Theoretical Framework for CA Foundation
The rules behind every entry: what accounting is, the concepts and conventions it follows, and how to tell capital items from revenue items.
AccountingPaper 113 MCQs3 lessons2 flashcards3 memory tricks
Practise Theoretical Framework free
What you'll learn
- Meaning and scope of accounting
Explain what accounting does and who uses it. - Accounting concepts, principles and conventions
Apply the key concepts to everyday situations. - Capital and revenue
Classify expenditure and receipts as capital or revenue.
Concepts explained
Basic accounting concepts
Accounting concepts are the basic assumptions on which every entry rests: business entity, money measurement, going concern, accrual, matching, dual aspect and historical cost.
What it means
- Business entity: the business is separate from its owner, so capital is a liability of the business.
- Money measurement: only events measurable in money are recorded.
- Going concern: the business is assumed to continue, so assets are at cost less depreciation.
- Accrual: income when earned, expenses when incurred.
- Matching: expenses of a period against the revenue they earned.
- Dual aspect: every transaction has two effects, so Assets = Liabilities + Capital.
- Historical cost: assets recorded at purchase price.
- Owner starts business with ₹1,00,000 cash
- Asset (cash) +1,00,000; Capital +1,00,000
Answer: Assets ₹1,00,000 = Liabilities 0 + Capital ₹1,00,000
- March salary of ₹20,000 paid on 5 April
- It belongs to March
Answer: Expense of the year ending 31 March; shown as outstanding salary
Related terms
- Conventions: conservatism, consistency, materiality, full disclosure
- GAAP: generally accepted accounting principles
Exam tip: Capital is a liability from the business's point of view (entity concept). This is a classic one-mark question.
Accounting conventions: conservatism, consistency, materiality
Conventions guide judgement: be prudent about losses, use the same methods each year, and treat trivial items simply.
What it means
- Conservatism (prudence): provide for all likely losses, don't anticipate profits; inventory at the lower of cost and net realisable value.
- Consistency: same methods year to year (e.g. depreciation), changed only for good reason with disclosure.
- Materiality: items too small to influence decisions can be treated in the simplest way.
- Full disclosure: all significant information must be shown, including in notes.
- Cost ₹80,000; net realisable value ₹72,000
- Take the lower
Answer: Value stock at ₹72,000
- Stapler bought for ₹150
Answer: Write it off as an expense, not a fixed asset
Related terms
- Net realisable value: estimated selling price minus costs to sell
- Provision for doubtful debts: an application of conservatism
Exam tip: Lower of cost and NRV, never the higher.
Capital vs revenue expenditure and receipts
Capital items give benefit over several years or come from non-operating sources; revenue items are used up in the year or arise from normal operations.
What it means
- Capital expenditure: buying or improving fixed assets, including installation and carriage to bring them into use.
- Revenue expenditure: day-to-day running costs such as wages, rent, routine repairs.
- Capital receipts: loans, fresh capital, sale of fixed assets.
- Revenue receipts: sales, commission, interest, rent received.
- New machine ₹50,000 + installation ₹2,000
- Both bring the asset into use
Answer: ₹52,000 capital expenditure
- Routine servicing ₹1,500 a year later
Answer: Revenue expenditure
Related terms
- Deferred revenue expenditure: large revenue spending whose benefit lasts a few years; generally expensed under current standards
Exam tip: Ask: does the benefit last beyond this year? Yes → capital. No → revenue.
Memory tricks
Use the first letters to recall all ten concepts in an answer.
Machine and installation: capital. Wages, routine repairs, electricity: revenue.
Provide for likely losses; don't anticipate gains. Inventory at the lower of cost and NRV.
Try 3 CA Foundation-style questions
Q1. The matching concept requires that
- assets are always equal to liabilities
- cash receipts equal cash payments
- expenses of a period are matched with the revenues of the same period
- the owner's capital matches the bank balance
Show answer
Answer: (3) expenses of a period are matched with the revenues of the same period
To find the true profit of a period, set against its revenue all the expenses incurred to earn that revenue, including outstanding ones.
Q2. A contingent liability, such as a guarantee given for another firm's loan, is usually
- recorded as a current liability
- added to the owner's capital
- disclosed in notes to the accounts, not recognised as a liability
- ignored completely
Show answer
Answer: (3) disclosed in notes to the accounts, not recognised as a liability
A contingent liability depends on a future event that may not happen, so it is disclosed in the notes rather than recognised in the balance sheet.
Q3. The convention of conservatism (prudence) requires an accountant to
- anticipate all possible profits
- provide for all likely losses but not anticipate profits
- ignore expected losses
- value inventory at the higher of cost and market price
Show answer
Answer: (2) provide for all likely losses but not anticipate profits
Prudence: recognise expected losses and liabilities early, but not unrealised gains. That is why inventory is valued at the lower of cost and net realisable value.
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