The absorption income statement, also known as the traditional income statement, uses the prime cost calculation for preparing the profit and loss statement. This method of income statement examines costs by breaking them down into product and period costs.
Explanation:
The core format of absorption costing income statement demonstrates the sales less the expenses of products sold equivalent gross revenue. In addition, it shows the gross profit less than the distribution and administration costs, which corresponds to the operating income.
In such a costing technique, there is no difference between fixed and variable costs in calculating profits. Absorption costing statement implies that fixed costs linked to products so all the production costs, fixed and variable, should become part of the product cost.
The absorption costing method corresponds to the generally accepted accounting principles and provides a more detailed way of tracking profits in a specific reporting period. Traditional income statements are typically applied in the same way despite the type of manufacturing company. The basic format has the following absorption costing income formula:
Sales
– Less the cost of goods sold
= Equals gross profit
– Less sales and management costs
= Equals operating income
The companies consider all manufacturing costs, involving both fixed and variable costs, as product costs within absorption costing. It is important to note that variable costs alter in proportion to changes in total activity, while the fixed costs remain the same as activity levels change.
The variable costs of production commonly enclose the published materials, variable business expenses, and direct labor. The product costs include direct materials, direct labor, and overhead expenses. The period costs include trade, overhead, and administration costs.
The absorption income statement calculator includes the following measures, such as calculating the unit labor cost and, thereafter, calculating all the variable items that are based upon the number of units sold. In terms of the absorption costing, the unit cost involves direct materials, direct labor, varying overhead expenses, and fixed costs.
As such, fixed cost per unit is estimated by dividing total fixed overhead by the number of production quantities. With the aid of the cost per unit, one may easily complete the rest of the income statement. The calculation of the varying elements is based on the number of units sold, including sales, cost of sales, and changing part of selling and administrative costs.
The absorption costing is generally is required for external financial reporting (GAAP) that includes all of a company’s financial disclosure to people outside of the company, and for income tax reporting.
This costing method is applied for business accounting and tax purposes because it reflects a more comprehensive net income on the income statement and a total cost of inventories on balance sheets by shifting costs between different periods according to the matching concept.
Furthermore, all manufacturing costs refer to the cost, including direct materials, direct labor, fixed and variable overhead. Such a costing method might be ambiguous, as products do not affect some costs. Fixed manufacturing overhead expenses are applied to both sold and produced units. By having a clear vision of the product and period costs, one might consider the statement process as much simpler to perform.
The first and most significant task is to calculate the unit cost, which is also the hardest part of the statement. However, the unit cost will facilitate further completion of the rest of the report. The absorption costing income statement is a fundamental tool that promotes manufacturing companies by addressing these costs in a manner that allows an in-depth analysis of profitability. The absorption income statement example:
