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Steve Scott paper F7Financial Reporting

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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

Main points of presentation

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

examinations.

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REVIEW OF

PAST EXAMS(Dec 07 to Dec 08)

The main focus of this years Teachers Conference is to build on the moregeneral 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]

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How the questions scored

Dec 07 J une 08 Dec 08

Question 1

- consolidation51% 52 % 60%

Question 2

- company reporting52% 43% 52%

Question 3

- interpretation45% 42%

40%

Question 4

- remaining syllabus35% 38% 27%

Question 5

- remaining syllabus29% 21% 40%

Percentage passing 40.3% 32.6% 42.5%

Average mark expressed as a percentage of marks available

Before going into detailed issues, I thought a review of the average markgained by candidates on each of the questions may prove informative. The

table gives the average mark for each question expressed as a percentageof the total marks available for that question. The topics of the first threequestions are broadly the same each diet. As we can see questions oneand two are the best scoring questions for candidates. Question three isnot quite as good, mainly because of mixed abilities with regard to theinterpretation of financial statements. The two remaining questionscovering the broader syllabus areas tend to achieve rather disappointingscores. [click]

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WHAT WAS

DONE WELL?

Looking at candidates performance in more depth[click]

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FinancialStatements

ConsolidatedAccounts

PerformanceAppraisal

What are often described as the core topics of question 1, 2 and 3 aregenerally done well.

Looking at question one on consolidations. Although there is a greatvariety of material within this subject, candidates have a goodunderstanding of most of the basic principles of this subject and haveadopted an appropriate methodical approach to answers. [click]

Question two requires candidates to produce or redraft the financialstatements of a single entity company. Typically this will be an incomestatement, a statement of financial position and a statement of changes inequity, although it may be that not all of these are tested in everyexamination. Most candidates have mastered the approach of takingfigures from a trial balance, making appropriate adjustments, and

preparing the required statements. [click]

Question three builds on candidates proficiency at producing financialstatements by testing their ability to interpret or appraise the performanceof a company from such statements. Questions normally ask candidates toprepare a statement of cash flows or calculate some accounting ratiosprior to their interpretation. Answers to the required calculations aregenerally well done, the interpretation of them is another matter. [click]

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WHAT WASNTDONE WELL?

Now for the bad news [click]

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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

Consolidated accounts

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 inthe remainder of syllabus.

For consolidations it is the more complex adjustments that, not surprisingly, causeproblems. [click]

For example where an acquisition involves deferred consideration, candidates are weak atdiscounting the consideration to its present value and even weaker at being able tounwind the finance cost related to the deferred consideration. [click]

There are many examples of confusion between what are pre acquisition adjustment andthose that should be post acquisition. The elimination of unrealised profits (on inventoriesand non-current assets) are often treated as pre acquisition adjustments. In the J une 08paper it was a common error for all of the intra group sales (and profits) to be eliminatedfrom 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 valueexercise had been accounted for by the subsidiary in the post acquisition period. Theeffect of this was that the loss should have been treated as an adjustment between thesubsidiary's pre and post acquisition profits. Many candidates ignored this treatment andinstead 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-controllinginterest, particularly in the income statement Dec 08[click]

.and I am still seeing the use of proportionate consolidation for subsidiaries andassociates, 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 toimagine that a candidate attempting to employ this technique has worked any of therelevant past examination questions. [click]

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Revaluations and related subsequent depreciation

Financial instruments:

- use of nominal the interest rate instead of the effectiverate

- gains on investments at fair value through profit or losstaken to reserves

Careless reading of the question ?

Even basic deferred tax is not understood

Statement of changes in equity

Single entity financial statements

The preparation of financial statements for single company, often called a published accountsquestion, 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 areanswered less well. J une 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 itis these areas that are not well answered. [click]

A perennial problem seems to be the revaluation of non-current assets. The timing of therevaluation is often misinterpreted by candidates as is the future depreciation charge. If therevaluation occurs at the end of the year then depreciation for the year, based on the assetsprevious value, must be accounted for before calculating the gain to the revaluation reserve oralternatively the impairment loss dependent upon the valuation. [click]

There will usually be a financial instrument to deal with and candidates often use the nominalinterest rate rather than the effective rate to calculate the finance cost. This confusion often carriesover into the carrying value of the instrument in the statement of financial position. Anothersurprising problem, given their description, is that the gain relating to financial instrumentsdescribed at fair value through profit of loss is frequently taken to reserves. [click]

The J une 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 toreturn, and many deducted the sales revenue as the adjustment rather than just the profit element. Ioften 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 candidatesinability to distinguish between temporary differences the deferred tax provision and for the whole ofthe deferred tax provision to be charged to income statement (rather than the movement in theprovision). Few candidate realise that deferred tax relating to a revaluation of non-current assetshould 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 surprisingas it is an area where there are relatively easy marks to be gained. Though this was not asprevalent in the Dec 08 paper [click]

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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

Performance appraisal

In performance appraisal questions, I find candidates have the most difficulty with the interpretationof 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 whatthe 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 hasincreased by $430,000, or the current ratio has decreased from 2.5 to 1.4. I would stress that thiskind of approach is not analysing or interpreting the data, it is merely describing it. What doesattract marks are plausible explanations of why ratios may have changed or what the implication ofthe changes may be. [click]

In Dec 07 question three required the comparative performance of a company over a two yearperiod where there had been a major acquisition at the beginning of the second period. Theacquisition had had a substantial beneficial effect on the results of year 2, but few candidates reallyfocused 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 fewcandidates could see through the selective ratios quoted by the Chief Executive when praising thecompanys performance. Many did not even address this issue despite the requirement clearlyasking for it.

In Dec 08 the question required the comparative performance of two separate companies from theprospective of a possible acquisition. A number of candidates treated this as if it was thecomparative 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 inthe scenario. [click]

Most candidates give a good attempt at preparing statements of cash flow, but less well-preparedcandidates display some fundamental weaknesses including not knowing the format of thestatement. [click]

Other weaknesses are not being able to distinguish between cash and non-cash flows e.g. in J une08 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 thecase of the movement of working capital items, for example, the mark available is for the signing ofthe cash flow, not for the monetary amount. [click]

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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 markersability to award marks.

Exam technique

Other problem topics:

Having dealt with problem areas within the core topics I will now look at problem areas in the widersyllabus. [click]

J une 08 contained a 10 mark question on a convertible loan note. This question polarisedcandidates 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 theloans effect on the financial statements. [click]

December 07 had 10 marks of question four relating to the treatment of leases. Many candidatesdid a reasonable attempt at the numbers, but were again poor at understanding the differentialeffect on the financial statements of a lease being treated as a finance lease compared to anoperating lease. [click]

A common and yet fundamental error in EPS calculations is that candidates fail to realise that thenumber of shares in issue is not the same as the monetary amountof share capital in issue. Forexample 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 theirlegal form. Many candidates think obsessively that substance issues relate to finance leases andnothing else. [click]

It is important to realise that normally approximately one third of the paper will be written ordiscursive questions; it was 35% in Dec 07 and 33% in J une 08 and 32% in Dec 08.

Amazingly a significant number of candidates make no attempt at all to answer these sections andmany others give them only token attention. If a candidates intention is to try to pass on thecomputation sections alone, they would need to score over 75% on those sections a very tallorder. [click]

There seems to be a growing problem in that many markers report that it is becoming very difficultto read some scripts. Be aware that if part of a script cannot be read, it simply cannot be given anymarks. [click]

Issues of examination technique will be discussed a little later. [click]

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Cannot distinguish between depreciation on cost or reducingbalance. 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 andpremium

Failure to properly read a questions requirement effectivelyanswering a different question than was asked

Fundamental issues

It is unfortunately necessary to draw attention to what I consider are some fundamentalweakness. Many of these should have been overcome in studying for paper F3. [click]

Questions requiring depreciation on the reducing balance method are sometimescalculated 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 salesas purchases, yet these are frequent occurrences. [click]

Some candidates are not aware of basic ratio definitions. Examples I have seen includethe gross profit percentage incorrectly calculated on cost of sales and inventory holdingperiods based on sales revenue rather than the cost of sales and asset turnovercalculated as the current ratio [click].

Another surprising weakness is the inability to allocate the proceeds of a share issuebetween 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 muststress that no marks will be awarded to answers that are not relevant to the questionasked. [click]

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LESSONS

LEARNED

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

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Consolidated statements of financial position far betteranswered than income statements

Questions on financial statements from trial balance scorebetter than restatement of given draft accounts

Whilst candidates are good at cash flows and ratiocalculations, they are poor at interpreting them

So the lesson learned try not to include all of the above inthe same exam! J une 08

From my point of view

[click]

There are certain aspects of the core topics that are not as well answered

as others. Candidates dont score as well on consolidated incomestatements as they do on consolidated statements of financial position.[click]

Similarly candidates find it harder to redraft given financial statementsrather than to prepare them from a trial balance. [click]

Interpretation is less well answered than the underling computations ofratios and cash flows. [click]

Perhaps I need to consider a better balance of these topics such that theydo not all paper in the same paper. This may have been a contributor tothe poor performance in J une 08. That said, these are all important topicsand will continue to be examined regularly.

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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 youwish had been set.

Dont waste time by telling the marker/examiner that you arerunning out of time!

From a candidates point of v iew

[click]

Dec 07 question three required the calculation of specified ratios and an

interpretation of them. Remarkably in answering this question a smallminority of candidates produced a cash flow statement. A few candidateseven apologised and explained that they had gambled on a statement ofcash flows question coming up, and thats what they were going to do![click]

In J une 08, nearly a quarter of all candidates scored 30 marks or less. Tome, 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 tostudy and practice full questions. If candidates cannot produce a basic setof financial statements, they wont be able to do an equivalent question at

F7. [click]

Many tutors complain that some candidates enrol on short revisioncourses when they have not done any prior study. This is not fair to tutorsand very unlikely to result in success. [click]

Even if candidates feel they have not studied an examined topicthoroughly, it is essential that they attempt some sort of answer. It takesonly a few marks to change a marginal fail to a pass. [click]

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Percentage not attempted

Dec 07 J une 08 Dec 08

Question 1

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WHAT TOFOCUS ON?

Every tutor gets asked by candidates questions like where do I focus myefforts 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 theproblem. [click]

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Understandthe principles

Applicationof knowledge

Criticalcomments

Know theaccountingstandards

Breath of study

[click]

In order to be confident of a pass, candidates need an all round knowledge of the breadth of thesyllabus.

Whilst it goes without saying that the core topics previously discussed must be mastered, this alonewill not guarantee success. Nor should it.

My own strong view, which I believe is shared by ACCA, is that I would not be comfortable withcandidates passing F7 by learning just three topics. It is poor grounding for paper P2 and does notequip 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 sizablesyllabus. However it is the principles that need to be understood rather than detailed knowledge orgreat depth. Question 4 in J une 08 required candidates to give examples of how some previouslydefined 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, itcan 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 examinetopics in a different manner, format or combination of topics to previous questions. This means thatmemorising past questions is not the route to success. Questions will require learned knowledge tobe applied to practical examples. [click]

Scenario questions may require candidates to criticise or comment on views put forward bymanagement. Question 5 in J une 08 required candidates to discuss the validity of a financialassistants observations of effects of the issue of a convertible loan note. I would mention here, as apiece of examination technique, that agreeing with the observations in the question in their entirety ishardly 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 goodmark. In J une 08 this question covered at least eight accounting standards. [click]

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HOW TOIMPROVE?

Improving your chances of success is really following previousadvice[click]

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Before starting F7 studies ensure competence in paper F3material.

Plan the study over a reasonable time span.

Avoid adopting a mechanical approach; focus on principlesand understanding. This will help when questions seemunfamiliar.

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

In summary - all of the above!

[click]

The starting point for F7 study is to have a good grounding at F3. A marginal pass at F3may signify more work needs to be done on foundation knowledge. [click]

When planning your studies, distinguish between learning the syllabus over a reasonabletime span and the honing of knowledge and technique in the period immediately beforethe exam. Studies in the pre-exam period should be focused on attempting pastquestions. By this I mean a timed attempt simulating exam conditions, not just an audit ofthe answers. [click]

Many candidates believe that rote learning of definitions, facts, lists or past answers is thekey to success; it isnt and it will not gain many marks. Instead it is the ability to applythem that will be tested in the examination. [click]

I frequently read candidates answers that do not address the question asked; they arereproductions of my answers to previous questions. These rote learned answers to pastquestions may be on the same subject area as the current question, but they arenonetheless different questions the require different answers. [click]

Examiners reports can be found in the Student Accountant. These provide valuablefeedback in the areas where previous candidates had difficulties. This should help you toavoid their mistakes. [click]

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An average of 7.5% of candidates score between 45 and 49marks, 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

Marginal candidates

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 mostdifficult papers to mark.

Many of these candidates fail, not because of a lack of knowledge, butoften by a lack of technique or perhaps experience.

The slide shows the score of an actual candidtes paper. Sadly I can findmany similar ones. Only three more marks were required to pass yet therewas 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 topicsthey 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

FUTUREEXAMS

What can be expected in the future.

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WHATS NEW?

Any new topics or material.

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Some existing areas are changing

Developments of IAS 1:

- terminology, presentation of income/comprehensiveincome

Developments of IFRS 3:

- calculation of goodwill and non-controlling interest

- changes to contingent consideration

- more recognisable intangibles

No new topic areas

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 area revision of an existing included standard. Indeed the revision of an accounting standardis 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 beenincorporated in questions. Probably the most noticeable change for F7 is the presentationof 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 oldmethod 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 inthe value of contingent consideration. [click]

Future questions may require candidates to recognise more types of intangibles as part ofthe acquisition of a subsidiary e.g. customer lists, newspaper titles, domain names etc.[click]

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WILL THINGSCHANGE?

Will any other aspect of the F7 paper change.

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Interpretation and cash flow question

May targetcertain calculations and ratios

Part of a statement on cash flows e.g. investing or/andfinancing activities

ROCE and its components; focus on liquidity

Looking for more understanding and less mechanical

churning

Different approach?

I may adopt a slightly different approach to some types of questions. Iwould stress that this does not mean new subject areas. [click]

As I said, I continue to be disappointed in many answers to cash flows andinterpretations. [click]

This may prompt me to set questions in targeted areas of a statement ofcash flows or to focus on some important ratios. For example these mayrequire the cash flows for just operating cash flows, investing actives orfinancing 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 andits components. [click]

In doing this I would be trying to avoid the mechanical churn of ratios andbland comments that do not explain or interpret performance at all. Insteadit would be testing whether candidates actually understand the meaningand implications of the ratios [click]

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Importance of the position and purpose of F7 in relation to F3and P2

Answer all questions (and parts of questions) and payattention 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 goodstructure, legibility, referencing

Key messages

So what are the he key messages. An awareness of the progression from paper F3 to F7and 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 knowledgethat 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 examtips 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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