To prepare an income statement from a trial balance, pull only the revenue and expense accounts from the adjusted trial balance, arrange them in the order the calculations flow, and work down to net income. Everything else on the trial balance (assets, liabilities, and equity) belongs on the balance sheet and stays out of this statement. The work is mechanical once you know which accounts to take, which format to use, and what each subtotal represents.
Pull Only the Revenue and Expense Accounts
The trial balance lists every account in the general ledger. The income statement uses a subset: revenues and expenses. Revenue accounts carry credit balances and usually sit near the bottom of the trial balance, below equity accounts like Retained Earnings. Expense accounts carry debit balances and cover items such as Salaries Expense, Rent Expense, Utilities, and Depreciation.
These are all temporary accounts. Their balances reset to zero at the end of each fiscal year through closing entries. Assets, liabilities, and equity are permanent accounts that carry forward, and they do not appear on the income statement.
Watch one boundary carefully. Unearned Revenue is a liability, not revenue, because the company has not yet delivered the goods or services the customer paid for. It stays on the balance sheet. Treating it as revenue inflates profit and is one of the more common preparation mistakes.
Work From the Adjusted Trial Balance, Not the Unadjusted One
Build the income statement from the adjusted trial balance. The unadjusted version confirms that debits equal credits, but it does not reflect the end-of-period adjustments that change the numbers. The adjusted trial balance includes those corrections.
Typical adjusting entries include accrued expenses (wages earned but not yet paid), prepaid expenses (insurance or rent paid in advance and spread across periods), depreciation on long-term assets, and deferrals for revenue collected before it was earned. For tax purposes, depreciation follows the rules in IRS Publication 946, which uses methods like MACRS to allocate the cost of property over its useful life.1Internal Revenue Service. Publication 946, How To Depreciate Property Skip these adjustments and you understate expenses and overstate profit, which then feeds bad numbers into the tax return and any external reports.
Choose Single-Step or Multi-Step
GAAP allows two formats, and the right one depends on how complex the business is and who reads the statement.
A single-step income statement groups all revenues together, groups all expenses together, and subtracts one from the other in a single calculation. It suits small service businesses with simple cost structures and no inventory. The trade-off: you lose the intermediate subtotals that show where money goes.
A multi-step income statement breaks the calculation into stages. Net Sales minus Cost of Goods Sold gives Gross Profit. Gross Profit minus operating expenses gives Operating Income. Non-operating items and taxes then bring you to Net Income. Investors and lenders expect this format because the subtotals reveal whether a profitability issue traces to pricing, production costs, overhead, or something outside the core business. Any company with inventory, multiple revenue streams, or outside stakeholders reviewing the financials should use multi-step. The walkthrough below follows that structure because it covers every calculation single-step would collapse.
Calculate Gross Profit
Start with Net Sales. Take Gross Sales from the trial balance and subtract contra-revenue accounts such as Sales Returns and Allowances and Sales Discounts. Those balances represent money the company will not actually collect.
Then subtract Cost of Goods Sold. COGS covers the direct costs of producing or purchasing what the company sold: raw materials, direct labor, and, for retailers, inbound freight. If the trial balance shows Gross Sales of $100,000, Sales Returns of $5,000, and COGS of $40,000, Net Sales is $95,000, and Gross Profit is $55,000.
Inventory Method Behind the COGS Figure
The COGS number on the trial balance depends on which inventory costing method the business uses, and the differences are not small.
- FIFO (First-In, First-Out) matches the oldest inventory costs against revenue first. When prices are rising, FIFO produces the lowest COGS and the highest gross profit.
- LIFO (Last-In, First-Out) matches the newest inventory costs against revenue first. During inflation, LIFO produces the highest COGS and the lowest gross profit, which reduces taxable income.
- Weighted Average blends all unit costs into a single average. COGS lands between FIFO and LIFO when prices are rising.
The chosen method is disclosed in the financial statement notes and must be applied consistently. Confirm the COGS figure on the trial balance reflects the method the company has been using. A mid-stream switch requires disclosure and can trigger restatements.
Calculate Operating Income
Subtract operating expenses from gross profit. Operating expenses are the day-to-day costs of running the business that are not directly tied to producing goods: office rent, advertising, administrative salaries, insurance premiums, and similar overhead. Pull each debit balance from the trial balance, list them individually, add them up, and subtract the total from gross profit. The result, Operating Income, isolates what the core business earns before financing costs and taxes.
Add Non-Operating Items and Subtract Taxes
Below operating income, account for revenue and expenses that fall outside the primary business. Interest income on bank accounts, gains or losses from selling equipment, dividend income from investments, and rental income from property the company does not primarily operate as a landlord all belong here. A company can post strong operating income and still report a loss after heavy interest payments on debt, which is why these items are separated.
Interest expense carries a tax consequence worth noting. Federal law caps how much business interest expense a company can deduct in a year, generally at 30% of adjusted taxable income.2Office of the Law Revision Counsel. 26 USC 163 Interest3Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense Any disallowed portion carries forward. That does not change how interest expense appears on the income statement, but it matters when the statement feeds the tax return.
After adding non-operating income and subtracting non-operating expenses, you have pre-tax income. Subtract income tax expense. For C corporations, the federal rate is a flat 21% of taxable income, with state taxes added on top.4Office of the Law Revision Counsel. 26 USC 11 Tax Imposed The income tax line reflects the total provision for the period, including current tax owed and any deferred tax adjustments.
What remains is net income, or net loss if expenses exceeded revenues. That figure eventually transfers to the balance sheet through Retained Earnings.
Report Discontinued Operations and EPS Separately
If the company shut down or sold a major line of business during the period, GAAP requires that segment’s results appear on a distinct line below net income from continuing operations, reported net of tax. Keeping it separate prevents a one-time disposal from distorting the picture of ongoing profitability.
Public companies must also present basic and diluted earnings per share on the face of the income statement for both continuing operations and net income. Private companies do not have to report EPS, but the discontinued operations rules apply whenever a major segment is disposed of.
Lay Out the Finished Statement
The document opens with a three-line header: the company’s legal name, the words “Income Statement,” and the period covered (for example, “For the Year Ended December 31, 2025”). That header identifies whose results the reader is looking at and over what timeframe.
The body flows top to bottom in the order the calculations were made. Net Sales at the top, then Cost of Goods Sold, then the Gross Profit subtotal. Operating expenses listed individually below, with their total subtracted to show Operating Income. Non-operating items next, then income tax expense, then net income at the bottom.
Formatting signals where the math happens. A single underline beneath a column of numbers means a subtotal follows. The final net income figure gets a double underline, which is the accounting convention for a final result. Reviewers expect both, and the underlines help prevent a subtotal from being misread as the bottom line.
Single-Step Layout
If you chose single-step, the layout is simpler. List every revenue account in one group at the top. List every expense (COGS, operating expenses, interest, and taxes) in a second group below. Subtract. You get one subtotal, net income. Header and underline conventions stay the same; the intermediate subtotals for gross profit and operating income just do not appear.
Close the Temporary Accounts
The statement is finished, but the accounting cycle is not. Temporary accounts have to be closed so the next period’s income statement does not include carryover balances that do not belong.
The process runs in four steps. First, transfer each revenue balance to an intermediary account called Income Summary by debiting the revenue account and crediting Income Summary. Second, transfer each expense balance to Income Summary by crediting the expense account and debiting Income Summary. At that point, Income Summary holds a credit balance equal to net income, or a debit balance equal to net loss. Third, close Income Summary into Retained Earnings: for a profit, debit Income Summary and credit Retained Earnings for the net income amount; for a loss, reverse the entry. Fourth, close any Dividends account by crediting it and debiting Retained Earnings.
Once these entries post, every revenue, expense, and dividend account carries a zero balance, and the period’s net income sits in Retained Earnings on the balance sheet. The books are clean, and the next accounting period can begin.