Financial and Management Accounting

This exercise intends to elucidate several financial accounting concepts that are commonly misconceived. These concepts include revenues, expenses, gains, losses, and cash flows. Recall that financial accounting follows an accrual basis and therefore, revenues and expenses are recognized when accrued – not when they are received or paid.

Gains and losses are also recognized on an accrual basis, but they are not exactly the same to revenues and expenses. The core difference is that revenues and expenses are gross inflows and outflows of economic benefits, whereas gains and losses are net results. Moreover, gains and losses are recognized when a firm sells goods that are not part of its main activity.  When a firm sells goods of its primary activity or provides services, it recognizes revenues and expenses.

Finally, cash inflows and outflows are easy to understand. Simply stated, they are the money you receive or pay. Although they are highly significant for the firm’s cash management they are generally irrelevant to revenue/expense recognition. Stated differently, firms never follow cash accounting.