How To Prepare A Multiple Step Income Statement For A Service Business

Learning Outcomes

Gear up a multi-step income statement

A merchandising visitor uses the same 4 financial statements we learned earlier:

income statement
statement of retained earnings
balance sheet
statement of cash flows

A handwritten money ledger.

The income statement for a merchandiser is expanded to include groupings and subheadings necessary to make it easier for investors to read and understand. We will look at the income statement only as the other statements have been discussed previously.

In preceding chapters, nosotros illustrated the income statement with but two categories—revenues and expenses. In contrast, a multi-step income statement divides both revenues and expenses into operating and nonoperating (other) items. The statement also separates operating expenses into selling and authoritative expenses. A multi-stride income statement is besides chosen a classified income statement.

Watch this video about preparing a multi-step income statement. Come back equally many times as you need to practice creating a multi-step income argument:

You lot can view the transcript for "Prepare a Multiple Step Income Argument (Financial Accounting Tutorial #32)" here (opens in new window).

The multi-footstep income argument shows important relationships that help in analyzing how well the company is performing. For example, by deducting COGS from operating revenues, you can determine by what amount sales revenues exceed the COGS. If this margin, called gross margin, is lower than desired, a visitor may need to increase its selling prices and/or decrease its COGS. The classified income argument subdivides operating expenses into selling and administrative expenses. Thus, statement users can see how much expense is incurred in selling the production and how much in administering the business. Statement users can also make comparisons with other years' information for the same business and with other businesses. Nonoperating revenues and expenses appear at the lesser of the income statement because they are less significant in assessing the profitability of the business organization.

Management chooses which income statement to present a visitor'due south financial data. This choice may be based either on how their competitors present their data or on the costs associated with assembling the data.

The major headings of the classified multi-step income statement are explained below:

Net Sales are the revenues generated by the major activities of the business concern—normally the sale of products or services or both less any sales discounts and sales returns and allowances.
COGS is the major expense in merchandising companies and represents what the seller paid for the inventory it has sold.
Gross margin or gross profit is the net sales COGS and represents the amount we charge customers above what we paid for the items. This is also referred to equally a visitor's markup.
Operating expenses for a merchandising company are those expenses, other than COGS, incurred in the normal business functions of a company. Usually, operating expenses are either selling expenses or administrative expenses. Selling expenses are expenses a company incurs in selling and marketing efforts. Examples include salaries and commissions of salespersons, expenses for salespersons' travel, commitment, advertizing, hire (or depreciation, if owned) and utilities on a sales building, sales supplies used, and depreciation on commitment trucks used in sales. Administrative expenses are expenses a company incurs in the overall management of a business. Examples include authoritative salaries, rent (or depreciation, if owned) and utilities on an administrative edifice, insurance expense, administrative supplies used, and depreciation on office equipment.
Income from Operations is Gross profit (or margin) operating expenses and represents the amount of income straight earned by business operations.
Other revenues and expenses are revenues and expenses non related to the sale of products or services regularly offered for auction by a business. This typically includes involvement earned (interest revenue) and interest owed (interest expense).
Net Income is the income earned after other revenues are added and other expenses are subtracted.

For case, hither are income statements from The Home Depot, Inc. annual study for the fiscal year ended Feb 2, 2020:

THE Domicile DEPOT INC.
CONSOLIDATED STATEMENTS OF EARNINGS
in millions, except per share information	Fiscal 2019	Fiscal 2018	Fiscal 2017
Internet sales	$ 110,225	$ 108,203	$ 100,904
Toll of sales	72,653	71,043	66,548
Gross Profit	Single line37,572	Single line37,160	Single line34,356
Subcategory, Operating expenses:	Single line	Single line	Single line
Selling, general and authoritative	19,740	nineteen,513	17,864
Depreciation and amortization	one,989	1,870	1,811
Damage loss	—	247	—
Total operating expenses	Single line21,729	Single line21,630	Unmarried line19,675
Operating income	Single line15,843	Single linefifteen,530	Single line14,681
Subcategory, Interest and other (income) expenses:	Single line	Single line	Unmarried line
Interest and investment income	(73)	(93)	(74)
Involvement expense	1,201	ane,051	1,057
Other	—	16	—
Involvement and other, net	Single line1,128	Unmarried line974	Single line983
Earnings before provision for income taxes	Single lineone,128	Single line974	Single line983
Provision for income taxes	three,473	3,435	5,068
Internet earnings	Unmarried line$ 11,242Double line	Single line$ 11,121Double line	Single line$ 8,630Double line

One of the important features of the multiple-step income argument is the sub-full for operating income. Observe that net income is the bottom line simply it includes a provision for income taxes and also interest expense. If you lot were comparing two different companies, one that was capitalized past possessor disinterestedness, and the other that relied heavily on borrowed money (that incurs involvement expense), the subtotal for operating income would give y'all a figure to compare between the two that is strictly the results of business organisation operations.

Summary

To summarize the of import relationships in the income statement of a merchandising firm in equation form:

Internet sales = Sales revenue − Sales discounts − Sales returns and allowances.
Gross profit = Net sales − Cost of appurtenances sold.
Operating expenses = Selling expenses + Administrative expenses.
Operating income = Gross margin − Operating (selling and administrative) expenses.
Other income/revenues and expenses = Other Revenues − Other Expenses
Net income/Net earnings = Income from operations + Other revenues − Other expenses.

Each of these relationships is important considering of the way it relates to an overall measure of business concern profitability. For case, a company may produce a high gross margin on sales. Still, because of large sales commissions and commitment expenses, the owner(s) may realize only a very pocket-sized amount of the gross margin every bit profit.

Exercise Question