The income statement is a financial statement that reports the results of operations of an entity during a specific accounting period such as a quarter or a year. It is also called a profit and loss (P&L) statement because the entity’s operating results for a specific accounting period may be presented in profit or loss. Based on the accounting equation, Revenue - Expenses = Profit and the specified criteria for classification and ordering of items, the income statement is prepared by classifying and listing appropriately all the revenues, expenses, gains and losses directly included in the income statement for the current period. As the information in the income statement depicts the conditions over a specific period of time, the income statement is a dynamic statement.
The income statement has the following functions:
(1) The income statement reflects the main sources and components of an entity's operating performance, which assist financial statement users in judging the quality of net income and its risks, and in predicting the sustainability of net income, thus making their right decisions.
(2) Through the income statement, users can have an overall view of the realization and composition of revenues, costs and expenses, and net income (or loss) of an entity, thus obtaining a comprehensive understanding of the entity’s operating results.
(3) Through the comparative figures provided by the income statement over time, users can analyze the entity's profitability and future trends of its earnings, and learn about the capital maintenance and value increase of investments contributed by investors, thus providing them with a basis for making economic decisions.
(4) The information in the income statement combined with the information in the balance sheet can also provide basic information for financial analysis, which can reflect the entity’s financial turnover, profitability and earnings level, and facilitate financial statement users to judge the entity’s future development trend, thus making economic decisions.
There are two primary formats of income statements: single-step income statements and multiple-step income statements.
In the single-step income statement, all the revenues and expenses for the current period are laid out separately in two sections where total expenses are subtracted from total revenues to arrive at net income (or loss) for the current period. This reporting format is straightforward and simple without complexities in categorizing line items, but it provides less information, which is not good for financial statement users to analyze the main sources and components of the entity’s operating results, to compare the components of profit or loss between different entities, or to predict the the entity’s future profitability.
In the multiple-step income statement, net income or loss for the current period is calculated on a step-by-step basis by grouping revenues and expenses based on their nature and presenting a number of interim profit indicators according to main steps for profit realization. Although this reporting format is more complex to calculate, it provides sufficient information to reflect not only the final operating results of an entity, but also the profit and loss levels of different business transactions, to give a view of the different sources and formation processes of the entity's operating results, thus facilitating the users of financial statements to analyze the reasons for the changes (increases or decreases) in the net income of the entity, to evaluate the quality of net income and its risks, and to help predict the future profitability of the entity.
The Chinese enterprises usually adopt the multiple-step format for their income statements (see the Sample of Income Statement below). The multiple-step income statement is divided into four levels: at the first level, operating profit is calculated; at the second level, total profit is calculated; at the third level, net income is calculated, and at the fourth level, total comprehensive income is calculated. The formulas for calculating the above four levels are illustrated as follows:
(1) Operating profit/loss:
Operating profit = Operating revenue - Operating costs – Operating taxes and surcharges - Selling expenses - Administrative expenses – Financial expenses - Impairment loss of assets + Income from changes in fair value (- Losses on changes in fair value) + Income from investments (- Losses on investments)
(2) Total profit/loss (Income/loss before income tax):
Total profit = Operating profit + Non-operating revenue - Non-operating expenses
(3) Net income/loss:
Net profit = Total profit - Income tax expense
(4) Total comprehensive income:
Total comprehensive income = Net income + Other comprehensive income