The multi-step income statement

The multi-step income statement includes multiple sub-totals within the income statement. This layout makes it easier for readers to aggregate selected types of information within the report. 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).

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).

However, the multi-step approach can still yield misleading results if management alters where expenses are recorded in the statement. For example, an expense may be shifted out of the cost of goods sold area and into the operating expenses area, resulting in a presumed improvement in the gross margin. This is a particularly pernicious problem when multi-step income statements are being compared across multiple periods, and the method of statement compilation is being altered within the presented periods. In this case, a reader might draw incorrect conclusions from the altered presentation of information. Consequently, when such a change is made, the nature of the change should be described in the footnotes that accompany the financial statements.

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.

Here is a sample format for a multi-step income statement:

Sales $1,000,000
Cost of goods sold 350,000
     Gross margin $650,000
Operating Expenses  
Advertising 30,000
Depreciation 20,000
Rent 40,000
Payroll taxes 28,000
Salaries and wages 380,000
Supplies 32,000
Travel and entertainment 50,000
Total Operating Expenses $580,000
Other Income  
Interest expense 25,000
Interest income (5,000)
     Total other income $20,000
Net Income $50,000