This is the method of income statement in which expenses are grouped according to their functions or classes such as cost of goods sold, administrative expenses, selling expenses. The beauty of this method is that it allows the calculation of gross profit and operating profits. That is why, it is used in multi step income statement.
This method is used in almost all medium and large size entities.
Example
CPT is a well known brand in North American region for selling high quality digital cameras. Within a short span of time, it has attracted a large customer base and is given a very tough time to the world’s most popular brand in North American countries. CPT imports all its components and parts from various suppliers and then assembles it to make the complete digital camera. The financial analysts think that the reason behind the rapid growth of the CPT is not other than the heavy marketing. CPT has incurred a heavy amount over the promotion of each of its digital camera using top class celebrities in the film industry. Following is the trial balance of CPT for the year ended 30th June, 2017:
KPT
Trial Balance
For the Period Ended 30th June, 2017
| Account | Debit | Credit |
| Sales revenue | 700,000 | |
| Purchases | 240,000 | |
| Debtors | 180,000 | |
| Creditors | 39,000 | |
| Freehold premises | 144,000 | |
| Property, Plant & Equipment | 210,000 | |
| Payroll | 30,000 | |
| Printing & Stationary | 2,400 | |
| Bad debts | 3,000 | |
| Cash at bank | 18,000 | |
| Cash in hand | 1500 | |
| Insurance expense | 3,000 | |
| Capital | 153,000 | |
| Opening stock | 60,100 | |
| Total | 892,000 | 892,000 |
Adjustments:
Closing stock is $100,000.
Depreciation is to be charged at 10{1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} on Property, plant & equipment.
Required:
Prepare multi-step income statement for CPT for the year ended 30th June, 2016.
Solution
CPT
Income Statement
For the Year Ended 30th June, 2016
| $ | $ | |
| Sales revenue | 700,000 | |
| Cost of goods sold | ||
| Opening stock | 60,100 | |
| Add: Purchases | 240,000 | |
| Less: Closing stock | (100,000) | |
| Gross profit | 200,100 | |
| Operating expenses | ||
| Depreciation expense ( 210,000 x 10 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} ) | 21,000 | |
| Payroll expense | 30,000 | |
| Printing & stationary | 2,400 | |
| Bad debts | 3,000 | |
| Insurance expense | 3,000 | |
| (59,400) | ||
| Net profit | 140,700 |
As you can see, we have prepared income statement by function process. First we calculate gross profit and then subtracted operating expenses from the gross profit figure to arrive at net profit figure. Income statement by function is a critical report for the management and Board of directors in making right decisions as compared to the income statement by nature where everything is grouped together to calculate the net profit figure.