Income Statement
Practice As You Learn
Practice as You Learn
You should memorize the formats of the single-step and the multi-step income statements
Single Step:
List all revenues and subtotal
List all expenses and subtotal
Total revenues less total expenses = net income
Multi Step:
Sales
– CGS___________
= Gross Profit
– Operating expense
= Income from operations
+ – Other revenues and expenses
= Income before tax expense
– Tax expense
= Income from continuing operations
+- Discontinued operations
= Net Income
Important:
Revenues are recognized when earned
Expenses are recognized when incurred
When cash is paid and received does not matter
This is accrual based accounting and follows the matching principle
Practice Problem 1 – Income Statement – Reporting revenues and expenses
Prepaid Legal, Inc. had the following transactions occur during the month of January:
- Customers paid the company $480,000 for one year of legal service to be earned equally over the year.
- Employees worked and the company incurred $14,000 in salaries for the month of January.
- The company paid $12,000 for salaries to employees during January.
- The December utility bill of $1,200 was paid in January
- The January utility bill of $2,500 was received but not paid.
- The company purchased office furniture for $32,000 in January that is expected to be used for the next 8 years.
- The company incurred $800 of interest expense in January that won’t be paid until March.
- Liability insurance in the amount of $3,600 to cover the next six months was paid for in January
- Rent for the first three months of the year was paid in January in the amount of $6,000.
- Supplies costing $2,000 were purchased in January and supplies costing $275 were used up in January.
Prepare a single-step income statement for the month of January using the accrual basis.
Check Your Answers
Answers to Practice Problem 1 – Income Statement – Reporting revenues and expenses
You must go through each transaction and determine what was earned and what was incurred (used up or provided to the company) in January.
The amount that is earned or incurred ONLY in January will be reported on the January income statement. Cash paid or received doe NOT matter.
1) Customers paid the company $480,000 for one year of legal service to be earned equally over the year.
$480,000 / 12 months = $40,000 earned each month
The amount earned is the amount recorded as revenue
When the cash is received does not matter
2) Employees worked and the company incurred $14,000 in salaries for the month of January.
The amount incurred in January is the expense for January
3) The company paid $12,000 for salaries to employees during January.
How much is paid is not reported under the accrual basis
This is ignored – the amount incurred (see 2) during the period is reported.
4) The December utility bill of $1,200 was paid in January
This was incurred in December and will be reported as a December expense. This will not be reported in January. When it is paid does not matter.
5) The January utility bill of $2,500 was received but not paid.
This was incurred in January and will be reported as a January expense
When the utility bill will be paid does not matter.
6) The company purchased office furniture for $32,000 in January that is expected to be used for the next 8 years.
The cost of using the asset for the month of January only will be expensed in January. The cost of using a long term asset is called depreciation expense
$32,000 / 8 years = $4,000 per year / 12 months = $333 per month
7) The company incurred $800 of interest expense in January that won’t be paid until March.
The amount incurred in January will be reported as an expense in January. When the expense is paid does not matter.
8) Liability insurance in the amount of $3,600 to cover six months was paid for in January
The amount incurred only for the month of January will be expensed in January. $3,600 / 6 months = $600 for one month
9) Rent for the first three months of the year was paid in January in the amount of $6,000.
Only the cost of the rent for January will be expensed in January
The total amount paid in January does not matter. It is not the expense for January
$6,000 / 3 months = $2,000 for one month of January
10) Supplies costing $2,000 were purchased in January and supplies costing $275 were used up in January.
Only the cost of the asset that was used up during January will be expensed in January. Expense the $275 used up. The rest, $1,725, is an asset and has future benefit.
Prepare the income statement – use the single step format since there is no cost of goods sold and this is a service company
| Service Fee Revenues | $40,000 | (1) |
| Less Expenses: | ||
| Salary | (14,000) | (2) |
| Utilities | (2,500) | (5) |
| Depreciation | (333) | (6) |
| Interest | (800) | (7) |
| Insurance | (600) | (8) |
| Rent | (2,000) | (9) |
| Supplies | (275) | (10) |
| Total Expenses | (20,508) | |
| __________ | ||
| Income before Tax | $19,492 | |
| ========= |
Practice Problem 2 – Prepare a Multi-Step Income Statement
The following items were taken from the company’s accounting records for the year ended December 31st.
| Sales |
5,400,000 |
General & Admin expense |
850,000 |
|
| Cost of Goods Sold |
3,200,000 |
Selling expense |
400,000 |
|
| Interest Expense |
70,000 |
Income tax expense |
40% |
|
| Rent Income |
80,000 |
Loss from selling a major prod line |
75,000 |
|
| Loss on sale of building |
15,000 |
Accumulated Depreciation |
27,000 |
|
| Unusual Loss |
130,000 |
Dividends Paid |
100,000 |
|
| Research and Develop |
125,000 |
Restructuring Expenses |
180,000 |
|
| Gain – Infrequent & Unusual |
200,000 |
Accrued expenses |
32,000 |
|
| Prepaid Expenses |
30,000 |
Salaries Payable |
49,000 |
Prepare a multi-step income statement in proper format.
Check Your Answers
Answers to Practice Problem 2 – Prepare a Multi-Step Income Statement
Write the standard format first and then write in the accounts and amounts
Accrued expenses is a liability that is reported on the balance sheet
Salaries payable is a liability that is reported on the balance sheet
Prepaid expenses is an asset that is reported on the balance sheet
Dividends paid is not an expense and is not reported on the income statement
Dividends paid is a reduction to retained earnings.
Accumulated depreciation is a contra-asset account that is reported on the balance sheet. It is for all prior years and is not the same as depreciation expense which is the expense related to using the asset for this year only.
Multi-Step Income Statement:
|
Sales
|
5,400,000
|
|
– CGS
|
3,200,000
|
|
= Gross Profit
|
2,200,000
|
|
– Operating expense:
|
|
|
Selling
|
400,000
|
|
General & Administrative
|
850,000
|
|
Research & Development
|
125,000
|
|
Restructuring
|
180,000
|
|
= Income from operations
|
645,000
|
|
+ – Other revenues and expenses:
|
|
|
Interest Expense
|
(70,000)
|
|
Rent Income
|
80,000
|
|
Loss on sale of building
|
(15,000)
|
|
Unusual Loss
|
(130,000)
|
|
= Income before taxes
|
510,000
|
|
– Tax Expense
|
(204,000)
|
|
= Income from continuing operations
|
306,000
|
|
+ – Discontinued operations loss
|
(75,000)
|
|
+ – Extraordinary gain
|
200,000
|
|
= Net Income
|
431,000
|
Unusual only is reported in the “other” category
Selling a major product line is a discontinued operation
Tax expense = Income before tax x 40%