Income Statement (By Nature Vs By Function)

Is an income statement presented by nature of expense or by function of expense?

Income Statement by Nature of Expense

Expenses in an income statement are either classified by their nature or by their function.

An income statement by nature is the one in which expenses are disclosed according to categories they are spent on, such as raw materials, transport costs, staffing costs, depreciation, employee benefit etc. The expenses will not be further classified into their functions (i.e cost of goods sold, selling, administrative, etc).

This method of disclosure of expenses is used in single step income statement, usually employed by small businesses as it is simple and relatively easier to be implemented. However, the drawback of this method is that it cannot be used to calculate gross profit within the income statement.

The following example shows the format of an income statement by nature.

Income Statement by Function of Expense

An income statement by function is the one in which expenses are disclosed according to different functions they are spent on (cost of goods sold, selling, administrative, etc.)

This method allows us to calculate gross profit and operating profit within the income statement, and therefore is usually used in the multi-step format of income statement. Most large and medium sized businesses use this method.

The following shows the format of an income statement by function of expense.