How to Prepare an Income Statement

An income statement contains information about a company's revenues and expenses and the resulting net income.

Net income is computed by deducting all expenses from all revenues. It is the primary measure of the company's ability to make money.

In this tutorial, we will prepare an income statement of a sole proprietorship service-type business using information from previous lessons. We will be using the adjusted trial balance from this lesson: Adjusted Trial Balance. If you want, you may take a look at how an income statement looks like here before we proceed.

When you're ready, let's begin.

Step 1: Gather the necessary information

In an accounting system, the best tool to take information from would be the "adjusted trial balance". This is the most updated trial balance (i.e. prepared after considering adjustments to several accounts). In any case, any report that shows a complete listing of company accounts can be used.

Let's take the adjusted trial balance of Gray Electronic Repair Services.

Gray Electronic Repair Services
Adjusted Trial Balance
December 31, 2014
         
Account Title   Debit   Credit
Cash   $    7,480.00    
Accounts Receivable   3,700.00    
Service Supplies   600.00    
Furniture and Fixtures   3,000.00    
Service Equipment   16,000.00    
Accumulated Depreciation       $      720.00
Accounts Payable       9,000.00
Utilities Payable       1,800.00
Loans Payable       12,000.00
Mr. Gray, Capital       13,200.00
Mr. Gray, Drawing   7,000.00    
Service Revenue       9,850.00
Rent Expense   1,500.00    
Salaries Expense   3,500.00    
Taxes and Licenses   370.00    
Utilities Expense   1,800.00    
Service Supplies Expense   900.00    
Depreciation Expense   720.00    
Totals   $  46,570.00   $  46,570.00

Step 2: Start by making the heading

The heading of a financial statement is made up of three lines. The first line contains the name of the company (Gray Electronic Repair Services). The second line shows the title of the report (Income Statement). And the third line indicates the period reported.

For income statements, we use For the Year Ended..., For the Quarter Ended..., For the Month Ended..., etc., depending on the period covered in the report. Nonetheless, some annual income statements omit the "For the Year Ended" phrase.

Gray Electronic Repair Services
Income Statement
For the Year Ended December 31, 2014
       

Step 3: Report all revenue accounts

From the trial balance, we will look for and report all income or revenue accounts. You will need to be familiar with different income accounts such as Service Revenue, Sales, Professional Fees, Interest Income, etc. If you need a review on that topic, you may visit this lesson: Elements of Accounting.

In the adjusted trial balance above, there is only one revenue account - Service Revenue.

Gray Electronic Repair Services
Income Statement
For the Year Ended December 31, 2014
         
Service Revenue   $ 9,850

Note: If there are multiple revenue accounts, you need to list them down and take the sum total of all revenues.

Step 4: Report all expense accounts

From the adjusted trial balance again, we will take all expenses and include them in the report. Once they are all listed, we will get the sum of all the expenses.

Gray Electronic Repair Services
Income Statement
For the Year Ended December 31, 2014
         
Service Revenue   $ 9,850
Less: Operating Expenses      
  Salaries Expense $ 3,500    
  Utilities Expense 1,800    
  Rent Expense 1,500    
  Service Supplies Expense 900    
  Depreciation Expense 720    
  Taxes and Licences 370   8,790

It is a good practice to list the expenses from highest to lowest whenever possible. This allows better analysis of company expenses.

Drawing a horizontal line means that a mathematical operation has been performed. The line after 370 indicates that we took the sum of all expenses which amounts to 8,790. The total amount of expenses is aligned with the total amount of revenues.

Step 5: Compute for the net income

Net income is equal to total revenues minus total expenses.

Gray Electronic Repair Services
Income Statement
For the Year Ended December 31, 2014
         
Service Revenue   $ 9,850
Less: Operating Expenses      
  Salaries Expense $ 3,500    
  Utilities Expense 1,800    
  Rent Expense 1,500    
  Service Supplies Expense 900    
  Depreciation Expense 720    
  Taxes and Licences 370   8,790
Net Income     $ 1,060

Again, we drew a single line under 8,790 to indicate that a mathematical operation was made. Two horizontal lines are drawn under the final amount (1,060 net income). This is known as "double-rule" and is similar to enclosing the final answers in a box or circle in your math test.

So there you go. The preparation is somewhat easy – you just need to be familiar with the different revenue and expense accounts.

Some Important Notes

This is a simplified illustration of preparing an income statement. Income tax expense was not considered in the above example. The treatment of income taxes depends upon the applicable laws of the state or country. Nonetheless, if the company is subject to income tax, the income tax expense should be deducted to get the net income. Since income tax expense is based on income, we need to get the income before tax first.

Total Revenues - Total Operating Expenses = Income Before Tax
Income Before Tax - Income Tax Expense = Net Income

Also, the income statements of merchandising and manufacturing businesses will look a little different from the above example. Gross Profit is computed before deducting the operating expenses. Gross profit is equal to Sales minus Cost of Sales.

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