What is a Multi-Step Income Statement?

The multi-step income statement includes multiple subtotals within the income statement. This layout makes it easier for readers to aggregate selected types of information within the report, especially in regard to the core operations of a business. The usual subtotals are for the gross margin, operating expenses, and other income, which allow readers to determine how much the company earns just from its manufacturing activities (the gross margin), what it spends on supporting operations (the operating expense total) and what component of its results do not relate to its core activities (the other income total). In short, this approach makes it easier to understand the financial results of a business.

Given its higher level of information content, the multi-step format is usually preferred over the single step format (which does not incorporate sub-totals and so can be more difficult to read).

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Problems with the Multi-Step Income Statement

There are some problems with the multi-step format for an income statement, which are as follows:

Complexity. A multi-step income statement is more detailed and longer than a single-step statement, making it harder for non-expert users to understand quickly. The extensive breakdown of revenues, expenses, and different profit levels can be overwhelming, especially for small business owners or investors without an accounting background.
Time-consuming preparation. Preparing a multi-step income statement requires detailed categorization of expenses into operating and non-operating items, which can be time-intensive for accounting teams. Smaller businesses with limited resources might find it challenging to maintain the level of detail required.
Risk of misclassification. The detailed nature of a multi-step income statement increases the risk of incorrectly categorizing expenses or revenues as either operating or non-operating. Misclassifications can distort profit margins and mislead stakeholders about a company’s core operational efficiency.
Potential for manipulation. Management might be tempted to reclassify certain expenses as non-operating to make operating income appear stronger. This potential for earnings management can reduce the reliability and credibility of the financial statements.
Not always suitable for service-based businesses. Multi-step income statements emphasize cost of goods sold (COGS) and gross profit, which may not be as relevant for service-based businesses that lack direct material costs. As a result, the format might not accurately reflect the financial performance of companies with a service-oriented model.

These problems highlight the challenges of using a multi-step income statement, particularly for smaller businesses or those in service industries.

Fraud in the Presentation of a Multi-Step Income Statement

It is possible that management could deliberately shift expenses out of the cost of goods sold category and into operating expenses in order to falsely imply an improvement in gross margins. This could be considered a form of financial statement fraud, and can only be perpetrated when the multi-step format is used, since readers are focusing on the content of the presented subtotals.