Name the method, model the procedure step by step, and walk through a worked example with visible intermediate values and grouping logic.
The Income Statement follows one formula: Revenues minus Expenses equals Net Income.But a trial balance does not hand you those numbers ready-made. You must pull them out yourself. Here is the procedure, step by step.
Step 1: Pull Out Only Revenue and Expense Accounts
Scan the trial balance. Every account name tells you what type it is. Look for accounts with "Revenue" or "Expense" in the name. Ignore Cash, Equipment, Accounts Payable, Common Stock—those belong on the Balance Sheet, not here.
Revenue Accounts (credit balances)
- Service Revenue: $6,800
Expense Accounts (debit balances)
- Rent Expense: $1,200
- Salary Expense: $2,400
- Supplies Expense: $350
Step 2: Add Up Each Group
Total Revenue = sum of all revenue accounts. Total Expenses = sum of all expense accounts.
Total Revenue
$6,800 (only one revenue account)
Total Expenses
$1,200 + $2,400 + $350 = $3,950
Step 3: Subtract Expenses from Revenue
$6,800 − $3,950 = $2,850
Net Income = $2,850. Sarah's business earned more than it spent. That is the profit signal the bank needs to see.
It is tempting to skip straight to the subtraction. But each step protects you from a specific mistake:
Step 1 protects you from mixing in Balance Sheet accounts.
If you accidentally include Cash or Equipment in your calculation, your Net Income will be wrong. Only revenue and expense accounts measure profit.
Step 2 protects you from missing accounts.
Adding each group separately lets you verify that you caught every revenue and expense line. If your totals look off, you can trace back to the list.
Step 3 gives you the answer and its meaning.
A positive result means the business was profitable. A negative result means it lost money. The number itself is the story.
Notice the structure: Revenue section at the top, expense section below it, and Net Income at the bottom. Every line comes from the trial balance, but only the revenue and expense accounts appear here.
- Revenue ($6,800) is the total of all revenue accounts.
- Operating Expenses ($3,950) is the total of Rent, Salary, and Supplies.
- Net Income ($2,850) is the difference. This is the profit the bank will evaluate.
Before you move on, confirm that you can explain the procedure in your own words:
- What is the first thing you do when you receive a trial balance and need to build an Income Statement?
- Why do you add up revenue and expense accounts separately instead of subtracting them one at a time?
- If Net Income is negative, what does that tell you about the business?
Discuss these with a partner or write your answers down. The next phase will add a complication to this same procedure.