This lesson explains how a company determines whether it has earned a profit or experienced a loss. It also distinguishes recurring business activity from infrequent gains and losses, helping readers assess the quality and sources of a company’s earnings.
Revenue is the value of goods or services a business provides to customers. It increases the value of the business. Expenses are the costs of providing those goods or services, and they decrease the value of the business.
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What is net income?
Net income is the amount by which revenues and gains exceed expenses and losses.
What is a net loss?
A net loss occurs when expenses and losses exceed revenues and gains.
How does a gain differ from revenue?
Revenue generally comes from ordinary business activity; a gain often comes from an infrequent activity outside the company’s primary business.
What are high-quality earnings?
Earnings based mainly on sustainable, ongoing activity rather than infrequent or temporary events.
How does accrual accounting differ from cash-basis measurement?
Accrual accounting records revenue when earned and expenses when incurred, even if cash moves at another time.
Quiz questions
Which condition produces net income when gains and losses are included?Answer: Revenues and gains exceed expenses and losses.
A bakery sells baked goods and sells a delivery truck for more than its recorded value. How is the amount above the truck’s recorded value classified?Answer: As a gain from an activity outside the bakery’s primary business.
Under accrual accounting, a business delivers goods to a customer who will pay later. When does the business generally record the revenue?Answer: When the goods are delivered and the revenue is earned.
A business has used electricity but has not yet paid its bill. Under accrual accounting, when is the electricity expense generally recorded?Answer: When the electricity is used and the expense is incurred.
What information does a statement of cash flows primarily report?Answer: Cash inflows and outflows during a period.
Based on Principles of Finance by Julie Dahlquist, Rainford Knight (OpenStax), licensed CC BY 4.0. Adapted into a summary, flashcards and quizzes.