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AAT - Success at DFS

Students of AAT Unit 11 ‘Drafting Financial Statements’ face a challenging paper in June 2010. Not only is the syllabus vast with a significant amount of demands placed on students, but there is so much to remember in a relatively short space of time.

This article aims to guide students onto the ‘straight and narrow’ with a view to making the overall requirements of DFS more digestible as well as easier to understand.

Objectives of DFS
The objectives of DFS are simple. Candidates need to be able to ‘draft’ limited company financial statements in accordance with IFRS and IAS as well as domestic legislation. In addition, candidates are also expected to ‘interpret’ financial statements. Therefore it is not enough to just calculate numbers, students need to understand those numbers and be prepared to write about them.

Section 1 is largely concerned with the ‘drafting’ side of things, whilst section 2 deals with the ‘interpretation’ aspects.

Section 1
Section 1 of DFS will form approximately 70% of the entire paper, therefore there will be a lot to do in this section! Typically, section 1 will consist of:

Preparation of single entity financial statements from an initial trial balance which requires adjustment.
Preparation of consolidated financial statements.
Preparation of the statement of cash flows.
Dealing with accounting standards.

Single Entity Financial Statements
The first question in Section 1 is usually the preparation of single entity financial statements. Candidates are usually given a trial balance, together with additional information which they are required to incorporate into the initial trial balance. Candidates are then required to prepare the statement of comprehensive income and the statement of financial position.

Candidates need to have a sound grasp of double-entry concepts in this question because the adjustments to the initial trial balance will have to be done by way of journal.

Consolidated Financial Statements
In question 2, candidates will be faced with a consolidation question. This is where the complexities of DFS really start to kick in. Invariably, the consolidated statement of financial position is examined, but candidates cannot ignore the consolidated statement of comprehensive income because this, too, is examinable so make sure your study and revision phase covers this important primary statement.

Candidates can expect to deal with a range of complexities in preparing the consolidated financial statements. Typically, past sittings have seen candidates having to deal with:

Elimination of intra-group trading.
Impairment of goodwill.
Calculation of non-controlling interest.
Calculation of % shareholding.

Elimination of intra-group trading is a core requirement in any consolidation. Consolidated financial statements need to show the results of a group as a single reporting entity i.e. as if the ‘group’ structure did not exist. It is for this reason intra-group trading (and the effects of intra-group trading) are eliminated in accordance with IAS 27 ‘Consolidated and Separate Financial Statements’.

Impairment of goodwill is thrown in because candidates usually trip up when dealing with this. Remember, when preparing the consolidated statement of financial position, the concepts of double-entry must still be applied. If goodwill is impaired it is clear that we credit goodwill, but students often forget that a corresponding debit is required! The corresponding debit is taken to the consolidated retained earnings.

Non-controlling interests are the outside investors who own the remaining shareholding of the subsidiary.

Calculation of shareholding is required where the question requirement does not specifically refer to the holding, for example “X acquired 80% of the net assets of Y”. Where the question does not explicitly refer to the holding, students will be required to calculate the holding by dividing the number of shares acquired into the number of issued shares of the subsidiary.

Past sittings have seen the students use this formula to calculate the holding but to arrive at a figure of 66.6667%. Where this happens, turn the % into a fraction, i.e. 2/3. The consolidated statement of financial position will still balance using the % but the numbers will be slightly out of ‘sync’.

Accounting Standards
Always a bone of contention with students of DFS! Remember, it is important that you print off the Guidance Notes from the AAT website which will tell you exactly which IFRS/IAS is examinable and which are not. For those which are, the Guidance Notes tell students exactly what they need to know for the exam. The only way to deal with these standards is to practise, practise and do more practise!

Statement of Cash Flows
Students either love or hate these! Typically students struggle in deciphering when to add and when to deduct movements in working capital. Think about the effects increases/decreases in working capital has on cash. For example, an increase in inventory means that more cash is tied up in inventory, representing an ‘outflow’ of cash. An outflow of cash for the purposes of the statement of cash flows is a deduction. Conversely, if we had a decrease in inventory then this means that we have turned more inventory into receivables or cash, representing an ‘inflow’ of money therefore we add the decrease to profit from operations.

Section 2
Students often neglect this section because they become bogged down in section 1. This section represents the remaining 30% of the DFS paper and because of the disproportionate weighting of this paper the scope for failure in section 2 is much wider.

Section 2 deals with the interpretation of financial statements so ratio analysis will feature. Ratios are a key tool used by accountants in interpreting financial statement information because ratio analysis tells us so much about the financial statements. Remember, the numbers are a form of shorthand and we, as accountants, have to translate this shorthand into understandable language that a client or a board of directors will understand. This is a fundamental job of an accountant.

Students need to make sure they comply with basic instruction so if the question says to write a report, then write a report. Do not write a letter or an e-mail!

A key aspect to this section is advising a third party as to whether to invest in a company or not. It is important, therefore, that students are able to arrive at a conclusion, backed up by reasoned argument. A conclusion must be that – do not ‘sit on the fence’. ‘Ifs’ ‘buts’ and ‘maybes’ are not to be used – in real life, clients want ‘yes’ or ‘no’ answers together with reasons. Be sure to do this in the exam.

Section 2 will also see an additional question on either an accounting standard or on the conceptual framework, such as define the ‘elements’ of the financial statements or define ‘assets’ ‘liabilities’ or ‘income’ and ‘expenses.

The only way to succeed at DFS is to work logically through the syllabus and during the revision phase attempt as many exam standard questions as possible, including all the past papers that examine international standards.

Steve Collings FMAAT FCCA DipIFRS is the audit and technical manager for LWA Limited and lectures on financial reporting and auditing issues.

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