The multiple-step format for the income statement provides more information than the single-step method and is the preferred format for the vast majority of publicly traded companies. A publicly traded company is one whose stock is for sale to the general public, like you or me, on one of the stock exchanges such as the NASDAQ Stock Market also known merely as the NASDAQ.
The big differences between the single- and multiple-step formats are the following:
The multiple-step format has a line item for gross profit and income from operations.
The multiple-step format uses parentheses to indicate certain items that are subtracted rather than added. The single-step format assumes that the readers can figure out this information on their own.
Regardless of which method you use, the bottom-line net income doesn’t change — just the presentation does. Here are the subdivisions of operating revenue and expense elements that separately show up with the multiple-step format:
Net sales: Net sales is the difference between gross sales and any relevant contra-accounts. The precipitating event with gross sales is an implicit or written contract between a company and its customer. The contract states that an agreed-upon good or service is to be provided for a set amount of money.
Two contra revenue accounts you cover in your financial accounting class are sales discounts and sales returns and allowances. Sales discounts reflect any discount a business gives to a good vendor that pays early. Sales returns and allowances reflect all products that customers return to the company after the sale is complete.
A company’s gross sales revenue includes only transactions that relate to the purpose of the business. For example, a department store’s revenue includes the gross amount of merchandise sold to customers.
Cost of goods sold: The cost of goods sold (COGS) reflects all costs directly tied to any product a company makes or sells.
Net sales minus cost of goods sold gives you gross profit.
A service company, such as a doctor’s or lawyer’s office, does not have a COGS because it does not sell a tangible product.
Selling expenses: These expenses are any expenses a company incurs to sell its goods or services to customers. Some examples are salaries and commissions paid to sales staff; advertising expense; store supplies; and depreciation of furniture, equipment, and store fixtures the company uses for the purpose of selling or marketing its products. Typical retail shop depreciable items include cash registers, display cases, and clothing racks.
General and administrative expenses: This category includes all expenses a company incurs to keep up normal business operations. Some examples are office supplies, officer and office payroll, nonfactory rent and utilities, and accounting and legal services.
Gross profit minus all operating expenses, such as selling and general and administrative expenses, gives you income (or loss) from operations.
Other revenues/gains: This section includes company income not related to its business purpose. An example of other revenue is the sale of a company vehicle for a gain or dividend income on investments the company holds.
Other expenses/losses: This section includes costs the company incurs outside the bounds of business operations. Two types of expenses you typically see in this section of the income statement are interest expense and loss on disposal of an asset.
Income from operations plus other revenues/gain and minus other expenses/losses gives you income before taxes.
Income tax: Before you figure the final total for net income or loss, you have to reduce income before taxes by subtracting a provision for the income tax the company will pay when it files tax returns. Just remember that, depending on many different factors, the business may owe federal or federal and state income tax — and maybe other types of income taxes as well.
You need to work through other income statement items, too, before you can really get a grip on preparing a multiple-step income statement.