Income Statement: Definition, Format, Components, and Example

Last updated: October 30, 2026

An income statement is a financial statement that reports a company’s revenues, expenses, gains, and losses over a period of time and ends with net income or net loss. It is also called the profit and loss (P&L) statement or statement of operations, and it is one of the four main financial statements under US GAAP.

The formula is simple: Revenues − Expenses + Gains − Losses = Net Income (or Net Loss).

In this guide, Professor Farhat walks you line by line through a multi-step income statement, works a full example for XYZ Corp, and flags the traps that show up on the CPA FAR exam. If you are studying for the CMA or taking your first financial accounting class, start here.

Why Does the Income Statement Matter?

The income statement answers one question: did the company make money this period, and how? That answer matters to several groups.

• Investors use it to judge profitability trends before buying, holding, or selling shares, and to compare companies in the same industry.
• Creditors and lenders use it, together with the statement of cash flows, to judge whether the company earns enough to cover interest and principal payments.
• Analysts build forecasts and valuation models from several years of income statements.
• Management uses it to spot cost problems, set prices, and build budgets.
• SEC reporting companies file annual financial statements that are audited by an independent registered public accounting firm. Their quarterly financial statements generally are unaudited and subject to an independent accountant’s review.
• Tax preparers start from pre-tax book income, but taxable income is computed under the Internal Revenue Code, so the two usually differ. Corporations reconcile book income to taxable income on Schedule M-1 or M-3 of Form 1120, and ASC 740 governs how those differences appear as income tax expense in the financial statements.

Exam note: FASB Concepts Statement No. 8 says the objective of financial reporting is to provide information useful to existing and potential investors, lenders, and other creditors. When a question asks who the primary users of financial statements are, that is the answer.

What Are the Components of an Income Statement?

Revenue: The Starting Point

Revenue, often referred to as sales or turnover, is the total amount of income generated by a company through its primary activities, such as selling goods or providing services, before any costs or expenses are deducted. It is the top line of the income statement, the figure from which all costs and expenses are subtracted to reach net income. Under ASC 606, revenue is reported net of discounts, returns, and allowances, so the first line is usually labeled net sales or net revenue.

Cost of Goods Sold (COGS)

Cost of goods sold (COGS) is the inventory cost assigned to goods sold during the period. For a merchandiser, it includes the acquisition cost of merchandise sold. For a manufacturer, it includes direct materials, direct labor, and allocated manufacturing overhead associated with the goods sold. Inventory costs remain assets until the related goods are sold, subject to applicable inventory measurement requirements.

Components of COGS

COGS typically includes:

• Raw Materials: The cost of raw materials used to produce the goods.
• Direct Labor: Wages paid to workers or employees who are directly involved in the production of the goods.
• Manufacturing Overhead: Indirect production costs that cannot be traced to a single unit, such as factory utilities, factory rent, depreciation of production equipment, and the wages of factory supervisors. Selling and administrative costs, such as marketing salaries or head office rent, are not manufacturing overhead. They are period costs and appear in operating expenses.

COGS Equation

The basic equation to calculate COGS is:

COGS = Beginning Inventory + Purchases during the period − Ending Inventory

Quick check with the XYZ Corp numbers used later on this page: beginning inventory of $40,000 plus purchases of $270,000 minus ending inventory of $10,000 equals cost of goods sold of $300,000. For a manufacturer, the corresponding formula is: beginning finished goods inventory + cost of goods manufactured − ending finished goods inventory = cost of goods sold.

• Beginning Inventory: The cost of goods on hand at the start of the period.
• Purchases during the period: The cost of goods bought during the period, including freight-in, net of purchase returns and discounts.
• Ending Inventory: The cost of goods still on hand at the end of the period, which becomes next period’s beginning inventory.

This equation helps in determining the cost associated with the goods that were actually sold during the period, excluding the cost of inventory that remains unsold.

Gross Profit: Measuring Production Efficiency

Gross profit is what is left after subtracting the cost of goods sold from net sales. For a service company, it is revenue minus the direct cost of providing the service. Selling costs, administrative salaries, and other operating expenses are not deducted here; they come out in the next step. Gross profit (and gross margin, which is gross profit divided by net sales) tells you how efficiently the company makes or buys what it sells.

Operating Expenses: The Operational Backbone

Operating Expenses include the costs associated with running the company’s core business operations that are not directly tied to the production of goods or services. This category includes expenses such as rent, utilities, salaries of non-production staff, marketing, and office supplies.

Operating Income: The Core Earnings Insight

Operating income, also called operating profit, is the profit earned from a company’s core business. For a typical merchandising or manufacturing company, it equals gross profit minus operating expenses and generally excludes financing costs and incidental investment income. Classification can differ for financial institutions and other businesses. Analysts often use EBIT (earnings before interest and taxes) as a shortcut for operating income, but the two are not always the same. EBIT is net income with interest expense and income taxes added back, so it still includes non-operating gains and losses. In the XYZ Corp example below, operating income is $85,000, while EBIT is $90,000 (pre-tax income of $80,000 plus interest expense of $10,000). The $5,000 difference is the interest income, which is non-operating.

Non-Operating Expenses and Income: Beyond the Core Business

Non-operating income and expenses are the revenues, expenses, gains, and losses that do not come from the company’s main business activities. Common examples are interest expense on loans, interest and dividend income on investments, and gains or losses on selling investments or equipment. One exam trap: US GAAP no longer allows a separate “extraordinary items” category. FASB removed it in ASU 2015-01, and IFRS prohibits it under IAS 1. Items that are unusual in nature or infrequent in occurrence now stay inside income from continuing operations, and ASC 220-20 requires that they be presented separately or disclosed in the notes.

Pre-Tax Income and Income Tax Expense: Towards Net Income

Pre-tax income, also labeled income before income taxes or income from continuing operations before taxes, is operating income plus other revenues and gains, minus other expenses and losses. Income tax expense is the total tax cost of the period under ASC 740. It has two parts: current tax expense (the tax payable on this year’s return) and deferred tax expense or benefit (the change in deferred tax assets and liabilities caused by temporary differences between book and tax rules). Because of deferred taxes, income tax expense usually does not equal the cash the company actually pays.

Net Income: The Bottom Line

Net income, also called the bottom line, net profit, or net earnings, is what remains after all expenses, including cost of goods sold, operating expenses, interest, and income taxes, are subtracted from total revenues and gains. Dividends are not expenses, so neither preferred nor common dividends reduce net income. For a simple capital structure, applicable preferred dividends are deducted from net income to determine income available to common shareholders, the numerator in basic earnings per share (EPS) under ASC 260. Deduct the current-period dividend requirement on cumulative preferred stock whether declared or not; for noncumulative preferred stock, deduct dividends declared for the period. Net income increases retained earnings through the closing process. Retained earnings is an equity balance, not a separate pool of cash; declared dividends reduce retained earnings.

Single-Step vs. Multi-Step Income Statement: Which Format Should You Know?

Both single-step and multi-step formats are used under US GAAP, subject to applicable presentation requirements. Students should understand how to classify accounts and calculate net income under either format.

Single-step format: all revenues and gains are listed in one group, all expenses and losses in another, and there is one subtraction.

Total revenues and gains − Total expenses and losses = Net income

Multi-step format: the same numbers, organized into subtotals that separate core operations from everything else. This is the format most public companies use and the one in the XYZ Corp example on this page.

1. Net sales − Cost of goods sold = Gross profit
2. Gross profit − Operating expenses (selling, general, and administrative) = Operating income
3. Operating income + Other revenues and gains − Other expenses and losses = Income from continuing operations before income taxes
4. Income from continuing operations before income taxes − Income tax expense = Income from continuing operations
5. Income from continuing operations + or − Discontinued operations, net of tax = Net income
6. Earnings per share (public companies only)

Classification depends on the nature of the business and applicable reporting requirements. Interest income is commonly non-operating for a manufacturer or retailer, but lending interest is a central source of operating revenue for a bank. In the XYZ Corp example, interest income and interest expense are treated as non-operating items.

What Else Can Appear on the Income Statement? Discontinued Operations, OCI, and EPS

Discontinued operations are included in net income, OCI is presented outside net income, and EPS expresses earnings on a per-share basis. For additional practice, explore the lessons on discontinued operations, comprehensive income, and basic EPS.

Discontinued operations. When a company disposes of, or classifies as held for sale, a component that represents a strategic shift with a major effect on its operations (for example, exiting a major line of business or a geographic area), the results of that component are reported in a separate section below income from continuing operations, net of tax (ASC 205-20). This lets readers see what the ongoing business earns without the part that is going away.

Other comprehensive income (OCI). Some gains and losses bypass net income and go straight to equity through OCI. Under ASC 220, the main items are unrealized gains and losses on available-for-sale debt securities, foreign currency translation adjustments, certain pension and postretirement plan adjustments, and gains and losses on cash flow hedges. Net income plus OCI equals comprehensive income, which must be presented either in one continuous statement or in a separate statement that immediately follows the income statement.

Earnings per share (EPS). Entities within the scope of ASC 260, generally those with publicly traded common stock or potential common stock, present basic and diluted EPS for income from continuing operations and net income on the face of the income statement when applicable. EPS for discontinued operations may be presented on the face or in the notes. Basic EPS equals income available to common shareholders divided by weighted average common shares outstanding. For a simple capital structure, deduct current-period cumulative preferred dividends whether declared or not and noncumulative preferred dividends declared for the period. Diluted EPS reflects dilutive potential common shares and any related numerator adjustments; antidilutive instruments are excluded. If XYZ has no preferred stock and 30,000 weighted average common shares, basic EPS is $60,000 ÷ 30,000 = $2.00 per share.

Video: Reading a Multi-Step Income Statement

Watch Professor Farhat explain how revenue, cost of goods sold, operating expenses, non-operating items, and income taxes lead to net income. This selected segment from Elements of the Income Statement runs from 7:46 to 12:23 and reinforces the components discussed above.

Want the full lecture, the practice questions, and Professor Farhat’s step-by-step solutions? Start with the Financial Accounting course if this is your first pass at the topic, or go to the Intermediate Accounting course if you are preparing for the CPA FAR exam. Not sure yet? Try the Free Sample Course first and see how the lessons work.

Income Statement Example: XYZ Corp (Multi-Step Format)

Here is a simplified multi-step income statement for a made-up company, XYZ Corp, for the year ended December 31, 2025. Follow the subtotals from the top line down to net income. Salaries, rent, utilities, marketing, and depreciation listed as operating expenses below are selling and administrative costs; production costs are already included in COGS. The tax rate is an assumed 25% combined federal and state rate, not the 21% federal corporate rate.

XYZ Corp
Income Statement
For the Year Ended December 31, 2025

Description	Amount ($)
Net sales	500,000
Cost of goods sold	(300,000)
Gross profit	200,000
Salaries and wages	(50,000)
Rent	(30,000)
Utilities	(10,000)
Marketing	(20,000)
Depreciation	(5,000)
Total operating expenses	(115,000)
Operating income	85,000
Interest income	5,000
Interest expense	(10,000)
Net non-operating expense (5,000 − 10,000)	(5,000)
Income before income taxes	80,000
Income tax expense (25%)	(20,000)
Net income	60,000

How to read it: net sales of $500,000 minus cost of goods sold of $300,000 gives gross profit of $200,000. Subtracting $115,000 of operating expenses leaves operating income of $85,000. Interest income of $5,000 and interest expense of $10,000 net to a $5,000 non-operating expense, so income before taxes is $80,000. Tax at 25% is $20,000, and net income is $60,000. If XYZ were a public company, the statement would end with earnings per share.

Real income statements have more line items and often show two or three years side by side, but the structure is the same.

Common Income Statement Mistakes on the CPA Exam

Check for these classification and presentation errors when preparing an income statement.

1. Treating dividends as an expense. Dividends are a distribution of retained earnings. They do not reduce net income. Applicable preferred dividends are considered in determining income available to common shareholders for EPS.
2. Putting an “extraordinary items” section on the statement. That category was eliminated by ASU 2015-01. Unusual or infrequent items stay in income from continuing operations and are presented separately or disclosed.
3. Showing discontinued operations before tax, or above operating income. They go below income from continuing operations, and they are shown net of tax.
4. Mixing gains with revenues. Revenues come from the company’s main operations, such as selling products or services. Gains come from peripheral or incidental transactions, such as selling an old delivery truck for more than its book value. The same split applies to expenses versus losses.
5. Using the wrong heading. A balance sheet is dated “As of December 31, 2025.” An income statement covers a period: “For the Year Ended December 31, 2025.” Graders and auditors both notice.
6. Assuming operating income equals EBIT. They differ by any non-operating item other than interest expense, which EBIT adds back. In the XYZ example, operating income is $85,000 and EBIT is $90,000.

What Are the Limitations of an Income Statement?

The income statement measures performance for a period, but it should be interpreted alongside the other financial statements, accounting policies, and relevant business information.

1. Accrual Income Differs from Cash Flow

Revenue from customer contracts is recognized as performance obligations are satisfied under ASC 606, which can occur before or after cash collection. Depreciation and amortization reduce income without a corresponding cash payment in the current period. These are normal features of accrual accounting. The statement of cash flows explains the related cash movements.

2. Expense Recognition Uses Different Approaches

Some costs are directly associated with revenue, such as the inventory cost recognized as COGS when goods are sold. Other costs are allocated systematically over periods, such as depreciation over an asset’s useful life. Costs that do not qualify as assets, or whose benefits have expired, are expensed immediately under applicable guidance. Matching does not justify recording an asset that fails recognition requirements.

3. Estimates and Policies Affect Comparability

Useful lives, expected credit losses, inventory measurement, and other estimates affect reported income. Permitted accounting policies and changes in estimates can complicate comparisons across entities and periods. Review the notes and distinguish supported judgments from biased estimates or improper recognition.

4. Historical Profit Is Not a Valuation

The statement reports performance for a completed period; it does not forecast future results or measure the present value of future cash flows. Some underlying accounting measurements incorporate discounting, but net income itself is not a discounted cash flow valuation. Consider recurring earnings, unusual items, and changes in business conditions when assessing future prospects.

5. Financial Performance Is Only Part of the Picture

Net income alone does not establish liquidity or solvency and does not capture all factors affecting future success, such as customer satisfaction, employee retention, and competitive position. Read it with the balance sheet, statement of cash flows, statement of equity, and accompanying notes.

Standards Update: Upcoming Presentation and Disclosure Changes

The following standards have different scopes and effective dates. Distinguish US GAAP expense disclosures from IFRS presentation requirements.

• US GAAP: ASU 2024-03, Disaggregation of Income Statement Expenses (ASC Subtopic 220-40), requires public business entities to disclose, in the notes, a breakdown of major expense captions into categories such as purchases of inventory, employee compensation, depreciation, and intangible asset amortization. As clarified by ASU 2025-01, it is effective for annual reporting periods beginning after December 15, 2027, and interim periods within annual reporting periods beginning after December 15, 2028. Early adoption is permitted. It changes the notes, not the face of the income statement.
• IFRS: IFRS 18, Presentation and Disclosure in Financial Statements, replaces IAS 1 for annual periods beginning on or after January 1, 2027. It classifies income and expenses into five categories, including operating, investing, and financing, and adds two mandatory subtotals: operating profit and profit before financing and income taxes.

Key Takeaways

• The income statement reports revenues, expenses, gains, and losses for a period and ends in net income or net loss.
• Formula: Revenues − Expenses + Gains − Losses = Net Income.
• Multi-step order: gross profit, then operating income, then income from continuing operations before taxes, then income from continuing operations, then net income, then EPS.
• Dividends are not expenses and do not reduce net income. Applicable preferred dividends affect income available to common shareholders for EPS.
• Extraordinary items no longer exist under US GAAP (ASU 2015-01).
• Discontinued operations are shown below continuing operations, net of tax.
• Net income plus other comprehensive income equals comprehensive income.
• Read the income statement with the balance sheet and the statement of cash flows. Profit is not cash.

Income Statement FAQ

What is the difference between an income statement and a balance sheet?

The income statement covers a period of time, such as a quarter or a year, and shows revenues, expenses, and net income. The balance sheet is a snapshot at a single date and shows assets, liabilities, and equity. Net income from the income statement flows into retained earnings on the balance sheet.

What is the difference between a single-step and a multi-step income statement?

A single-step statement subtracts total expenses and losses from total revenues and gains in one step. A multi-step statement adds subtotals, such as gross profit, operating income, and income from continuing operations, to separate core operations from other items. Both formats produce the same net income.

Are dividends on the income statement?

No. Dividends are distributions of retained earnings, not expenses, so they appear in the statement of stockholders’ equity. Preferred dividends are subtracted from net income only when calculating earnings per share.

What is the formula for net income?

Net income = Revenues − Expenses + Gains − Losses. In a multi-step statement: net sales minus cost of goods sold equals gross profit; minus operating expenses equals operating income; plus or minus other items equals income before taxes; minus income tax expense equals income from continuing operations; plus or minus discontinued operations, net of tax, equals net income.

Does the income statement show cash?

The income statement reports accrual-basis performance, not cash receipts and payments. Revenue and expenses can be recognized in a different period from the related cash flows. ASC 606 governs revenue from contracts with customers; other US GAAP guidance governs other transactions. Use the statement of cash flows to analyze operating, investing, and financing cash flows.

Conclusion

The income statement is a core financial statement that reports a company’s financial performance over a period of time, such as a quarter or a year. Think of it as a video of the period, while the balance sheet is a photo taken on the last day. By analyzing the income statement, stakeholders can make informed decisions regarding investments, credit lending, and management strategies to improve profitability and operational efficiency.

Ready to practice? Watch the full Elements of the Income Statement lecture on YouTube, then work the multiple-choice questions in the Financial Accounting course. If you are preparing for the CPA FAR exam, the Intermediate Accounting course covers discontinued operations, comprehensive income, and EPS in depth.

Sources and Further Reading

• U.S. Securities and Exchange Commission, Beginners’ Guide to Financial Statements: https://www.sec.gov/about/reports-publications/beginners-guide-financial-statements
• FASB Accounting Standards Codification (ASC 220 Income Statement, ASC 205-20 Discontinued Operations, ASC 260 Earnings Per Share, ASC 606 Revenue, ASC 740 Income Taxes): https://asc.fasb.org
• FASB Accounting Standards Update 2015-01, Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items
• FASB Accounting Standards Update 2024-03, Disaggregation of Income Statement Expenses, as clarified by ASU 2025-01
• IFRS 18, Presentation and Disclosure in Financial Statements (IFRS Foundation)

About the Author

Mansour Farhat, CPA, CIA, CFE, CGMA, MAcc, is the founder of Farhat Lectures and has taught accounting at the college level. He has recorded more than 1,500 video lectures covering financial accounting, intermediate accounting, and the CPA, CMA, and EA exams, and students around the world use his lessons as a supplement to their college courses and CPA review programs.