Income Statement Practice

An income statement answers one question: did the business earn more than it spent to earn it during the period? This guide shows how to prepare one from an adjusted trial balance, which accounts belong on it and which don't, and how to handle a month that ends in a loss. It finishes with the mistakes the exercises catch.

What an income statement shows

The income statement covers a period of time, such as a month or a year. That is why its heading says "for the month ended September 30" rather than "as of September 30". It reports two kinds of accounts:

• Revenues: amounts the business has earned by providing goods or services in the period, such as Service Revenue or Interest Revenue.
• Expenses: the costs used up in earning that revenue, such as wages, rent, utilities, repairs and depreciation.

Subtract total expenses from total revenues and you have the bottom line. If revenues are bigger, the result is net income. If expenses are bigger, it is a net loss.

Everything else on the trial balance belongs somewhere else. Assets, liabilities and the owner's capital go on the balance sheet. Owner's Drawing goes on the statement of owner's equity. The income statement is deliberately narrow: it measures performance, not what the business owns or owes.

Why start from the adjusted trial balance

A trial balance lists every account with its balance in a debit or credit column. The adjusted trial balance is the version prepared after the month-end adjusting entries are posted. Those entries record the expenses and revenues that belong to the period but haven't come through as everyday transactions yet: depreciation, wages earned but not paid, supplies used up, insurance that has expired.

If you built the income statement from the unadjusted trial balance, those amounts would be missing and net income would be wrong. So the order is fixed: adjust first, then prepare the statements. If you want to see where the adjusted figures come from, the adjusting entries practice and depreciation journal entry pages cover the entries that create them.

How to read the trial balance for income statement accounts

You can usually spot the accounts you need by their names and their normal balances.

• Revenue accounts increase with credits, so they sit in the credit column.
• Expense accounts increase with debits, so they sit in the debit column.

On the income statement itself you list each amount as a positive number under its heading. The headings, not debit and credit columns, tell the reader which is which. If you need a refresher on which side each account type normally sits on, see normal balance of accounts.

Names can mislead, though. "Unearned Revenue" contains the word revenue, but it is a liability. "Owner's Drawing" has a debit balance like an expense, but it is not an expense. More on both below.

Worked example: Northside Print Shop, September

Northside Print Shop has posted its adjusting entries for the month ended September 30. Here is its adjusted trial balance.

Step 1: pick out the revenues

Go down the credit column. Accumulated Depreciation, Accounts Payable, Wages Payable and Owner's Capital all have credit balances, but none of them is earned income. Accumulated Depreciation reduces an asset, the two payables are liabilities, and capital is the owner's equity. That leaves one revenue account: Service Revenue of $34,600.

Step 2: pick out the expenses

Go down the debit column. Cash, Accounts Receivable, Supplies, Prepaid Insurance and Equipment are assets: they are resources the business still has. The expenses are the four accounts whose names end in "Expense": Wages $3,890, Utilities $4,960, Repairs $5,410 and Depreciation $4,140.

Step 3: total each section

Total revenues are $34,600, because there is only one revenue account. Total expenses are $3,890 + $4,960 + $5,410 + $4,140 = $18,400.

Step 4: find net income

Net income = total revenues − total expenses = $34,600 − $18,400 = $16,200. Revenues are bigger, so it is a positive figure: net income, not a loss.

The finished statement looks like this.

In the exercise you build exactly this layout: you choose each account for the Revenues or Expenses section, type its balance, and then fill in the three totals. Each line and each total is checked on its own, so the feedback tells you which part to look at.

Accounts that look like they belong, but don't

The second exercise in the lesson adds two traps. Juniper Landscaping's November trial balance includes Unearned Revenue of $1,950 and Owner's Drawing of $5,300.

• Unearned Revenue is money a customer paid in advance for work not yet done. The business owes the work (or a refund), so it is a liability. It becomes revenue only when the work is done, through an adjusting entry. The unearned revenue adjusting entry page shows that step.
• Owner's Drawing is money the owner takes out for personal use. It reduces equity, but it is not a cost of earning revenue. It appears on the statement of owner's equity.

Juniper also has two real revenue accounts: Service Revenue of $39,390 and Interest Revenue of $420. Both go on the statement. Total revenues are $39,810, total expenses across its six expense accounts are $26,930, and net income is $12,880.

When expenses are bigger: a net loss

The method doesn't change when the business has a bad month. In the third exercise, Copperleaf Studio's March revenues are $28,910 and its seven expenses total $29,880. Revenues minus expenses is $28,910 − $29,880 = −$970.

That minus sign matters. It tells the reader the business lost $970 in March. In the exercise you enter it as a negative number in the "Net income (loss)" line. On a printed statement you would often see the line labeled "Net loss" with the amount shown in parentheses, as ($970). Both say the same thing.

Common mistakes

These are the mistakes the three exercises check for. Each one gives a specific wrong number, so the size of your error often tells you which one you made.

Subtracting in the wrong order

Net income is revenues minus expenses, not expenses minus revenues. Reversing it gives the right size with the wrong sign. For Northside Print Shop, $18,400 − $34,600 = −$16,200, which would report a loss in a month the business made a profit. The same slip in the loss month turns Copperleaf's −$970 into $970, hiding the loss. A quick sense check catches both: if revenues are bigger, the answer must be positive; if expenses are bigger, it must be negative.

Stopping at total revenues

Writing $34,600 as Northside's net income means the expenses were never subtracted. Total revenues are the top line, not the bottom line. "Net" means what is left after the costs, so the last step is always a subtraction.

Listing Owner's Drawing as an expense

Drawing has a debit balance and sits near the expenses on many trial balances, so it is easy to sweep it in. If Juniper Landscaping did, total expenses would rise from $26,930 to $32,230 and net income would fall from $12,880 to $7,580. For Copperleaf Studio, the $4,300 of drawings would deepen the loss from −$970 to −$5,270. In both cases the statement would understate how the business performed, because what the owner takes home is not a cost of running it.

Listing Unearned Revenue as revenue

The word "revenue" in the name is the trap. Adding Juniper's $1,950 of Unearned Revenue would raise total revenues to $41,760 and net income to $14,830. But that money is for work the business hasn't done yet. Only earned revenue belongs on the income statement.

How to check your work

• Every line is a revenue or an expense. Read each account name and ask: was this earned, or used up, in this period? If neither, it doesn't belong.
• Nothing is missing. Count the revenue and expense accounts on the trial balance and count the lines on your statement. The numbers should match.
• The totals add up. Re-add each section. A total that is off by a round amount often means one balance was typed wrongly.
• The sign makes sense. Compare the two totals before you subtract, so you know whether to expect income or a loss.

Where net income goes next

Net income doesn't stay on the income statement. It flows into the statement of owner's equity, where it increases capital (a net loss decreases it), and drawings are subtracted there. At the end of the period, the closing entries move the revenue and expense balances into capital so the accounts start the next period at zero. The closing entries practice page follows that step. If you prepare statements in a spreadsheet, income statement in Excel builds the same totals with formulas.