In this video, we walk through 6 FAR practice questions teaching about preparing an income statement. These questions are from FAR content area 1 on the AICPA CPA exam blueprints: Financial Reporting.
The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.
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Preparing an Income Statement
An income statement, also known as a profit and loss statement, is a financial statement that summarizes the revenues, costs, and expenses incurred during a specific period. It provides an overview of a company’s financial performance and profitability. There are two primary formats for income statements: the single-step income statement and the multi-step income statement. Below is an overview of how to prepare each type, with a detailed focus on the multi-step income statement.
Preparing a Single-Step Income Statement
A single-step income statement is straightforward and easy to prepare. It involves combining all revenues and gains and subtracting all expenses and losses to determine net income.
Example of Single-Step Income Statement
Cedar Enterprises
Income Statement
For the Year Ended December 31, 2023
| Revenues | Amount |
|---|---|
| Sales Revenue | $3,500,000 |
| Gain on Sale of Investments | $20,000 |
| Interest Revenue | $10,000 |
| Total Revenues | $3,530,000 |
| Expenses | Amount |
|---|---|
| Cost of Goods Sold | ($1,200,000) |
| Selling Expenses | ($300,000) |
| Administrative Expenses | ($200,000) |
| Interest Expense | ($50,000) |
| Loss on Sale of Equipment | ($30,000) |
| Income Tax Expense | ($100,000) |
| Total Expenses | ($1,880,000) |
| Net Income | $1,650,000 |
Preparing a Multi-Step Income Statement
A multi-step income statement is more detailed and provides a clearer picture of a company’s financial performance. It separates operating revenues and expenses from non-operating items and distinguishes between continuing and discontinued operations.
Steps in Preparing a Multi-Step Income Statement
- Calculate Gross Profit:
- Gross Profit = Net Sales – Cost of Goods Sold
- Calculate Operating Income:
- Operating Income = Gross Profit – Operating Expenses (Selling and Administrative Expenses)
- Calculate Non-Operating Income:
- Non-Operating Income includes revenues and expenses not related to core business operations, such as interest revenue, interest expense, and gains or losses on sales of investments.
- Calculate Income from Continuing Operations Before Tax:
- Income from Continuing Operations Before Tax = Operating Income + Non-Operating Income
- Calculate Income Tax Expense:
- Income Tax Expense = Income from Continuing Operations Before Tax * Tax Rate
- Calculate Income from Continuing Operations After Tax:
- Income from Continuing Operations After Tax = Income from Continuing Operations Before Tax – Income Tax Expense
- Calculate Income from Discontinued Operations:
- Income from Discontinued Operations includes gains or losses from the disposal of segments of the business and any operating results from those segments, net of tax.
- Calculate Net Income:
- Net Income = Income from Continuing Operations After Tax + Income from Discontinued Operations
Example of Multi-Step Income Statement
Birchwood Corporation
Income Statement
For the Year Ended December 31, 2023
| Description | Amount |
|---|---|
| Revenues | |
| Sales Revenue | $4,800,000 |
| Sales Returns and Allowances | $(90,000) |
| Net Sales | $4,710,000 |
| Cost of Goods Sold | $2,100,000 |
| Gross Profit | $2,610,000 |
| Operating Expenses | |
| Marketing Expenses | ($500,000) |
| Administrative Expenses | ($350,000) |
| Total Operating Expenses | ($850,000) |
| Operating Income | $1,760,000 |
| Non-Operating Items | |
| Gain on Sale of Investment Property | $25,000 |
| Interest Revenue | $15,000 |
| Interest Expense | $(30,000) |
| Total Non-Operating Income | $10,000 |
| Income from Continuing Operations Before Tax | $1,770,000 |
| Income Tax Expense | $(495,600) |
| Income from Continuing Operations After Tax | $1,274,400 |
| Discontinued Operations | |
| Loss on Disposal of Discontinued Operations (net of tax) | $(10,800) |
| Income from Discontinued Operations | $(10,800) |
| Net Income | $1,263,600 |
Explanation of Key Sections
- Gross Profit: This section shows the profit a company makes after deducting the costs associated with making and selling its products. It is calculated by subtracting the cost of goods sold (COGS) from net sales.
- Operating Income: This is the profit realized from the company’s core business operations. It is derived by subtracting operating expenses (selling and administrative expenses) from gross profit.
- Non-Operating Income: This section includes income and expenses not related to the company’s main business activities, such as interest revenue, interest expense, and gains or losses from investments.
- Income from Continuing Operations: This represents the company’s profit from its ongoing business activities after accounting for taxes.
- Discontinued Operations: This section includes results from parts of the business that have been sold or terminated, including any gains or losses from the disposal, presented net of tax.
By breaking down the income statement into these sections, a multi-step income statement provides a detailed and comprehensive view of a company’s financial performance, making it easier for stakeholders to understand the sources of income and expenses.
