Question

Analyze the major pros and cons of a single-step income statement and a multi step income statement. Identify at least two critical items of a multistep income statement that is useful to creditors. Provide a rationale for your response.

Answer 1

1] Single-step Income Statement:

Under the single step income statement all revenues', including other incomes, are shown one after the other and the total is shown as 'Total revenues'.

Similarly, all expenses, including interest expense and taxes expense, are shown one after the other and cumulated as 'Total expenses.

The difference between the total revenues and total expenses is shown as 'Net income'.

A multistep income statement would appear as under [without figures]:

INCOME STATEMENT [Single Step]
Revenues:
Sales	x
Other revenues/Income	x
Total revenues		x
Expenses:
Sales Salaries Expenses	x
Advertising Expense	x
Depreciation Expense-Store Equipment	x
Miscellaneous selling expense	x
Office Salaries Expense	x
Rent Expense	x
Depreciation Expense-Office Equipment	x
Insurance Expense	x
Office Supplies Expense	x
Miscellaneous administrative expense	x
Interest Expense	x
Total expenses		x
Net Income		x

The advantages of a single step statement are:

*The total of revenues and total of expenses are available as separate single totals.

*It can be understood easily by a common man.

The disadvantages are:

*There is no separate figure for gross profit, operating profit and net profit.

*Expenses are bunched together. Hence, it is not possible to know how much is spent in total for selling and for administration.

2] Multi-step Income Statement:

INCOME STATEMENT [Multi-step]
Sales			x
Cost of Merchandise sold			x
Gross Profit			x
Expenses:
Selling Expenses:
Sales Salaries Expenses	x
Advertising Expense	x
Depreciation Expense-Store Equipment	x
Miscellaneous selling expense	x
Total Selling Expenses		x
Administrative Expenses:
Office Salaries Expense	x
Rent Expense	x
Depreciation Expense-Office Equipment	x
Insurance Expense	x
Office Supplies Expense	x
Miscellaneous administrative expense	x
Total Administrative Expenses		x
Total Operating expenses			x
Income from operation			x
Other Income/Expense:
Other income		x
Interest Expense		x	x
Net Income			x

The advantages of the multi-step income statement are:

*This format shows the profit at different stages of operations, namely, Gross profit, Operating profit and Net profit.

*The selling expenses are shown separately and aggregated. So also are the administrative expenses.

*Other revenues and expenses are shown are separately, so that profit from normal operations is shown separately.

Disadvantage:

*Total revenues and total expenses are not available as a single figure.

*Layment will find if difficult to understand the different profit figures.

Critical items of multi-step income statement:

*Operating income, and

*Interest expense

The above two items can be used to calculate the 'Times interest earned ratio' as:

Operating income/Interest expense

The ratio gives the number of times the interest expense is covered by the operating income. Higher the ratio higher the safety for creditors.