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