What is the Income Statement?

The income statement presents the financial results of a business for a stated period of time. The statement quantifies the amount of revenue generated and expenses incurred by an organization during a reporting period, as well as any resulting net profit or net loss. The income statement is an essential part of the financial statements that an organization releases. The other parts of the financial statements are the balance sheet and statement of cash flows.

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The Income Statement

The Interpretation of Financial Statements

Types of Income Statements

There are several types of income statements. Several variations are discussed below:

Classified income statement. This statement is structured to include subtotals for the gross margin, all operating expenses, and again for all non-operating expenses. A business uses a classified income statement when it has a large number of revenue and expense accounts, and wants to consolidate this information to make it more easily readable. Larger businesses use this format.
Single step income statement. This statement only uses one subtotal for all revenues and one subtotal for all expenses. The single step approach is used by many smaller organizations that do not store information in very many accounts.
Condensed income statement. If the intent is to present just a few summary-level line items, then a condensed format can be used. This presentation likely only has one line item for revenue, one line item for the cost of goods sold, and one more for operating expenses. It is useful when reporting to outside users that only care about the general results reported by a business.
Comparative income statement. This format shows the results of more than one reporting period in a set of adjacent columns. It is highly recommended for evaluating an organization’s results over time, through a simple side-by-side comparison of the reported information.

The income statement may be presented by itself on a single page, or it may be combined with other comprehensive income information. In the latter case, the report format is called a statement of comprehensive income.

How to Use an Income Statement

An income statement can be used in several ways. One is to develop ratios that can pinpoint areas of improvement for a business, such as the gross margin ratio (calculated as the gross margin divided by sales) and the net profit ratio (calculated as the net profit or loss divided by sales). Another use is to track income statement line items over time, to see if there are any spikes or dips in the data that indicate the presence of problems that management should address.

Contents of an Income Statement

There is no required template in the accounting standards for how the income statement is to be presented. Further, the information contained within it can vary considerably by industry. Nonetheless, there are certain common elements found in most income statements, which are noted below.

Revenue

Revenue is the sales generated by a business. The gross amount of revenue is stated in the first line item of the income statement, after which deductions are listed for sales returns and allowances. These deductions are subtracted from the revenue figure to derive a net revenue number. Some organizations prefer to net these two line items together, so that only a net revenue figure is presented. Another option is for a business to present a different line item for each revenue source, such as one line for goods sold and another line for services sold.

Cost of Goods Sold

The cost of goods sold line item appears directly beneath the revenue line item. It states the total expense associated with the goods and services sold during the stated reporting period. It contains the costs of direct labor, direct materials, and factory overhead. If only services are being sold, then this line may instead be stated as the cost of services provided, or the cost of sales.

Gross Profit

The gross profit line item is revenue minus the cost of goods sold.

Operating Expenses

The operating expenses section contains a number of line items that may instead be classified as selling, general and administrative expenses. It includes all expenses required to run the business that were not already included in the cost of goods sold. These expenses cover the areas of sales, marketing, IT, risk management, human resources, accounting, and finance. The line items in this section may be stated by function, such as rent expense, utilities expense, and compensation expense.

Profit Before Tax

The profit before tax line item is the gross profit minus all operating expenses.

Income Tax Expense

The income tax expense line item contains both paid and accrued income taxes for the reporting period.

Profit After Tax

The profit after tax line item is the profit before tax minus the income tax expense.

Presentation of the Income Statement

When presenting information in the income statement, the focus should be on providing information in a manner that maximizes information relevance to the reader. This may mean that the best presentation is one in which the format reveals expenses by their nature, as shown in the following example. This format typically works best for a smaller business.

Revenue
 
XXX

Expenses:
 
Change in finished goods inventories
XXX
 
Raw materials used
XXX
 
Employee benefits expense
XXX
 
Depreciation expense
XXX
 
Telephone expense
XXX
 
Other expenses
XXX
 
Total expenses
 
XXX

Profit before tax
 
XXX

However, relevance to the reader may dictate that a better approach is to present expenses by function, in which case the layout changes to something similar to the following example. This format usually works best for a larger organization that has multiple departments.

Revenue
XXX

Cost of sales
XXX

Gross profit
XXX

Administrative expenses
XXX

Distribution expenses
XXX

Research and development expenses
XXX

Other expenses
XXX

Total expenses
XXX

Profit before tax
XXX

Of the presentation methods just described, showing expenses by their nature is the simplest to account for, since it involves no allocations of expenses between segments of the business. However, showing expenses by their function makes it easier to determine where costs are consumed within an organization, and so contributes to the control of costs.

It is useful to include in either form of presentation as many aggregated line items and subtotals as necessary to most clearly convey to the reader the financial performance of the reporting entity.

Example of an Income Statement

The Hegemony Toy Company presents its results in two statements by their nature, resulting in the following format, beginning with the income statement:

Hegemony Toy Company
Income Statement
For the years ended December 31

(000s)
20x2
20x1

Revenue
$1,000,000
$800,000

Other income
10,000
15,000

Changes in finished goods inventories
(320,000)
(205,000)

Raw materials used
(70,000)
(80,000)

Employee benefits expense
(150,000)
(210,000)

Depreciation and amortization expense
(120,000)
(105,000)

Impairment of property, plant, and equipment
0
(35,000)

Other expenses
(55,000)
(61,000)

Finance costs
(19,000)
(20,000)

Profit before tax
276,000
99,000

Income tax expense
(95,000)
(35,000)

Profit for the year from continuing operations
181,000
64,000

Loss for the year from discontinued operations
(35,000)
0

PROFIT FOR THE YEAR
$146,000
$64,000

 
 
 

Earnings per share:
 
 

Basic
$0.15
$0.11

Diluted
0.07
0.08

Hegemony then adds on the following statement of comprehensive income:

Hegemony Toy Company
Statement of Comprehensive Income

(000s)
20x2
20x1

Profit for the year
$146,000
$64,000

Other comprehensive income:
 
 

Exchange differences on translating foreign operations
12,000
11,000

Available-for-sale financial assets
5,000
(2,000)

Actuarial losses on defined benefit pension plan
(1,000)
(5,000)

Other comprehensive income, net of tax
16,000
4,000

TOTAL COMPREHENSIVE INCOME
162,000
68,000