ACCA AFM December 2026: Dividend Capacity — Why Your FCFE Figure Is Too High

Dividend capacity is free cash flow to equity: profit after interest and tax, plus depreciation, minus all the investment the business needs to keep going and grow. Most wrong answers come out too high, either because tax is worked out before interest is deducted or because depreciation is added back with nothing taken off for replacement capex.

What the AFM examiner keeps seeing

Dividend capacity has been a 10-mark calculation in recent Section A questions, and the examiner's reports show the same mistakes coming up again and again. In the March/June 2026 report (Pittu Co), the examiner said the basic calculation was often done well. Marks were then lost on the details: candidates didn't use interest to reduce taxable profit, didn't spot that depreciation and replacement investment cancelled each other out, and taxed the overseas subsidiary only on the dividend it sent home instead of on its full profits.

This isn't new. The September 2019 AFM report lists the same three errors: not deducting tax relief on interest, adding back depreciation that had already been dealt with, and working out the additional investment wrongly. Back in the P4 days, the June 2018 report said only a minority of candidates got the initial dividend capacity right.

The bigger miss is the next step. In 2026 many candidates calculated the capacity and then stopped. They never compared it with the planned dividend, and that comparison is the shortfall the whole question is built around. If you don't work out the gap, you can't discuss how to close it, so the 8-mark dividend policy discussion that follows falls apart too.

FCFE also comes up in valuation questions. In the same 2026 sitting (Colmcille Co), candidates applied growth to a year 1 FCFE figure the question had already given them. The examiner said no growth should have been applied to that figure.

Worked example: wrong vs right

Operating profit $120m. Interest $20m. Tax 25%. Depreciation $30m. Replacement capex $30m. Growth capex $15m. Increase in working capital $5m. Planned dividend $60m.

Wrong answer: Tax = 25% × $120m = $30m. $120m – $30m – $20m = $70m. Add depreciation $30m = $100m. Less growth capex $15m and working capital $5m = $80m capacity. The dividend is covered with $20m to spare.

That answer has two errors. Tax ignores the relief on interest, and depreciation is added back with no replacement capex taken off.

Correct answer: Profit before tax = $120m – $20m = $100m. Tax 25% = $25m. Profit after tax = $75m. Add depreciation $30m, less replacement capex $30m, less growth capex $15m, less working capital $5m = $55m capacity. Shortfall against the planned dividend = $5m.

So the company that could "easily" pay turns out to be $5m short. Every discussion mark after this depends on that shortfall: borrowing to pay the dividend, pulling more cash up from a subsidiary, cutting the payout, or what a cut signals to the market.

What to do

1. Use a fixed layout every time. Operating profit, less interest, less tax on the result, plus depreciation, less replacement capex, less growth capex, less working capital, then plus or minus new debt and repayments. Label each line. Markers give follow-through marks on workings they can read.

2. Tax overseas subsidiaries on their full profits. Tax is charged on what the subsidiary earns, not on what it remits. Then check whether extra tax is due in the parent's country when the remittance arrives.

3. Always finish with "capacity vs planned dividend = shortfall". Write that line before you start the discussion. In 2026 the examiner noted that sending more cash up from the subsidiary would not by itself close Pittu's gap. Use your shortfall number to test each option.

The bottom line

The AFM pass rate was 44% in March 2026, and the examiner's main complaint was discussion that didn't use the numbers. Dividend capacity is one of the few AFM areas where the method is the same in every question.

Get the cash right and the shortfall right, and the discussion marks are much easier to pick up.