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DA1 - EXAMINER’S REPORT – June 2008

General Paper Comments
There was no change in the format of the paper. As in recent sittings, it comprised three sections. Section A was made of 20 multiple choice questions of 2 marks each, all of which were compulsory. Sections B and C included three questions each. These questions were worth 20 marks each and candidates were required to answer at least one question from section B (Interpretation of Financial Statements), at least one question from section C (performance management), and a further question from either section B or C. The questions in sections B and C required a mixture of discursive and computational answers.

It was good to note that the majority of candidates attempted the required number of questions. This indicates that, in the main, candidates had attempted to prepare across the whole syllabus. However, the comments on specific questions illustrate that this was done with varying degrees of success.

In many cases, there were two main reasons for candidates not achieving the pass mark. The first of these was that some candidates attempted to provide answers which were over-elaborate (the specific comments on questions one and six will provide a better understanding of what is meant by this observation). The second reason was the opposite of this, with some candidates unable to demonstrate an understanding of the basic principles. This was most evident in question 3, as the comments below illustrate.

A perusal of the suggested solutions should reveal that adequate answers tend to communicate the key technical issues in short sentences, and a logical structure. Similarly, for computational answers, a logical structure is essential in order to demonstrate an understanding of the required approach.

One very simple way in which candidates could have improved their performance was to ensure that their answers were clearly labelled, so that there would be no doubt as to what is being answered. This is related to the point immediately above regarding structure. If an answer is not clearly structured, with a clear label to show which part of the question is being answered, it is difficult to award marks. When the questions are being drafted, an attempt is made to ensure that the elements of the requirement are structured in a logical manner. This was particularly the case in question 5. Identifying problems is a different issue to generating potential solutions. However, it is critical that problems are identified before solutions can be considered.

These issues of logic, structure, technical understanding and communication are precisely the managerial skills which are being tested in this qualification. 

For those candidates who had taken account of these matters, they obtained very good marks  

Question Comments

The use of multiple choice questions allows each exam paper to achieve broad syllabus coverage – hence candidates should avoid preparation which only concentrates parts of the syllabus. A recent article in Finance Matters provided guidance on how to prepare for MCQs. The key issue in the exam is that each multiple choice question will tend to focus on a specific aspect of a topic. Therefore, a clear understanding of the key points of each topic is required. For some candidates, this may come to be interpreted as meaning that MCQs do not require detailed knowledge or application. This misunderstanding may be why candidates seem to find questions which require more than one step in a set of calculations or a thought process more difficult. In this sitting, this was the case, with questions 13, 15 and 16 being answered correctly by the fewest candidates.

Such questions can be answered by adopting the same approach as is required for the questions in sections B and C i.e. by taking a logical approach and completing each step in turn. It is interesting to note that a number of candidates do not do this, as some answer booklets contain no workings. It is difficult to understand why so many candidates attempt to answer all questions without recoding intermediate steps.

Question 1
This question tested candidates’ knowledge of how the nature of a liability, the calculation of earnings per share and the calculation and interpretation of the current ratio.

Although this may seem like a lot of issues for one question, the intention was to provide an opportunity for those candidates who had a good understanding of the key points of each of these matters to obtain good marks.

In a number of cases, candidates were able to do this.

There were a number of reasons that other candidates did not obtain good marks. In the main, such candidates did not demonstrate a clear understanding of key issues such as:

the ‘acceptable’ result for the current ratio
too many candidates answered part (a) by making general comments about the current ratio, and the importance of this being above 1.0. The wording of the question was intended to provoke candidates to consider why it may sometimes be appropriate for this to be below 1.0. If this was combined with the fact that company was in the retail sector, a possible answer should have become apparent. Retail companies will have very low or nil receivables, and will seek to minimise the stock turnover period. These two factors will mean that a current ratio of less than 1.0 is often an indication of sound management, rather than an indication of problems.

the nature of a liability
here the key issue is whether or not the facts indicate the existence of an obligation, and whether that obligation can be reliably measured. Marks were awarded to candidates for discussing these matters and using the facts provided in the question as the basis for the discussion. In some cases, candidates digressed into consideration of matters which were not included in the question, and which were therefore irrelevant. As a result, it was not possible to award marks

calculation of current ratio
in general, this aspect of the question was answered well, with most candidates correctly calculating the current ratio, based on their preceding comments and decisions. However, a few candidates who had correctly noted that the company had a liability arising from the legal dispute did not include the liability in a revised calculation of the current ratio. This is not logical, and indicates that such candidates are not carrying decisions through from one section of a question to the next.

calculation of EPS
this part of the question presented the most difficulty for candidates. Some candidates did not follow through their previous observations, and therefore did not recalculate ‘earnings’, based on the revised financial statements.
By far the most common problem was that many candidates were unable to calculate the weighted average number of shares making appropriate use of the theoretical ex-rights price.

Question 2
Accounting for groups is frequently examined, although candidates at sittings from December 2008 should be aware that IFRS 3 as revised in January 2008 will be the relevant accounting standard from that sitting onwards. Under the revised standard, two possible methods may be applied to the calculation of the value of the non controlling interest (previously referred to as ‘minority interest’) and consequently goodwill on acquisition. For the diploma, the ‘fair value’ method of calculating the value of non controlling interest will apply. This means that the calculations included in the suggested solution to this question (and questions on this topic in previous sittings) will have been superseded.

As in question 1, the wording and structure of the question was intended to provide a logical progression for candidates.

A number of candidates demonstrated a good knowledge of the calculations, and consequently obtained very good marks.

In some cases, candidates could not be awarded good marks because their work was not clearly labelled, and it was not clear what their calculations were intended to represent.

Unfortunately, there were also answers in which the calculations were incorrect, and these could not be awarded marks. The most frequent reasons for this were:
- lack of differentiation between pre-acquisition and post-acquisition earnings of the acquired company when calculating goodwill on acquisition and consolidated reserves;
- lack of awareness of the correct treatment of the fair value adjustment relating to the land (both on acquisition and subsequent to the acquisition);
- uncertainty about what should be included in the calculation of minority interest;
- incorrect calculation of the adjustment in respect of unrealised profit on intra-group trading
- omitting this adjustment altogether;
- exclusion of goodwill from the value of the group’s non-current assets
- failure to eliminate inter-company balances when calculating current assets and current liabilities.

Question 3
To obtain good marks in this question, candidates were required to demonstrate understanding of the principles of inventory valuation, in respect of both raw materials and work in progress. Those candidates who were able to demonstrate this understanding and apply it to the scenario obtained very good marks.

Unfortunately, a number of candidates did not appear to have a sound understanding of how ‘cost’ and ‘net realisable value’ should be calculated. Specifically, the fact that the valuation of work in progress should include a share of overheads – and the basis for calculating the overhead to be included was omitted by a number of candidates. With regard to net realisable value, a number of candidates had a very poor grasp of the basis of this calculation.   

In part (b), the question required two possible methods of valuation of raw materials inventory to be identified and described. It was implicit in this question that only methods which would be acceptable under generally accepted accounting practice should be referred to. Therefore no marks could be awarded for references to last in first out (LIFO). Nevertheless, a surprising number of candidates included this method in their answers. This suggests that such candidates are either using study material which is out of date, or they were unable to differentiate between theoretical methods and those which can realistically be applied in practice.

When carrying out the calculations in part (c), it was necessary to recognise that, as the data in the question indicated that prices were rising, first in first out (FIFO) would produce the highest reported profit. Most candidates seemed to recognise this fact, but a number were unable to apply this logically to the data to complete the calculation. Even fewer were able to calculate the overhead element of work in progress, based on the normal level of activity. These are specific examples of how questions are intended to test candidates understanding of the key aspects of a topic.   

Question 4
An understanding of the impact of costs on selling price, which is central to many management decisions, was the focus of this question. In particular, an understanding of how target costing and pricing strategies might be applied, was the key issue in obtaining good marks.

As in the other questions, those candidates who adopted a logical approach obtained good marks. There were two key issues in part (a). The first was to recognise that having calculated the cost per unit at one volume of sales, the only difference at the other volume of sales was due to the development costs and fixed costs. The second was ensuring that profit margin (profit as a percentage of sales) was not confused with mark up (profit as a percentage of cost).

Most candidates dealt correctly with the first issue, but a number simply added 20% (rather than 20/80) to cost to obtain the selling price.

In part (ii), a brief explanation of target costing, and recommendations to reduce cost were required. Few candidates had a problem making appropriate recommendations, but a number were unable to offer a reasonable explanation of the concept of target costing. Many of the inappropriate answers were, in fact, explanations of cost plus pricing.

In part (b) many candidates appear to have  a good understanding of market penetration and market skimming as most of the answers  were of a good standard. However some  candidates did not present an answer for this part of the question which suggests that these candidates had not covered the topic in  depth.          

In this context, it may be worth reiterating the importance of the mark allocation, as some candidates provided too much material in their answers to part (a) (ii) and part (b). a review of the marking scheme (for this sitting and previous sittings) will highlight that, in general, each valid comment (or calculation to derive a new value) attracts one mark. While this in not the case in every situation, it can be a useful rule of thumb to assist candidates to estimate how much material should be included in their answer. In the context of part (a) (ii), this would mean that if three points were made about target costing, no more than four recommendations to reduce cost were necessary. A number of candidates provided a comprehensive list of recommendations. Unfortunately, as the only the allocated number of marks can be awarded, this meant that part of the answer was redundant.

While making this point, it should be emphasised that a ‘valid’ point has two characteristics. As well as being technically correct, it must also be related to the specific question which has been asked. In this question therefore, there could be no marks awarded for recommending a reduction in development costs, given that the question stated that the product was now fully developed – meaning that development costs were a sunk cost.

Question 5
Given that this question related to value-for-money (VFM), it goes without saying that knowledge of this topic was a pre-requisite to attempting the question. As this is not a core topic, it is perhaps not surprising that it was attempted by fewer candidates than any other question.

Taking up the point made in respect of the mark allocation in the comments on question five, it is worth noting that good marks could be obtained by breaking the question down into its constituent parts. For example, in part (a), 8 marks were available for explaining the concept of value-for-money and recommending how each element could be measured. A basic knowledge of VFM would reveal that there are three elements. Therefore, full marks could be obtained by recommending two valid measures for each element, and two valid points about the concept.

Those candidates who adopted this approach, did obtain full marks. As is normal in discursive questions, the main reason that some answers did not score high marks was that the comments were poorly structured – in some cases not even clearly indicating what element of VFM was being discussed.   

Parts (b) and (c) are particularly relevant with regard to the general point about the need to structure an answer logically – and to pay attention to the mark allocation. Too many candidates wrote at length about problems and then provided little or no discussion of how these might be solved. Given that 6 marks were available for each part, identifying 6 problems with one solution for each would obtain full marks. However a long list of problems could not be awarded more than 6 marks – even if all the problems identified were valid. Once again, unbalanced answers such as this did not obtain the number of marks which the candidate presumably expected. Moreover, the misuse of time, may have adversely impacted on the time available to answer other questions, thereby further reducing the opportunity to obtain marks.

Question 6
There were a number of excellent – and insightful – answers to this question. Essentially it tested candidates’ ability to think logically and identify problems which may arise if particular initiatives were implemented.

Some candidates made good use of the material provided in the question, and recognised that as the salons were based in four and five star hotels, this would have an impact on the customer base.

In the main, these candidates used the scenario as the basis for their answers, and also demonstrated good commercial awareness through their comments and recommendations.  

It was perhaps in part (b) of this question in that the tendency towards over-elaboration was most evident. The requirement asked for answers to be ‘based on the available information.’ Some candidates attempted to introduce additional facts, and as a result their answers become complex and difficult to follow. Also, introducing additional information meant that the specific question was not being answered, and marks could not be awarded