Income Statement

The income statement (also called the statement of operations or profit and loss statement) reports an entity's financial performance over a period of time. It summarizes revenues, expenses, gains, and losses, ultimately arriving at net income or net loss.

:::info Key Concept

The income statement answers: How much did the company earn (or lose) during this period? It is an accrual-basis statement—revenues are recognized when earned, and expenses when incurred, regardless of cash flow timing.

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Core Components

Revenues and Expenses

• Revenues arise from an entity's ongoing major or central operations (e.g., sales revenue, service revenue, interest revenue for a bank).
• Expenses are outflows or depletions of assets (or incurrences of liabilities) from delivering goods, rendering services, or carrying out other activities that constitute the entity's ongoing operations.

Gains and Losses

• Gains are increases in equity from peripheral or incidental transactions (e.g., gain on sale of equipment).
• Losses are decreases in equity from peripheral or incidental transactions (e.g., loss from a lawsuit, loss on disposal of assets).

:::tip Exam Tip

Revenues and expenses relate to the core business. Gains and losses relate to peripheral activities. The distinction matters for income statement classification.

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Expired vs. Unexpired Costs

Term	Definition	Example
Unexpired cost	A cost that has future economic benefit — reported as an asset on the balance sheet	Prepaid insurance, inventory, PP&E
Expired cost	A cost whose benefit has been consumed — reported as an expense on the income statement	Cost of goods sold, depreciation expense, rent expense

When a cost expires, it moves from the balance sheet to the income statement.

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Gross vs. Net Reporting

:::warning Important Distinction

Revenues and expenses are reported at gross amounts. Gains and losses are reported at net amounts (proceeds minus carrying value).

::: Example — Bear Co. sells equipment:

• Original cost: $50,000
• Accumulated depreciation: $30,000
• Sale price: $25,000

$$\text{Gain} = \$25{,}000 - (\$50{,}000 - \$30{,}000) = \$5{,}000$$

The income statement reports the net gain of $5,000, not gross proceeds of $25,000.

Debit

Credit

Cash

$25,000

Accumulated depreciation

30,000

Equipment

$50,000

Gain on sale of equipment

5,000

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Income Statement Formats

Single-Step Income Statement

Groups all revenues and gains together, then subtracts all expenses and losses in a single step.

	Amount
Revenues and Gains
Sales revenue	$500,000
Interest revenue	10,000
Gain on sale of equipment	5,000
Total revenues and gains	$515,000
Expenses and Losses
Cost of goods sold	(300,000)
Selling expenses	(50,000)
Administrative expenses	(40,000)
Interest expense	(15,000)
Loss on lawsuit	(8,000)
Total expenses and losses	(413,000)
Income before income taxes	$102,000
Income tax expense	(30,600)
Net income	$71,400

Multiple-Step Income Statement

Separates operating and nonoperating activities, providing subtotals such as gross profit and operating income.

	Amount
Sales revenue	$500,000
Less: Cost of goods sold	(300,000)
Gross profit	$200,000
Operating expenses:
Selling expenses	(50,000)
Administrative expenses	(40,000)
Operating income	$110,000
Other revenues and gains:
Interest revenue	10,000
Gain on sale of equipment	5,000
Other expenses and losses:
Interest expense	(15,000)
Loss on lawsuit	(8,000)
Income before income taxes	$102,000
Income tax expense	(30,600)
Income from continuing operations	$71,400

:::tip Exam Tip

The multiple-step format is tested more frequently. Know the order: Sales → COGS → Gross Profit → Operating Expenses → Operating Income → Other Items → Income from Continuing Operations → Discontinued Operations → Net Income.

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Income from Continuing Operations

This is the bottom line of regular, recurring business activities before any discontinued operations. It includes:

1. Operating revenues and expenses
2. Nonoperating items (interest, gains/losses on asset disposals)
3. Income tax expense on continuing operations

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Discontinued Operations

:::warning Critical Topic

Discontinued operations are reported separately, net of tax, below income from continuing operations. This is one of the most heavily tested income statement topics on the CPA exam.

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What Qualifies?

A component qualifies as a discontinued operation when it represents a strategic shift that has (or will have) a major effect on the entity's operations and financial results. Examples include:

• Disposal of a major line of business
• Disposal of a major geographical area
• Disposal of a major equity method investment

Held-for-Sale Classification

A component is classified as held for sale when all of the following criteria are met:

1. Management commits to a plan to sell
2. The component is available for immediate sale in its present condition
3. An active program to locate a buyer has been initiated
4. The sale is probable and expected within one year
5. The component is being actively marketed at a reasonable price
6. It is unlikely that significant changes will be made to the plan

Reporting Discontinued Operations

Two amounts are reported (net of tax) on the face of the income statement:

1. Gain or loss from operations of the discontinued component (revenue minus expenses during the period)
2. Gain or loss on disposal (or expected disposal) of the component

Impairment Loss — Held for Sale

When classified as held for sale, the component is measured at the lower of carrying amount or fair value less costs to sell.

Example — Gies Co. discontinues its consulting division:

• Carrying amount of division's net assets: $800,000
• Fair value less costs to sell: $650,000
• Operating loss of the division during the year: $120,000
• Tax rate: 25%

$$\text{Impairment loss} = \$800{,}000 - \$650{,}000 = \$150{,}000$$

Debit

Credit

Loss on impairment — discontinued operations

$150,000

Net assets of discontinued component

$150,000

Income statement presentation (below income from continuing operations):

	Amount
Income from continuing operations	$500,000
Discontinued operations (net of tax):
Loss from operations of discontinued division ($120,000 less tax of $30,000)	(90,000)
Impairment loss on discontinued division ($150,000 less tax of $37,500)	(112,500)
Net income	$297,500

Subsequent Fair Value Increases

If the fair value of a held-for-sale component increases after an impairment write-down, the entity may reverse the loss up to the cumulative amount previously recognized. The reversal is reported in discontinued operations, net of tax.

Debit

Credit

Net assets of discontinued component

$60,000

Gain on recovery — discontinued operations

$60,000

note

The reversal cannot exceed the total impairment loss previously recognized. You cannot write the asset above its original carrying amount before impairment.

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Foreign Currency Transactions

When an entity enters transactions denominated in a foreign currency, exchange rate fluctuations create gains and losses.

Recording at the Spot Rate

Transactions are initially recorded at the spot exchange rate on the transaction date.

Example — MAS Inc. purchases inventory from a French supplier for €100,000 when the spot rate is $1.10/€:

$$\text{Payable in USD} = 100{,}000 \text{ EUR} \times \$1.10 = \$110{,}000$$

Debit

Credit

Inventory

$110,000

Accounts payable

$110,000

Year-End Adjustment (Remeasurement)

At the balance sheet date, monetary items (receivables, payables) denominated in a foreign currency are remeasured at the current spot rate. The resulting gain or loss is reported in net income.

If the spot rate at year-end is $1.15/€:

$$\text{New payable} = 100{,}000 \text{ EUR} \times \$1.15 = \$115{,}000$$ $$\text{Exchange loss} = \$115{,}000 - \$110{,}000 = \$5{,}000$$

Debit

Credit

Foreign currency transaction loss

$5,000

Accounts payable

$5,000

:::tip Exam Tip

A weakening U.S. dollar (higher exchange rate) means foreign-currency payables cost more (loss) and foreign-currency receivables are worth more (gain). Think: "Owe more = loss; Collect more = gain."

:::

Settlement

When the transaction is settled, any additional exchange difference is recognized.

If the spot rate at settlement is $1.12/€:

$$\text{Payable at settlement} = 100{,}000 \text{ EUR} \times \$1.12 = \$112{,}000$$ $$\text{Exchange gain (from year-end)} = \$115{,}000 - \$112{,}000 = \$3{,}000$$

Debit

Credit

Accounts payable

$115,000

Cash

$112,000

Foreign currency transaction gain

3,000

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Summary

:::danger Common Exam Pitfalls

1. Reporting gains gross instead of net — always net gains/losses.
2. Forgetting to report discontinued operations net of tax.
3. Mixing up foreign currency gains and losses — remember the direction of the rate change relative to whether you hold a receivable or payable.
4. Reversing impairment on held-for-sale components above the original carrying amount. :::

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Practice Problem

Kingfisher Industries reports the following for the year ended December 31:

• Sales revenue: $1,200,000
• Cost of goods sold: $720,000
• Operating expenses: $180,000
• Interest expense: $25,000
• Gain on sale of investments: $15,000
• Loss from operations of discontinued segment (pre-tax): $60,000
• Gain on disposal of discontinued segment (pre-tax): $40,000
• Tax rate: 25%

Required: Prepare a multiple-step income statement.

Solution

Kingfisher Industries	Amount
Sales revenue	$1,200,000
Cost of goods sold	(720,000)
Gross profit	$480,000
Operating expenses	(180,000)
Operating income	$300,000
Interest expense	(25,000)
Gain on sale of investments	15,000
Income before income taxes	$290,000
Income tax expense (25%)	(72,500)
Income from continuing operations	$217,500
Discontinued operations (net of tax):
Loss from operations ($60,000 × 75%)	(45,000)
Gain on disposal ($40,000 × 75%)	30,000
Net income	$202,500