How to Prepare a Multi-Step Income Statement

A multi-step income statement provides a detailed view of a company’s financial performance, breaking down revenues and expenses into distinct categories. This process not only helps in understanding the overall profitability but also in analyzing operational efficiency and cost management.

Understanding the Multi-Step Income Statement

A multi-step income statement is more detailed than a single-step income statement. It separates operating revenues and expenses from non-operating ones and distinguishes between direct and indirect expenses. The primary advantage of a multi-step income statement is that it provides a clear and comprehensive breakdown of a company’s financial activities, which can be highly beneficial for management, investors, and other stakeholders.

Key Components of a Multi-Step Income Statement

  1. Gross Profit: This is calculated by subtracting the cost of goods sold (COGS) from net sales.
  2. Operating Income: This is derived by subtracting operating expenses from gross profit.
  3. Non-Operating Income and Expenses: These include revenues and expenses not related to the core business operations.
  4. Net Income: The final profit after all revenues and expenses have been accounted for.

Let’s break these down further and discuss how to compile each section step by step.

Step 1: Net Sales

Net sales represent the revenue from the sale of goods or services, after deducting returns, allowances, and discounts. It is the first line item on the income statement.

Calculation:

\text{Net Sales} = \text{Gross Sales} - \text{Sales Returns and Allowances} - \text{Sales Discounts}

Example: If a company has gross sales of $500,000, sales returns and allowances of $20,000, and sales discounts of $5,000, the net sales would be:

\text{Net Sales} = \$500,000 - \$20,000 - \$5,000 = \$475,000

Step 2: Cost of Goods Sold (COGS)

COGS is the direct cost attributable to the production of the goods sold by the company. This includes the cost of materials and direct labor used in creating the product.

Calculation:

\text{COGS} = \text{Beginning Inventory} + \text{Purchases during the Period} - \text{Ending Inventory}

Example: If the beginning inventory is $50,000, purchases during the period are $200,000, and ending inventory is $40,000, the COGS would be:

\text{COGS} = \$50,000 + \$200,000 - \$40,000 = \$210,000

Step 3: Gross Profit

Gross profit is calculated by subtracting the COGS from net sales. It represents the profit a company makes after deducting the costs associated with making and selling its products.

Calculation:

\text{Gross Profit} = \text{Net Sales} - \text{COGS}

Example: Using our previous examples for net sales ($475,000) and COGS ($210,000):

\text{Gross Profit} = \$475,000 - \$210,000 = \$265,000

Step 4: Operating Expenses

Operating expenses are the costs required to run the day-to-day operations of the business. These can be divided into selling expenses and general and administrative expenses.

Categories:

  1. Selling Expenses: Costs related to the sale of products (e.g., advertising, sales salaries, commissions).
  2. General and Administrative Expenses: Overhead costs not directly tied to production or sales (e.g., office salaries, rent, utilities).

Example: If selling expenses are $60,000 and general and administrative expenses are $90,000, the total operating expenses would be:

\text{Total Operating Expenses} = \$60,000 + \$90,000 = \$150,000

Step 5: Operating Income

Operating income is calculated by subtracting the total operating expenses from the gross profit. It represents the profit earned from the core business operations.

Calculation:

\text{Operating Income} = \text{Gross Profit} - \text{Operating Expenses}

Example: Using our previous examples for gross profit ($265,000) and operating expenses ($150,000):

\text{Operating Income} = \$265,000 - \$150,000 = \$115,000

Step 6: Non-Operating Income and Expenses

Non-operating income and expenses include revenues and costs not related to the primary business activities. These can include interest income, interest expense, gains or losses on sales of assets, and other miscellaneous items.

Example: If a company has interest income of $5,000, interest expense of $10,000, and a gain on the sale of an asset of $2,000, the net non-operating income/expense would be:

\text{Net Non-Operating Income/Expense} = \$5,000 - \$10,000 + \$2,000 = -\$3,000

Step 7: Income Before Taxes

Income before taxes is calculated by adding the operating income and the net non-operating income/expenses. This represents the total income before tax obligations are accounted for.

Calculation:

\text{Income Before Taxes} = \text{Operating Income} + \text{Net Non-Operating Income/Expense}

Example: Using our previous examples for operating income ($115,000) and net non-operating expense (-$3,000):

\text{Income Before Taxes} = \$115,000 - \$3,000 = \$112,000

Step 8: Income Tax Expense

Income tax expense is the amount of tax the company owes to the government based on its taxable income.

Example: If the income tax rate is 30%, the income tax expense would be:

\text{Income Tax Expense} = \$112,000 \times 0.30 = \$33,600

Step 9: Net Income

Net income is the final profit of the company after all revenues and expenses, including taxes, have been accounted for.

Calculation:

\text{Net Income} = \text{Income Before Taxes} - \text{Income Tax Expense}

Example: Using our previous examples for income before taxes ($112,000) and income tax expense ($33,600):

\text{Net Income} = \$112,000 - \$33,600 = \$78,400

Comprehensive Example

Let’s compile all these steps into a comprehensive example to create a multi-step income statement.

Example Data:

  • Gross Sales: $600,000
  • Sales Returns and Allowances: $30,000
  • Sales Discounts: $10,000
  • Beginning Inventory: $70,000
  • Purchases during the Period: $250,000
  • Ending Inventory: $80,000
  • Selling Expenses: $70,000
  • General and Administrative Expenses: $100,000
  • Interest Income: $6,000
  • Interest Expense: $12,000
  • Gain on Sale of Asset: $4,000
  • Income Tax Rate: 30%

Step-by-Step Calculation:

  1. Net Sales:
    \text{Net Sales} = \$600,000 - \$30,000 - \$10,000 = \$560,000
  2. COGS:
    \text{COGS} = \$70,000 + \$250,000 - \$80,000 = \$240,000
  3. Gross Profit:
    \text{Gross Profit} = \$560,000 - \$240,000 = \$320,000
  4. Total Operating Expenses:
    \text{Total Operating Expenses} = \$70,000 + \$100,000 = \$170,000
  5. Operating Income:
    \text{Operating Income} = \$320,000 - \$170,000 = \$150,000
  6. Net Non-Operating Income/Expense:
    \text{Net Non-Operating Income/Expense} = \$6,000 - \$12,000 + \$4,000 = -\$2,000
  7. Income Before Taxes:
    \text{Income Before Taxes} = \$150,000 - \$2,000 = \$148,000
  8. Income Tax Expense:
    \text{Income Tax Expense} = \$148,000 \times 0.30 = \$44,400
  9. Net Income:
    \text{Net Income} = \$148,000 - \$44,400 = \$103,600

Final Multi-Step Income Statement:

Company Name
Income Statement
For the Year Ended [Date]

Net Sales:                   $560,000
Cost of Goods Sold:          $240,000
                             ---------
Gross Profit:                $320,000

Operating Expenses:
  Selling Expenses:          $70,000
  General & Administrative:  $100,000
                             ---------
Total Operating Expenses:    $170,000
                             ---------
Operating Income:            $150,000

Non-Operating Income/Expenses:
  Interest Income:           $6,000
  Interest Expense:          ($12,000)
  Gain on Sale of Asset:     $4,000
                             ---------
Net Non-Operating Expenses:  ($2,000)
                             ---------
Income Before Taxes:        

 $148,000
Income Tax Expense (30%):    $44,400
                             ---------
Net Income:                  $103,600

Analysis and Interpretation

A multi-step income statement not only provides detailed insights into a company’s profitability but also highlights key areas such as gross profit, operating income, and non-operating activities. By analyzing these components, stakeholders can make more informed decisions regarding operational efficiency, cost control, and investment strategies.

Gross Profit Margin

Gross profit margin is an important metric that indicates the percentage of revenue that exceeds the COGS. It measures how efficiently a company uses its materials and labor to produce and sell products.

Calculation:

\text{Gross Profit Margin} = \left( \frac{\text{Gross Profit}}{\text{Net Sales}} \right) \times 100

Example:

\text{Gross Profit Margin} = \left( \frac{\$320,000}{\$560,000} \right) \times 100 \approx 57.14\%

Operating Margin

Operating margin shows the percentage of revenue that remains after covering operating expenses. It is a key indicator of a company’s operational efficiency.

Calculation:

\text{Operating Margin} = \left( \frac{\text{Operating Income}}{\text{Net Sales}} \right) \times 100

Example:

\text{Operating Margin} = \left( \frac{\$150,000}{\$560,000} \right) \times 100 \approx 26.79\%

Net Profit Margin

Net profit margin indicates the percentage of revenue that remains as profit after all expenses, including taxes, have been deducted.

Calculation:

\text{Net Profit Margin} = \left( \frac{\text{Net Income}}{\text{Net Sales}} \right) \times 100

Example:

\text{Net Profit Margin} = \left( \frac{\$103,600}{\$560,000} \right) \times 100 \approx 18.5\%

Conclusion

Preparing a multi-step income statement involves a detailed breakdown of revenues and expenses, allowing for a comprehensive analysis of a company’s financial health. By following the steps outlined in this tutorial, you can accurately compile each section of the income statement, from net sales to net income. This process not only enhances transparency but also provides valuable insights for strategic decision-making.

Related posts:

  1. The Role of Accounting in Corporate Social Responsibility (CSR)
  2. Fair Value Accounting: Advantages and Pitfalls
  3. The Importance of Earnings Quality in Financial Reporting
  4. How to Prepare for an IRS Audit: A Checklist for Accounting Pros
  5. Embracing Technology to Attract Young Accounting Professionals
  6. A Deep Dive into the Accounting Standards Codification (ASC)
  7. Budgeting 101: A Beginner’s Guide to Taking Control of Your Finances
  8. Using Horizontal and Vertical Analysis in Financial Statements
  9. How to Account for Bad Debts Using the Allowance Method
  10. How to Prepare a Trial Balance