There are two primary formats for the income statement.
The single step income statement, which are already familiar with,
and the multi-step income statement, which we will learn about in this podcast.
The single step income statement lists all revenues together and totals them for total revenue.
Then all expenses are listed together and totaled for total expenses. The difference is then
net income. This format is primarily used by service firms.
Here's an example of single step income statement. You can see that revenues and gains
which will learn about later, are all listed together - same with expenses.
Let me point out one area of the presentation that some students struggle with.
Often when we report financial statements,
if we have a list of common accounts like revenues and expenses,
we will list them all in one column and carry the total out to the far column.
That does not mean - the columns don't mean debit and credit in this case, not when we're presenting the financial statements.
A multi-step income statement still lists revenues and expenses but it separates
operating revenues and expenses from nonoperating revenues and expenses,
as well as divides the accounts into important subtotals that highlight areas of importance
for investors and creditors. The subtotals include gross profit and operating income.
Here is an example of the multi-step income statement.
You can see the different subtotals listed.
Again you will see items on an inner column being subtotalled and then that amount being carried to the outer column.
Again that does not mean debit or credit so please remember that.
Now let's look at the multi-step income statement more closely.
The multi-step income statement starts with a calculation of net sales revenue.
No other revenue is included in this section.
So sales revenue's reported is first, then sales returns and allowances and sales discounts are deducted to arrive at net sales revenue.
The next important subtotal is gross profit.
This is calculated by taking net sales revenue minus cost of goods sold.
At this point cost of goods sold is the only expense deducted in this section.
You recall that gross profit is the amount that inventory was sold for, more than the cost of inventory.
The next section lists all of the operating expenses of a business.
Notice that not all expenses are listed here because not all expenses relate to operations.
The most notable expense that doesn't belong in the section is interest expense.
Because interest expense relates to how a business finances its operation not operates it.
So here operating expenses are deducted from gross profit to arrive in operating income.
Operating income has a few different names that you might hear from time to time.
It is also known as income from operations or EBIT.
EBIT stands for earnings before interest and taxes. In fact and we look back at the multi-step
income statement you'll see that about the only things that remain are interest and taxes.
Operating income is one of the most important pieces of financial data for investors and creditors
because it tends to be the most
tends to be more repeatable but since the more than net income which may include some one time events.
Therefore it has a higher predictive value
and that is important to investors.
The next section of the income statement reports not operating revenues and expenses. These items are either one time amounts like
gain on sale of land or lost from earthquake damage or items not part of central operations
like interest revenue which is earned by making a loan,
or interest expense which is incurred by financing assets with debt.
This section is sometimes known as the other section.
So here other revenues or gains are added to operating income and other expenses and losses are deducted from operating income.
This gives us a new subtotal called income before taxes.
The final section before we arrive at net income or at least the final section for an accounting
principles course is of the income tax expense section.
This expense is reported separately from all other expenses
because it's the expense that managers have the least control over.
So income tax expense is deducted from income before taxes to arrive at net income.
So which format is better?
Well it depends. The single step is easier to read and understand for service firms which don't have gross profit
and there isn't a lot of benefit from distinguishing between operating and nonoperating activities. It's the simple way to express profitability.
But there are some drawbacks. In the example this firm earned $80,000 of net income
on 303,000 dollars of revenue, but the question is how repeatable is that next year?
Let's answer that by looking at the multistate format.
The multi-step format gives us better information about gross profit and operating income. That is why non-service firms use this format.
Notice that although the company had $80,000 of net income from $200,000 of net sales revenue,
operating income was only $45,000.
In fact, 80,000 net came from the non-operating section.
If you recall, this company had a $100,000 gain on the sale of land.
How repeatable is that?
Could they just sell land at a profit each year into perpetuity?
No, they can't and that's why the multi-step format breaks out the different types of account data, so investors and creditors
can make more informed and better decisions.
And that concludes this short video on a multi-step income statement.