Basic Accounting:
How to Prepare an Income Statement

In order to prepare an income statement, the accounting cycle involved must be closed; this means that a trial balance sheet must be prepared that effectively begins the summarization of the monthly recorded financial transactions.  Any adjustment to the data that is assembled, compiled and summarized is done from the trial balance sheet.  Once the information has been verified, the closing entries are journalized and posted to the ledger, and a post-closing trial balance is prepared.  Then the Income Statement is prepared.

The Income Statement is divided into three parts: Total revenues, total expenses, and net income.  The next paragraph examines the information that is contained within each section, and the role it plays in creating the remaining financial statements.

The first section listed on the Income Statement is the Total Revenues reported for the particular period of time reported.  Total Revenues are a reflection of either Sales of merchandise or Fees earned.  In a retail sales or production/manufacturing environment, total revenues is a result of product sold; therefore, the label "Sales" would be used to report revenue from business operations.  If the business is a service-based business, the revenues are labeled as "fees earned"; individual service companies such as lawyers, doctors, and accountants would use the designated label of "fees" to report revenue from business operations.

There are other sources of revenue that must also be included in the "Total Revenue" area.  Rent and Interest Revenue would be included at this point.  Also, discounts and returns would be deducted from the revenue totals.  Generally, service businesses do not include a "returns and allowances" section.  They would however at times have significant discount figures that would be included at this point.  After the addition and subtraction of the necessary figures has taken place, you have the end result known as "Total Revenues".  This completes the first section of information for the Income Statement.

Next, you have the section known as "Total Expenses".  This section includes all expenses incurred in the direct operation of the business.  The most common forms of expense include wages, salaries, rents, utilities, insurance and supplies.  Almost every business has an inclusion of variable expenses that is lumped into one category known as "miscellaneous expense"; these expenses are generally listed from largest to smallest, with miscellaneous always being the last expense reported, no matter how large or small.

Finally, the entry known as "Net Income" is a result of the subtraction of the total expenses from the total revenues.  The Net Income that is reported on the Income Statement is then transferred to the Statement of Owner's Equity, and incorporated further into the information that is made available through the Financial Statements. 

This format for reporting revenue and expense in the Income Statement is known as the Single-step format.  There are more complex forms, and more pieces of information that are tied to the Income Statement.  They will be examined in more detail in the next few articles in this series.

Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.