Multi-Step Income StatementExplained & Defined

Written By:
Adiste Mae

Reviewed By:
FundsNet Staff

What is a Multi-Step Income Statement?

A multi-step income statement is an accounting manner of segregating the total revenue and expenses into specific functions like operating and non-operating activities.

By way of this method of recording, businesses can easily analyze the financial performance in a specific accounting period.

It also benefits the users of the income statement to understand the operations of the business and provides the user an insight into how the company generates income through its primary income-related activities, as well as the behavior of costs of sales and other operating and non-operating expenses.

The multi-step income statement is used when a single-step income statement is inadequate for a reporting period for a business.

Components of a Multi-Step Income Statement

A Multi-Step Income Statement is composed of the following:

Gross Profit (Operating Head)

In a multi-step income statement, one of the major account items to compute and also located in the report’s first section is the gross profit.

It is computed by recording the total sales and then deducting the cost of goods sold.

The Gross Profit’s function is to provide a clear picture of the profitability of the business and to provide insight to creditors that the business will be able to address their debt obligations when they arise.

Creditors rely on the borrower’s ability to pay through the gross profit rate.

Investors also rely on the gross profit as an indication of the overall financial health of the company.

In computing the gross profit, the company only considers the sales from its primary activities and the cost of manufacturing the products (for manufacturing companies) or the cost of purchased inventories (for retail companies).

The Gross Profit is computed as:

Gross Profit = Total Sales – Cost of Goods Sold

Selling & Administrative Expense (Operating Head)

The second section after the Gross Profit is the Selling and Administrative Expense which includes all of the costs related to selling the main products of the business.

The selling and administrative expenses related to operating activities are deducted to arrive at the company’s Operating Income.

Selling Expenses are expenses incurred when a company’s products are advertised and marketed to potential customers.

It also includes related freight charges and the sales personnel salary.

Administrative expenses are expenses that do not directly relate to the company’s sale of goods or services.

These are secondary-like expenses and are not related directly to the sale of the products.

Examples are salaries of the administrative staff, utility expenses, other office-related expenses, etc.

Both the selling and administrative expenses are added up to form part of the total operating expenses.

To compute the Operating Income, the formula to be used is:

Operating Income = Gross Profit – Operating Expenses

Non-Operating Head

The Non-Operating income statement accounts may be seen on the third part of the multi-step income statement.

These are income and expense accounts that are not directly related to the company’s sale of goods or services.

For example, a lawsuit is settled by the company for a breach of contract to a third party.

An example of non-operating income is when a company receives a gain from foreign exchange transactions.

Recognizing non-operating income and expenses are not part of the company’s day-to-day operations.

After deducting non-operating expenses from non-operating income, the excess amount is recognized as non-operating items.

To arrive at the Net Income:

Net Income = Operating Income + Non-Operating Items

Advantages of the Multi-Step Income Statement

A Multi-step Income Statement presents the financial performance of the business operation.

The common users of the said report are the investors, creditors, stakeholders, key management personnel, etc.

The multi-step income statement is used as a monitoring tool to compare the company’s current gross profit margin from the previous periods or other industries as a benchmark of the company’s operational efficiency.

Multi-step Income Statement segregates the income and expenses from operating activities and non-operating activities.

This manner of recording gives the management and end users the importance of the primary and non-primary activities of the business.

The Income Statement will then be able to present how much of the business’s primary activities attribute towards the revenue of the company, while also showing and excluding the sales generated from non-primary activities.

Businesses that Use a Multi-Step Income Statement

The multi-step Income statement is mainly used for companies that have complex business operations and comprises many income and expense account titles.

For example, in manufacturing with multiple income-generating units, the management is advised to use the multi-step income statement to account for the transactions from the company’s principal activity and other non-operating activities.

Some companies use the multi-step income statement not only to ease the manner of recording and reporting but also for regulatory compliance.

Detailed reporting will also be required to show the primary and non-primary activities of the business.

Single Step vs Multi-Step Income Statement

The single-step is a concise manner of recording the company’s day-to-day operations.

Like the multi-step income statement, it records and reports revenue, expenses, gains, and losses, but such account items are reported in a simplified report.

The single-step equation is as follows:

Net Income = (Revenue + Gains) – (Expenses + Losses)

A multi-step income statement, on the other hand, has three divided sections: segments of all operating income and expenses, segments of all non-operating activities, and segments for revenue and expenses that are indirectly related to business operations.