An example of a manufacturing firm income statement application with variable costing, highlighting product and period costs

An example of a manufacturing firm income statement application with variable costing, highlighting product and period costs

Under variable costing, only variable manufacturing costs are product costs and therefore inventoriable. Fixed manufacturing overhead is treated as a period cost and expensed in full in the period incurred, even if some units remain unsold. The usual presentation is a contribution-margin income statement, rather than a gross-profit format.

Typical statement template

[Company name]
Variable-Costing (Contribution-Margin) Income Statement
For the [month/year] ended [date]

Item	Amount	Product or period cost?
Sales revenue	XXX	Revenue—not a cost
Less: Variable cost of goods sold	(XXX)	Product cost expensed when units are sold
Less: Variable selling expenses	(XXX)	Period cost
Less: Variable administrative expenses	(XXX)	Period cost
Contribution margin	XXX	Sales less all variable costs
Less: Fixed manufacturing overhead	(XXX)	Period cost
Less: Fixed selling expenses	(XXX)	Period cost
Less: Fixed administrative expenses	(XXX)	Period cost
Operating income	XXX
Less: Finance costs / interest expense	(XXX)	Period/ financing cost
Profit before tax	XXX
Less: Income-tax expense	(XXX)	Tax expense—not product cost
Net income	XXX

The defining calculation is:

Contribution margin=Sales revenue−Total variable costs

“Total variable costs” includes both variable manufacturing costs attached to goods sold and variable non-manufacturing costs, such as sales commissions. Fixed costs are then deducted to calculate operating income.

Variable product cost

A separate schedule can show the variable manufacturing cost per unit used to value work-in-progress, finished-goods inventory, and variable COGS:

Variable product-cost schedule	Amount per unit	Classification
Direct materials	XXX	Product cost
Direct labour that varies with output	XXX	Product cost
Variable manufacturing overhead	XXX	Product cost
Variable manufacturing cost per unit	XXX	Total product cost per unit

 

Product versus period costs

Cost item	Classification under variable costing	Income-statement treatment
Direct materials	Product cost, provided they vary with production	Included in inventory, then variable COGS when sold
Direct labour paid per unit or production hour	Product cost, to the extent it varies with output	Included in inventory, then variable COGS when sold
Variable factory power, indirect materials, production supplies, piece-rate support labour	Product cost	Variable manufacturing overhead in inventory, then variable COGS
Fixed factory rent	Period cost	Expensed as fixed manufacturing overhead in the current period
Factory depreciation	Period cost	Expensed as fixed manufacturing overhead in the current period
Salary of a fixed-salaried factory manager	Period cost	Expensed as fixed manufacturing overhead in the current period
Sales commissions	Period cost	Included among variable selling expenses
Delivery/ distribution cost that varies by order or unit	Period cost	Included among variable selling expenses
Advertising	Period cost	Normally fixed selling expense, unless it varies with sales activity
Sales staff fixed salaries	Period cost	Fixed selling expense
Head-office salaries, office rent, legal and IT costs	Period cost	Administrative expense
Interest expense	Not a product cost	Finance cost for the current period

The important distinction is not simply whether a cost relates to manufacturing. Under variable costing, a manufacturing cost must also vary with output to be inventoried. Therefore, fixed factory overhead is a period cost—unlike under absorption costing—while selling and administrative costs remain period costs whether they are variable or fixed.

** reference:  a collection of management accounting notes

An example of a manufacturing firm income statement application with absorption costing, highlighting product and period costs

An example of a manufacturing firm income statement application with absorption costing, highlighting product and period costs

 

Under absorption costing, every manufacturing cost is treated as a product cost: direct materials, direct labour, variable manufacturing overhead, and fixed manufacturing overhead. These costs are held in inventory until the related goods are sold, at which point they appear in cost of goods sold (COGS); selling and administrative costs are normally period costs, expensed in the period incurred.

Typical income statement

Manufacturing Company
Absorption-Costing Income Statement
For the year/month ended [date]

Item	Amount	Cost classification
Sales revenue	XXX	Revenue—not a cost
Less: Cost of goods sold		Product cost, released from inventory when goods are sold
Opening finished-goods inventory	XXX	Product cost
Add: Cost of goods manufactured	XXX	Product cost
Goods available for sale	XXX	Product cost
Less: Closing finished-goods inventory	(XXX)	Product cost deferred to a future period
Cost of goods sold	(XXX)	Product cost expensed
Gross profit	XXX
Less: Selling expenses	(XXX)	Period cost
Less: Administrative expenses	(XXX)	Period cost
Less: Research and development, if expensed	(XXX)	Period cost
Less: Other operating expenses/losses	(XXX)	Normally period cost
Operating income	XXX
Less: Finance costs / interest expense	(XXX)	Period cost /  financing cost
Profit before tax	XXX
Less: Income-tax expense	(XXX)	Tax expense—not product cost
Net income	XXX

This is the conventional “sales − COGS = gross profit − operating expenses = operating income” format used for absorption costing.

Product-cost schedule

The COGS figure in the income statement normally comes from a separate cost of goods manufactured (COGM) schedule:

Cost of goods manufactured schedule	Amount	Cost classification
Cost of goods manufactured schedule			Amount	Cost classification
Direct materials used			XXX	Product cost
Direct labour			XXX	Product cost
Variable manufacturing overhead			XXX	Product cost
Fixed manufacturing overhead			XXX	Product cost
Total manufacturing costs			XXX	Product cost
Add: Opening work-in-progress inventory			XXX	Product cost
Less: Closing work-in-progress inventory			(XXX)	Product cost deferred
Cost of goods manufactured			XXX	Product cost transferred to finished goods

 

Product versus period costs

Cost item	Product or period cost under absorption costing?		Typical accounting treatment
Cost item		Product or period cost under absorption costing?		Typical accounting treatment
Direct materials used in production		Product cost		Included in WIP, then finished goods, then COGS on sale
Direct labour of production employees		Product cost		Included in inventory, then COGS on sale
Factory machine electricity		Product cost		Variable manufacturing overhead; included in inventory
Indirect production materials		Product cost		Manufacturing overhead; included in inventory
Factory supervisor salary		Product cost		Fixed manufacturing overhead; included in inventory
Factory rent, depreciation and insurance		Product cost		Fixed manufacturing overhead; included in inventory
Sales commissions		Period cost		Selling expense in the current period
Advertising and marketing		Period cost		Selling/ marketing expense in the current period
Delivery costs to customers		Usually period cost		Selling/ distribution expense, unless a specific accounting policy requires another treatment
Sales staff salaries		Period cost		Selling expense in the current period
Head-office salaries		Period cost		Administrative expense in the current period
Office rent, office IT and legal fees		Period cost		Administrative expense in the current period
Interest expense		Not a manufacturing product cost		Finance cost in the current period

The practical distinction is manufacturing versus non-manufacturing, not merely fixed versus variable. Thus, a fixed factory manager’s salary is a product cost, while a variable sales commission is a period cost.

** reference:  a collection of management accounting notes