Study: Preparing Single-Step and Multi-Step Income Statements
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Study the (8m:58s) video for this topic provided below: Preparing Single and Multi-Step Income Statements - Slides 1-18
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Slides 1-4 (0m:41s)
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Welcome to Introduction to Accounting Preparing for a User's Perspective
Preparing Single-Step and Multi-Step Income Statements
Income Statement - Introduction
The income statement
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This topic will help you see how a properly prepared income statement can help debt and equity financiers better understand a company's financial strengths and weaknesses.
Slides 5-7 (0m:55s)
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Income Statement - Key formulas you should know
In general, income statements provide revenue and expense information for a period of time, such as for a whole year, a quarter, a month or any other time frame that the company wants to present.
The summarized income statement equation is: Net Income = Revenues – Expenses
The Net Income
Links to an external site. that a company earns must either be paid out to the owners or retained in the business on behalf of the owners. Income retained in sole proprietorships
Links to an external site. or partnerships will be retained in accounts called Capital. Income retained in corporations, rather than being paid out as dividends
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The statement of retained earnings equation is: Beginning Retained Earnings + Net Income (or - Net Loss) - Dividends = Ending Retained Earnings
Slides 8-9 (1m:09s)
Links to an external site.This topic introduces two formats for the Income Statement: a Single-Step Income Statement and a Multi-Step Income Statement.
Format for Single-Step Income Statement
Here is a simplified version of a Single-Step Income Statement.
Candy Store Co.
Income Statement
For the year ended December 31, 20X1
Total Revenues
Less: Total Expenses
= Net Income (Net Loss)
==================
It is called a "Single-Step Income Statement" because Net Income is computed in one single-step (Total Revenues - Total Expenses = Net Income). This sample Income Statement covers a period of one full year ended December 31, 20X1, but depending on what the statement users need, management can prepare an Income Statement for any period users want. I once had a client that, due to a sale of one of its subsidiaries, had to prepare, and I had to audit, an income statement that covered a period of only 17-days.
When you prepare a Single-Step Income Statement, make sure you title it properly with the name of the company, the name of the statement (i.e. income statement), the period covered by the statement and then list all revenue accounts and total them up, list all expense accounts and total them up, and then in one single-step, take Total Revenues less Total Expenses to arrive at Net Income.
Slides 10-11 (0m:41s)
Links to an external site.Let's see if you can create a Single-Step Income Statement on your own. Please get out a piece of paper and see if you can use the following revenue and expense information for Candy Store Company below to create a Single-Step Income Statement for the year ended December 31, X1. Hint: It really will improve your learning if you will write it out on a piece of paper before looking at the solution that follows.
| Sales Revenue | 100 | Utilities Expense | 3 | ||
| Cost of Goods Sold | 30 | Advertising Expense | 1 | ||
| Wages Expense | 20 | Income Tax Expense | 10 | ||
| Rent Expense | 5 | Rent Revenue | 2 |
Let's look at the solution below to see how you did:
Candy Store's owner's should note that their store was profitable in that it earned $33 of Net Income. The owners will now have to decide whether to retain the Net Income in the business in their Retained Earnings account or to pay it out to themselves as a dividend.
Slide 12 (m:25s)
Links to an external site.Format for Multi-Step Income Statement
Although the Single-Step Income Statement does indicate whether a company was profitable or not, it doesn't highlight other key operational results of the business that users want to know, such as the company's ability to:
1) sell its product for more than its cost (Gross Margin
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2) generate positive income from its core operations (Operating Income
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3) generate income before taxes (Income Before Taxes)
Slide 13 (2m:12s)
Links to an external site.To resolve these deficiencies of the Single-Step Income Statement, company management often provides a Multi-Step Income Statement as noted below.
Note: The Earnings per share Links to an external site. (EPS) figure provided at the bottom of the Income Statement, is one of the most important numbers in the financial world, and must be disclosed on the Income Statement of publicly traded companies. It is computed as Net Income / Average Shares Outstanding During the Period. In this example, I assumed that 1,000 shares were outstanding for the whole year ($33 Net Income/1,000 Average Shares Outstanding). Investors track this number very closely because it indicates how much profit the business has generated in relation to each share [of ownership] held by its investors. Investors use a business’ current EPS, and their own forecasted EPS, to compute how much they might be willing to pay to invest in a single share in the business.
Here are some key benefits of the Multi-Step Income Statement.
1) it Indicates that the company was able to sell its product for more than its cost (Gross Margin)
The Candy Store's Gross Margin of $70 is positive. This is a clear indication that it was able to sell its product at a price (i.e. Sales Revenues) greater than its cost (i.e. Cost of Goods Sold).
2) it shows that the company was able to generate positive income from its core operations (Operating Income)
The Candy Store's Operating Income of $41 is positive. This is a clear indication that its gross margin was more than enough to cover its basic operating expenses of wages, rent, utilities and advertising and still have some positive income from its core operations left over.
3) it indicates that the company was able to generate income before taxes (Income Before Taxes)
The Candy Store's Income Before Taxes of $43 is positive. This is a clear indication that the company has been able to successfully generate profits, some of which will need to be paid to the government in the form of income taxes. A company's income before taxes helps users assess management's ability to generate profits before having to worry about its tax obligations to the government, which obligations tend to be out of the personal control of a company's day-to-day management.
Slide 14 (1m:01s)
Links to an external site.Common Revenue Accounts You Should Know
Here are the common revenue accounts that you should know and use throughout this course:
| Sales Revenue |
| Rent Revenue |
| Interest Revenue |
Sales Revenue is part of a company's core operations and will be used to compute Gross Margin. On the other hand, Rent Revenue and Interest Revenue are considered to be "below-the-line" items, because they are not normally part of a company's core operations. However, if this were the Income Statement of a landlord, Rent Revenue would be part of the company's core operations and would appear "above-the-line". If this were a bank, Interest Revenue would also be "above-the-line" and be used to compute operating income. When Revenues are not considered to be part of a company's core operations, they will appear "below-the-line" in "Other Revenues". You should learn these account names and recognize that they are all revenues that will be added to arrive at Net income on the Income Statement.
Slide 15 (0m:24s)
Links to an external site.Common Expense Accounts You Should Know
The primary expense accounts that we will use throughout this course are as follows:
| Cost of Goods Sold |
| Advertising Expense |
| Delivery Expense |
| Postage Expense |
| Salaries Expense |
| Wages Expense |
| Rent Expense |
| Utilities Expense |
| Office Supplies Expense |
| Bad Debt Expense |
| Insurance Expense |
| Interest Expense |
| Income Tax Expense |
Interest Expense and Income Tax Expense are not Operating Expenses. They are "below-the-line" deductions that do not impact a company's Operating Income. Interest Expense is classified as an "Other Expense".
Slide 16 (0m:39s)
Links to an external site.In summary, the math supporting the Income Statement clearly shows that if a business’s revenues exceed its expenses, the business will report positive Net Income. However, if a business’ expenses exceed its revenues, then it will report a (Net Loss). Accountants often use "( )" rather then "-" to indicate negative amounts or deductions. Businesses that are able to consistently increase their Net Income year after year tend to be healthy and vibrant resulting in increased stock values, an increased ability to pay dividends and an increased ability to service additional debt.
Slides 17-18 (1m:08s)
Links to an external site.Through proper use of an Income Statement, a creditor or an investor can understand how a business was able to generate its Net Income. Even better, with proper analysis, and a comparative Income Statement to be discussed in the next topic, a creditor or an investor can use the Income Statement to help forecast the business' future profits. Detailed Income Statement analysis, coupled with an analysis of the Balance Sheet, Statement of Shareholder Equity, and Statement of Cash Flows, and related footnote disclosures, as well as a review of economic trend data, consumer preference data, and other business data, can all serve to help creditors and investors predict the likelihood of being repaid on loans, having their stock values increase, or receiving dividends.
By now you should be able to create a Single-Step Income Statement and a Multi-Step Income Statement. You should also be able to read these income statements focusing on key pieces of information such as Net Sales Revenues, Gross Margin, Operating Income, Income Before Taxes and Net Income. In the next topic we will analyze the Income Statement a little further.