How to Prepare an Income Statement From a Trial Balance: Step-by-Step With a Full Example

Start With the Adjusted Trial Balance

Financial statements are always prepared from the adjusted trial balance — after all adjusting entries for accruals, deferrals and depreciation have been posted. If you use the unadjusted trial balance, expenses like depreciation, accrued wages and bad debts will be missing and net income will be overstated. If adjusting entries still feel shaky, review the adjusting entries guide first. You can see where this step fits in the bigger picture in the accounting cycle.

We will use one company throughout. Northgate Supply Co. is a small merchandising business. Here is its adjusted trial balance:

We will use this same trial balance to build the balance sheet in our companion guide, how to prepare a balance sheet.

Step 1: Pick Out the Income Statement Accounts

Only temporary accounts that measure performance for the period go on the income statement: revenues, gains, expenses and losses. Assets, liabilities, equity and dividends do not. Go down the trial balance and tick each account that belongs:

• Revenues and gains: Sales Revenue, Sales Returns and Allowances (a contra-revenue), Gain on Sale of Equipment.
• Expenses: Cost of Goods Sold, Wages, Rent, Depreciation, Utilities, Advertising, Insurance, Bad Debt, Interest, Income Tax.

Step 2: Write the Heading Correctly

Every financial statement heading has three lines: the company name, the statement name, and the period. Because the income statement covers a span of time, the third line says "For the Year Ended December 31, 2025" — not "December 31, 2025," which is the format for the balance sheet, a single point in time. Many instructors deduct marks for this.

Step 3: Calculate Net Sales

Start with gross sales and subtract contra-revenue accounts: sales returns and allowances and sales discounts.

Step 4: Gross Profit

Subtract cost of goods sold from net sales. Gross profit shows how much is left from sales after paying for the products sold, before any operating costs.

Service businesses do not have COGS, so they often use a single-step format instead. For how COGS itself is calculated, see FIFO, LIFO and weighted average.

Step 5: Operating Expenses and Operating Income

List the costs of running the business day to day. Many textbooks split them into selling expenses (advertising, sales salaries, delivery) and general and administrative expenses (rent, office wages, insurance, utilities). Follow your instructor's preferred format; the totals are the same.

Operating income measures how profitable the core business is before financing costs and one-off items. It is the number analysts watch most closely — see the income statement explained for how to interpret it.

Step 6: Other Income and Expenses

Items that are not part of normal operations go below operating income: interest expense, interest income, and gains or losses on selling assets. Northgate sells supplies; selling a piece of equipment is not its business, so the gain is "other income."

Step 7: Income Tax and Net Income

Income tax expense is shown last, after income before tax, because it is calculated on that number.

Net income now flows into the statement of retained earnings: beginning retained earnings 18,700 + net income 9,400 − dividends 5,000 = ending retained earnings 23,100. That ending figure is what appears on the balance sheet.

The Finished Statement

Mistakes That Cost Marks

1. Including dividends as an expense.
2. Using the unadjusted trial balance, so accrued and deferred items are missing.
3. Wrong date line — "December 31, 2025" instead of "For the Year Ended December 31, 2025."
4. Putting interest or gains in operating expenses instead of other income and expenses.
5. Forgetting contra-revenue accounts like returns, allowances and discounts.
6. Adding contra-asset accounts such as accumulated depreciation or the allowance — those belong on the balance sheet, not the income statement.