it is merely describing it. What does attract marks are plausible explanations of why ratios may have changed or what the implication of the changes may be. [click] In Dec 07 question three required the comparative performance of a company over a two year period where there had been a major acquisition at the beginning of the second period. The acquisition had had a substantial beneficial effect on the results of year 2, but few candidates really focused on this issue. Indeed without the acquisition the companys results would have been poor, but many candidates believed the companys underlying performance had improved. Also very few candidates could see through the selective ratios quoted by the Chief Executive when praising the companys performance. Many did not even address this issue despite the requirement clearly asking for it. In Dec 08 the question required the comparative performance of two separate companies from the prospective of a possible acquisition. A number of candidates treated this as if it was the comparative results of the same company over two years (as in Dec 07) and perform trend analysis. [click] In short many answers used a formulaic approach which gave no consideration to the information in the scenario. [click] Most candidates give a good attempt at preparing statements of cash flow, but less well-prepared candidates display some fundamental weaknesses including not knowing the format of the statement. [click] Other weaknesses are not being able to distinguish between cash and non-cash flows e.g. in June 08 movements in reserves and provisions were often reported as cash flows. [click] Another problem seems to be identifying whether an item is an inflow or an outflow of cash. In the case of the movement of working capital items, for example, the mark available is for the signing of the cash flow, not for the monetary amount. [click]

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Other problem topics:

Financial instruments Leases EPS Substance over form Written elements of questions: -Dec 07 - 35%; June 08 - 33%; Dec 08 32% - Poor handwriting (sometimes almost illegible) hampers the markers ability to award marks. Exam technique

Having dealt with problem areas within the core topics I will now look at problem areas in the wider syllabus. [click] June 08 contained a 10 mark question on a convertible loan note. This question polarised candidates in that they either scored badly, maybe one mark or even zero, or they scored quite well. Particularly disappointing was the inability to correct an assistants misunderstanding of the loans effect on the financial statements. [click] December 07 had 10 marks of question four relating to the treatment of leases. Many candidates did a reasonable attempt at the numbers, but were again poor at understanding the differential effect on the financial statements of a lease being treated as a finance lease compared to an operating lease. [click] A common and yet fundamental error in EPS calculations is that candidates fail to realise that the number of shares in issue is not the same as the monetary amount of share capital in issue. For example there would be 4 shares of 25 cents for every $1 of issued capital. [click] Many candidates find it difficult to grasp the substance of transactions where they differ from their legal form. Many candidates think obsessively that substance issues relate to finance leases and nothing else. [click] It is important to realise that normally approximately one third of the paper will be written or discursive questions; it was 35% in Dec 07 and 33% in June 08 and 32% in Dec 08. Amazingly a significant number of candidates make no attempt at all to answer these sections and many others give them only token attention. If a candidates intention is to try to pass on the computation sections alone, they would need to score over 75% on those sections a very tall order. [click] There seems to be a growing problem in that many markers report that it is becoming very difficult to read some scripts. Be aware that if part of a script cannot be read, it simply cannot be given any marks. [click] Issues of examination technique will be discussed a little later. [click]

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Fundamental issues
Cannot distinguish between depreciation on cost or reducing balance. Depreciation of land. Bank overdraft treated as an asset Cost of sales treated as purchases Definitions of (basic) ratios Proceeds of share issues not split between capital and premium Failure to properly read a questions requirement effectively answering a different question than was asked

It is unfortunately necessary to draw attention to what I consider are some fundamental weakness. Many of these should have been overcome in studying for paper F3. [click] Questions requiring depreciation on the reducing balance method are sometimes calculated on cost. This is either a fundamental weakness or careless reading. [click] [click] A similar comment can be said for treating a bank overdraft as an asset and cost of sales as purchases, yet these are frequent occurrences. [click] Some candidates are not aware of basic ratio definitions. Examples I have seen include the gross profit percentage incorrectly calculated on cost of sales and inventory holding periods based on sales revenue rather than the cost of sales and asset turnover calculated as the current ratio [click]. Another surprising weakness is the inability to allocate the proceeds of a share issue between capital and premium. This principle can be tested in virtually any question. [click] As said, it is possible that some of the above are due to not reading the question properly. This can also lead to candidates answering a question that has not been asked. I must stress that no marks will be awarded to answers that are not relevant to the question asked. [click]

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LESSONS LEARNED
So are there any lessons that can be learned ? [click]

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From my point of view

Consolidated statements of financial position far better answered than income statements Questions on financial statements from trial balance score better than restatement of given draft accounts Whilst candidates are good at cash flows and ratio calculations, they are poor at interpreting them So the lesson learned try not to include all of the above in the same exam! June 08

[click] There are certain aspects of the core topics that are not as well answered as others. Candidates dont score as well on consolidated income statements as they do on consolidated statements of financial position. [click] Similarly candidates find it harder to redraft given financial statements rather than to prepare them from a trial balance. [click] Interpretation is less well answered than the underling computations of ratios and cash flows. [click] Perhaps I need to consider a better balance of these topics such that they do not all paper in the same paper. This may have been a contributor to the poor performance in June 08. That said, these are all important topics and will continue to be examined regularly.

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From a candidates point of view

Question spotting is fatal Prior paper competences are vital.. Dont rely on a revision course alone. Attempt all questions. Answer the question set by the examiner not the one you wish had been set. Dont waste time by telling the marker/examiner that you are running out of time!

[click] Dec 07 question three required the calculation of specified ratios and an interpretation of them. Remarkably in answering this question a small minority of candidates produced a cash flow statement. A few candidates even apologised and explained that they had gambled on a statement of cash flows question coming up, and thats what they were going to do! [click] In June 08, nearly a quarter of all candidates scored 30 marks or less. To me, this indicates that those candidates did not master, or have forgotten, the competences required at paper F3. There is a real need at paper F3 to study and practice full questions. If candidates cannot produce a basic set of financial statements, they wont be able to do an equivalent question at F7. [click] Many tutors complain that some candidates enrol on short revision courses when they have not done any prior study. This is not fair to tutors and very unlikely to result in success. [click] Even if candidates feel they have not studied an examined topic thoroughly, it is essential that they attempt some sort of answer. It takes only a few marks to change a marginal fail to a pass. [click]

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Percentage not attempted

Dec 07 June 08 Dec 08

Question 1 Question 2 Question 3 Question 4 Question 5 Total

< 1% 1.2% 2.5% 6.7% 15% 26%

< 1% 2.4% 2.7% 5.6% 26% 37%

< 1% 3% 3% 13% 15% 32%

Reinforcing the last point we can see that a substantial number of candidates do not attempt one or more questions, especially question five. [click]

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WHAT TO FOCUS ON?

Every tutor gets asked by candidates questions like where do I focus my efforts in order to achieve a pass or what topics do I need to know to gain 50 marks? Understandable though these questions are, they can be major part of the problem. [click]

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Breath of study Understand the principles

Know the accounting standards

Application of knowledge Critical comments

[click] In order to be confident of a pass, candidates need an all round knowledge of the breadth of the syllabus. Whilst it goes without saying that the core topics previously discussed must be mastered, this alone will not guarantee success. Nor should it. My own strong view, which I believe is shared by ACCA, is that I would not be comfortable with candidates passing F7 by learning just three topics. It is poor grounding for paper P2 and does not equip members for life as a practising accountant. [click] Although some topics were eliminated from paper 2.5 when setting F7s syllabus, it still has a sizable syllabus. However it is the principles that need to be understood rather than detailed knowledge or great depth. Question 4 in June 08 required candidates to give examples of how some previously defined accounting concepts and principles are applied to the accounting treatment of inventory. [click] There is much merit in developing a methodical approach to answering some types of questions, it can improve accuracy and is time efficient. However a methodical approach should not obscure the need to understand the topic area. I see it as part of my job that future questions should examine topics in a different manner, format or combination of topics to previous questions. This means that memorising past questions is not the route to success. Questions will require learned knowledge to be applied to practical examples. [click] Scenario questions may require candidates to criticise or comment on views put forward by management. Question 5 in June 08 required candidates to discuss the validity of a financial assistants observations of effects of the issue of a convertible loan note. I would mention here, as a piece of examination technique, that agreeing with the observations in the question in their entirety is hardly likely to gain many marks what would be the point of such a question! [click] Question 2 will always require the understanding of many accounting standards to achieve a good mark. In June 08 this question covered at least eight accounting standards. [click]

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HOW TO IMPROVE?

Improving your chances of success is really following previous advice[click]

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In summary - all of the above!

Before starting F7 studies ensure competence in paper F3 material. Plan the study over a reasonable time span. Avoid adopting a mechanical approach; focus on principles and understanding. This will help when questions seem unfamiliar. Rote learning of facts or lists will not gain many marks. It is the ability to apply them that will be examined. Read the examiners report

[click] The starting point for F7 study is to have a good grounding at F3. A marginal pass at F3 may signify more work needs to be done on foundation knowledge. [click] When planning your studies, distinguish between learning the syllabus over a reasonable time span and the honing of knowledge and technique in the period immediately before the exam. Studies in the pre-exam period should be focused on attempting past questions. By this I mean a timed attempt simulating exam conditions, not just an audit of the answers. [click] Many candidates believe that rote learning of definitions, facts, lists or past answers is the key to success; it isnt and it will not gain many marks. Instead it is the ability to apply them that will be tested in the examination. [click] I frequently read candidates answers that do not address the question asked; they are reproductions of my answers to previous questions. These rote learned answers to past questions may be on the same subject area as the current question, but they are nonetheless different questions the require different answers. [click] Examiners reports can be found in the Student Accountant. These provide valuable feedback in the areas where previous candidates had difficulties. This should help you to avoid their mistakes. [click]

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Marginal candidates
An average of 7.5% of candidates score between 45 and 49 marks, therefore looking for no more than 5 marks to pass. Attempt all questions an all sections of questions: A real example: Q1 18 Q2 15 Q3 14 Q4 not attempted Q5 not attempted Total 47

For revision work as many past questions as possible

I want to make a special mention of marginal candidates. [click] By margin I mean candidates that score between 45 and 49 marks. [click]

All markers would agree that marginal candidates papers are the most difficult papers to mark. Many of these candidates fail, not because of a lack of knowledge, but often by a lack of technique or perhaps experience. The slide shows the score of an actual candidtes paper. Sadly I can find many similar ones. Only three more marks were required to pass yet there was no answer to question 4 or 5. Most people would agree that such candidates have the ability and (probably) the knowledge to pass, but are let down by other factors: - poor planning of the answers and their time allocation - a lack of confidence to attempt written questions or questions on topics they have not fully study - not enough practice of past questions - perhaps even thinking they have already done enough to pass

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FOCUS ON FUTURE EXAMS

What can be expected in the future.

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WHATS NEW?

Any new topics or material.

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No new topic areas

Some existing areas are changing Developments of IAS 1: - terminology, presentation of income/comprehensive income
Developments of IFRS 3:

- calculation of goodwill and non-controlling interest - changes to contingent consideration - more recognisable intangibles

At the moment neither myself nor ACCA see the need for any new syllabus areas. [click] Future accounting standards will be incorporated in the examinable documents if they are a revision of an existing included standard. Indeed the revision of an accounting standard is more likely to trigger an exam question. [click] Two recent examples of this are IAS 1 and IFRS 3. [click] The changes in terminology and presentation of financial statements have been incorporated in questions. Probably the most noticeable change for F7 is the presentation of revaluation gains. [click] The new Business Combinations standard IFRS 3 has more implications. [click] The calculation of goodwill and non-controlling interest has changed. Although the old method is still allowed, the new method is more likely to be examined. [click] There are also amendments to the recognition and accounting for subsequent changes in the value of contingent consideration. [click] Future questions may require candidates to recognise more types of intangibles as part of the acquisition of a subsidiary e.g. customer lists, newspaper titles, domain names etc. [click]

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WILL THINGS CHANGE?

Will any other aspect of the F7 paper change.

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Different approach?
Interpretation and cash flow question May target certain calculations and ratios Part of a statement on cash flows e.g. investing or/and financing activities ROCE and its components; focus on liquidity Looking for more understanding and less mechanical churning

I may adopt a slightly different approach to some types of questions. I would stress that this does not mean new subject areas. [click] As I said, I continue to be disappointed in many answers to cash flows and interpretations. [click] This may prompt me to set questions in targeted areas of a statement of cash flows or to focus on some important ratios. For example these may require the cash flows for just operating cash flows, investing actives or financing activities rather than a full cash flow question. [click] Similarly rather than expect a bank of ratio calculations, candidates may be required to focus on the calculation and interpretation of say ROCE and its components. [click] In doing this I would be trying to avoid the mechanical churn of ratios and bland comments that do not explain or interpret performance at all. Instead it would be testing whether candidates actually understand the meaning and implications of the ratios [click]

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Key messages
Importance of the position and purpose of F7 in relation to F3 and P2 Answer all questions (and parts of questions) and pay attention to question requirements Application more important then learning facts Develop commercial awareness interpretation questions Exam technique important time management, avoid question spotting, ignore hot tips for the exam Improve answer style by practicing past questions good structure, legibility, referencing

So what are the he key messages. An awareness of the progression from paper F3 to F7 and the role of F7 to in forming a solid footing going forward to study for paper P2. A major falling is that candidates jeopardize their chances of success by not answering all parts of the paper. A good memory of facts is useful, but it is the application of knowledge that will gain high marks. The best approach to the exams is to study the whole syllabus, practice past questions and improve your examination technique. In my opinion exam tips dont help candidates; question spotting should be avoided. There is no easy way to pass the examination - nor should there be.

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That covers the formal presentation, are there any questions

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