The theory questions of CA Foundation Paper 1

What the paper actually sets

Accounting is a subjective paper. ICAI’s study material for Paper 1 states it outright, and it matters: there is no multiple choice anywhere in this paper, so there is nowhere a half-remembered rule can be recognised rather than produced.

The paper runs three hours for 100 marks and sets six questions of 20 marks each. Question 1 is compulsory; of the remaining five you attempt any four. So five questions are answered, and one of the five is fixed.

That fixed question is where the theory lives. Recent papers have built it as:

• 12 marks — six statements, each to be marked True or False with reasons, two marks apiece.
• 4 marks — a short written explanation of a concept or a pair of terms.
• 4 marks — a small practical, usually from the accounting process: a subsidiary book, a posting, an entry.

Sixteen marks of writing, then, before Question 2 is reached. A candidate who treats theory as something to glance at the night before has given away a sixth of the paper and will need three-quarters of the remaining eighty to reach fifty.

Where the statements come from

Not from one chapter. The theoretical framework supplies the concepts and the conventions, but a statement can be set on anything in the syllabus where a rule governs an entry:

• which cost formulae the accounting standards permit, and which they do not;
• whether a change in the method of depreciation is applied backwards or forwards;
• what the Companies Act allows a particular reserve to be used for;
• what a trial balance proves, and what it cannot;
• the days of grace on a bill, and when there are none;
• whether a given expense is capital or revenue.

Theory in this paper means the reasoning behind the entries. It is examined separately from the practical questions because it can be got wrong by somebody whose arithmetic is perfect.

The marks are for the reason

Two marks a statement, and a bare “False” is not worth two marks. Take this one, which is set often and answered wrongly often:

Here is an answer that is right and earns very little:

And here is one that earns the marks:

The difference between the two is not knowledge. Both writers knew the answer. The difference is that the second one wrote down what follows from it — and what follows is the part the examiner is paying for.

Why our practice papers set the verdict, and what that cannot do

These papers mark figures and classifications. A written reason is not something they can mark, and we would rather say so than pretend otherwise.

So each statement carries its two marks on the verdict, and the reason — the full one, written as it would need to be written in the examination — is in the worked solution for every statement on the paper. A wrong verdict is traced to the kind of misunderstanding that produces it and counted against the number of times the paper gave you the chance to make it, in the same way as a wrong figure.

What that cannot do is tell you whether you can write. Recognising that a statement is false is one skill; producing the reason in two sentences under examination conditions is another, and the second is harder. A candidate can take all six verdicts and still earn four marks out of twelve. Nothing on this site will catch that, and the next section is how to catch it yourself.

How to make the practice do the examination’s work

Three steps, and the whole of the difficulty is in the second one.

1. Answer the statement. True or false, in the box, as you would in the examination.
2. Write the reason out before you look. One or two sentences, on paper, in full. Not a phrase, not a mental note — the sentences you would write in the hall. This is the step everybody skips, and skipping it is what produces a candidate who knew the answer and could not say it.
3. Then read ours, and find what yours was missing. Usually it is the consequence rather than the rule: you wrote that it is a change in estimate and did not write that nothing earlier is recomputed.

Do that for eight statements a paper across ten papers and you will have written eighty reasons and compared every one of them against a model. That is what makes the sixteen marks safe. Reading the solutions without step two will not.

Ten to try

These are drawn from the same bank the papers use. Decide first, write your reason, and only then open the answer.

Sixty-six statements sit behind the papers, and no paper takes more than two of any one kind, so no single set of eight leans on one chapter.

The eight habits the diagnosis names

A wrong verdict is not reported as a wrong verdict. It is reported as one of these, and counted as a rate across every paper you sit: taking a mistake four times in five is worth an evening, once in five is a slip you can forget.

Confused one accounting concept or convention with another

The concepts are not interchangeable pieces of good sense: each answers one question. Going concern says the business will continue, which is why unexpired costs are carried forward. Accrual says when a transaction is recorded. Matching says against which revenue a cost is set. Conservatism says which way to lean when the answer is uncertain. Naming the right concept for a treatment is half of understanding the treatment.

Classified a capital item as revenue, or the reverse

The test is not the size of the amount or how often it recurs. It is whether the benefit is consumed within the period or endures beyond it — and, for an asset, whether the spending was needed to bring it into working condition. Everything spent to make an asset fit for use belongs to its cost; everything spent to keep it working thereafter is revenue. Getting this wrong misstates both the profit and the balance sheet, and in opposite directions.

Mistook what is recognised for what is merely disclosed

Recognition puts an item in the accounts; disclosure only tells the reader about it. Prudence keeps unrealised gains out of the accounts altogether while requiring foreseeable losses to be provided for, so the two sides of an uncertainty are never treated alike. A contingent liability is disclosed and not provided; a contingent asset is neither recognised nor even disclosed in the statements themselves.

Reworked the past where only the future should change

A change in an accounting estimate — the method of depreciation, the useful life, the residual value — is applied from the date of the change onwards. Nothing already charged is recomputed. A change in an accounting policy is a different thing and is disclosed as such. Much published material still teaches the old retrospective treatment for a change of depreciation method, which is why this is worth knowing precisely.

Applied the wrong rule for valuing inventory

Three rules decide almost every inventory question. Inventory is carried at the lower of cost and net realisable value, and item by item. Net realisable value is the selling price less what it will cost to complete and to sell. And the cost formula must be one the accounting standards permit, which first in first out and weighted average are and last in first out is not.

Used a reserve or an account for something the statute does not permit

Company accounting is not a matter of which reserve looks big enough. The Companies Act names what each may be used for: the securities premium account has its own list in section 52, bonus shares may come only from free reserves, securities premium or capital redemption reserve, and the capital redemption reserve may be used for nothing but fully paid bonus shares. A reserve created by revaluing assets is not a free reserve at all, because nothing has been realised.

Misread a rule about bills of exchange or promissory notes

These rules come from the Negotiable Instruments Act and not from accounting convention, so they have to be known rather than reasoned out. Three days of grace, but not on a bill payable on demand or at sight. A due date falling on a known public holiday moves back a day, while one falling on an unforeseen holiday moves forward. A bill is accepted; a promissory note is not.

Mistook what a particular book or statement is

Each record answers its own question, and confusing two of them produces answers to neither. A trial balance proves the arithmetic of the ledger and nothing about its accuracy. A bank reconciliation statement is a statement and not an account. A receipts and payments account is a cash summary covering every year and both capital and revenue; an income and expenditure account is a profit and loss account covering this year and revenue alone.