There are a variety of ways to think about business costs. Marginal costing income statements are more useful for analyzing inventory and production costs, while absorption costing is required under some accounting standards. The two income statements differ in format and can even result in a different net operating income for the period.
Stylistic Differences
The absorption costing and marginal costing income statements differ significantly in format. Both begin with gross sales and end with net operating income for the period. However, the absorption costing income statement first subtracts the cost of goods sold from sales to calculate gross margin. After that, selling and administrative expenses are subtracted to find net income.
In contrast, the variable costing statement segments costs by variable expenses and fixed expenses. Variable expenses are subtracted from gross sales to arrive at contribution margin before finding net income. A marginal income statement makes it easier for managers to understand product margins and production efficiency, suggests Financial Accountancy. However, absorption-style income statements are required by generally accepted accounting principles.
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Product Versus Period Costs
Absorption costing and variable costing differ slightly in how they define product and period costs. When accountants look at the costs of running a business, they label them as either product costs or period costs. Product costs, also known as the cost of goods manufactured, are the costs directly associated with creating a good or service.
Period costs are costs that the company incurs regardless of how much inventory it produces. Selling and administrative expenses are considered period costs under both costing systems.
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Both methods also classify direct materials, direct labor and marginal manufacturing overhead as product costs. However, fixed manufacturing overhead is a product cost under the absorption costing income statement and a period cost under the marginal income statement. The difference alters the cost of goods sold for the period, which often means a different net income figure for the period.
Preparing an Absorption Costing Income Statement
As Accounting Tools notes, the first line item of an absorption income statement is gross sales for the period. Next, comes the cost of goods sold. To find COGS, start with the dollar value of beginning inventory and add the cost of goods manufactured for the period. The resulting figure is goods available for sale. Subtract the ending inventory dollar value, and the result is cost of goods sold. Subtract gross sales from cost of goods sold to calculate the gross margin. Subtract selling expenses to find net operating income for the period.
Preparing a Marginal Income Statement
As with the absorption costing income statement, you begin a marginal costing income statement by calculating gross sales for the period. Next, you calculate variable cost of goods sold and variable selling expenses. To calculate variable cost of goods sold, start with beginning inventory, add variable manufacturing costs and subtract ending inventory. Subtract total variable costs from gross sales to find the contribution margin for the period. Subtract fixed manufacturing overhead and fixed selling and administrative expenses to arrive at net operating income for the period.
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