There are two primary formats for the income statement the single step income statement and the multi-step income statement.
The Single Step Income Statement lists all revenues together and totals them for total revenue. All expenses are then listed together and totaled for total expenses. The difference is then net income or loss. This format is primarily used by service firms.
A Multi-Step Income Statement still lists revenues and expenses but it separates operating revenues and expenses from non operating revenues 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.
Let's look at the multi-step income statement more closely.
The multi-step income statement starts with the calculation of net sales.
Sales revenue is reported first then sales returns and allowances and sells discounts are deducted to arrive at net sales.
An important subtotal is Gross Profit. This is calculated by taking net sales revenue and deducting costs of goods sold.
The next section lists all of the operating expenses of a business. Note that not all expenses are listed here because not all expenses relate to operations.
The most notable expense that doesn't belong in this section is interest expense because interest expense relates to how a business finances its operation not operates it.
The total operating expenses are deducted from gross profit to arrive at operating income. Operating income has a few different names that you might hear from time to time such as income from operations or EBIT. EBIT stands for earnings before interest and taxes.
The next section of the income statement reports the non operating revenues and expenses. These items are either one-time amounts like a gain on the sale of land or a loss 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. It's here that other revenues and 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 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.
The income tax expense is deducted from income before taxes to arrive at net income or loss.
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 non-operating activities. It's the simple way to express profitability.
The multi-step format gives us better information about gross profit and operating income. That is why non service firms use this format. The multi-step format breaks out the different types of account data so investors and creditors can make more informed and better decisions.