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Principles of Accounting/Introduction to Accounting and Business/Single-Step vs. Multiple-Step Income Statements

Introduction to Accounting and Business

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Single-Step vs. Multiple-Step Income Statements

Single-Step Income Statement

Preparing the single-step income statement involves a simple process using one subtraction to calculate net income. It can be used by very small businesses.
An income statement, which is a summary of a business's revenues and expenses over a period of time, can be presented two different ways: multiple-step or single-step. The single-step income statement is an income statement that shows only revenues less expenses and does not include gross profit. It uses just one subtraction in order to calculate net income.
Net Income=(Revenue + Gains)−(Expenses + Losses)\text {Net Income}=\left(\text {Revenue + Gains}\right) - \left(\text {Expenses + Losses}\right)
While the single-step financial statement is a simple and basic way of presenting the income statement, it provides limited information and does not provide a detailed breakdown for operations performance of a company. Because one overall calculation is used, it is known as the single-step income statement. This format may be appropriate and allowed for very small businesses, such as sole proprietorships and partnerships. Some very small businesses might use a single-step income statement, though most businesses and all publicly traded companies must use the multiple-step income statement as required by generally accepted accounting principles (GAAP).

Single-Step Income Statement

The single-step income statement is a basic way to present an income statement. It subtracts total expenses and losses, such as costs of goods sold, from total revenues and gains in order to calculate net income.
The main difference between the single-step income statement and the multiple-step income statement is the presentation. The single-step income statement looks only at the company as a whole and does not differentiate between operating and nonoperating income. The multiple-step income statement details both operating and nonoperating expenses, providing a better disclosure of the company's operating stability. It is more common for businesses to use the multiple-step income statement because it provides greater detail on the statement and highlights the company's overall operating efficiency.

Multiple-Step Income Statement and Gross Profit

Preparing the multiple-step income statement involves numerous steps to arrive at comprehensive income. One of the first notable steps is calculating gross profit.

A multiple-step income statement is an income statement with multiple sections, subsections, and subtotals, including gross profit. It uses multiple steps to disclose operating income, income from continuing operations, net income, and comprehensive income, separating the operating income and operating expenses from the nonoperating income and expenses, gains, and losses. It is generally preferred by larger businesses as it allows investors a better understanding of the financial strength of the company. A multiple-step income statement is so named because it uses multiple steps to arrive at net income. It reports the gross profit, subtracts operating expenses, and subtracts nonoperating expenses to reach net income. Several steps are involved in preparing this type of income statement.

The first line of the multiple-step income statement is sales. Sales include the revenue a company generates during the financial statement period. For example, if a company sells $100,000 worth of products during the year, then that amount would equal sales during the financial statement period for a yearly financial statement. Also, sales less sales returns combined with allowances less sales discounts equals net sales. Net sales less cost of goods sold equals gross profit.

Cost of merchandise sold and cost of goods sold are synonymous terms. Cost of goods sold looks at the total cost of the business's goods that were sold during the year. The basic formula to calculate this is:
Cost of Goods Sold=(Beginning Inventory+Purchases)−Ending Inventory\text {Cost of Goods Sold} = \left(\text{Beginning Inventory}+\text{Purchases}\right)-{\text {Ending Inventory}}
Beginning inventory plus purchases represent the total inventory that a company could sell to its customers during the year. By subtracting ending inventory in the cost of goods sold formula, the company is not expensing any goods that have not been sold but remain in inventory. This allows for a more accurate representation of how well the company did during the year and adheres to the matching principle. Gross profit is the income from sales, or revenue, minus the cost of goods sold. It reflects how much money a company has left for other operating and nonoperating expenses. The formula for gross profit is:
Gross Profit=Sales−Cost of Goods Sold\text {Gross Profit}=\text {Sales} - {\text {Cost of Goods Sold}}
The formula for gross profit takes into account only the amounts relating the actual selling and production for the company. By looking at gross profit, any income left over can be used to run the company's operations. This may be used for expenses such as salaries, utilities, and rent. If a company has a negative gross profit, it shows the company is not selling its goods at a high enough price to cover the cost of producing the goods. Negative gross profit is typically an indicator that a company will not last much longer in the marketplace unless this problem can be solved.

How to Prepare a Multiple-Step Income Statement

Preparing the multiple-step income statement involves numerous steps after the gross profit calculation, including calculating operating income, net income, and comprehensive income, which provides details about a company's financial performance.

Calculating gross profit is a crucial step in the multiple-step income statement. However, there are additional steps necessary to fully communicate the organization's performance to financial statement users. After gross profit is entered, operating income, interest expense, taxes, discontinued operations, extraordinary items, and other comprehensive income are also presented.

Operating income, which is income earned from normal business operations, is determined next. It is calculated as gross profit less operating expenses. Common operating expenses can include advertising, sales commissions, supplies, or office equipment. Operating income excludes taxes and interest from the gross profit and reduces it by any operating expenses. These expenses are basically anything that involves the day-to-day operations of the company.
Operating Income=Gross Profit−Operating Expenses\text {Operating Income}=\text {Gross Profit}-\text {Operating Expenses}
The larger the operating income of a company, the more successful the company may be. The larger income shows that the operations of the company have been profitable before considering other revenue and expenses. It is important to know a business's income before and after taxes, as shown in the income statement.

Other revenues and expenses are items not related to the operation of the company. Common forms of other revenue and expenses include interest income, interest expenses, and dividends. Usually most of the revenues and expenses come from investments, as they are a common source of revenues that do not directly come from the company's operations.

Next, calculate net income, which is the amount of income left after all expenses have been deducted, including common nonoperating income and expenses. These may include interest revenue, interest expenses, sale of investments, or any income or expenses that do not relate to the operations of the business.
Net Income=Operating Income+Nonoperating Income(Interest, etc.)−Nonoperating Expenses(Interest, etc.)−Income Taxes\begin{gathered}\text{Net Income}=\text{Operating Income}+ \text{Nonoperating Income}\left(\text{Interest, etc.}\right)-\\ \text{Nonoperating Expenses}\left(\text{Interest, etc.}\right) - \text{Income Taxes} \end{gathered}
Then calculate comprehensive income, the amount left after deducting other comprehensive income, from the net income. Comprehensive income includes transactions that do not affect a company's operations.
Comprehensive Income=Net Income+Other Comprehensive Income\text {Comprehensive Income}=\text {Net Income}+\text {Other Comprehensive Income}

Multiple-Step Income Statement

Beginning with the important calculation for gross profit, the multiple-step income statement allows a company to disclose its operating income as well as other revenue and expenses to give a good picture of the company's operating efficiency.
<Financial Statements and their Relationships>Unusual or Infrequently Occurring Items