What is Variable Costing Income Statement?
Variable costing income statement is one where all variable expenses are subtracted from revenue which results to contribution margin, from this all fixed expense are then subtracted to arrive at the net profit or loss for the period. It is useful to determine a proportion of expenses that actually varies directly with revenues.
In many businesses, the contribution margin will be substantially higher than the gross margin, because such a large amount of its production costs are fixed, and few of its selling and administrative expenses are variable.
The formula for Net profit or loss is:-
- Contribution Margin =Revenue – Variable Production Expenses – Variable Selling and administrative expenses
- Net profit or Loss = Contribution Margin – Fixed production expenses – Fixed Selling and administrative expenses
Examples of Variable Costing Income Statement
Let’s understand the variable costing income statement with some examples.
A company named ABC Cotton sells cotton $30 per Kg. The data for the year 2016 is given below:-
- Sales in Kg- 80,000 kgs
- Finished goods inventory at the beginning of the period- 15,000 kgs
- Finished goods inventory at the closing of the period-20,000 kgs
- Variable costs- $10 per Kg
- Fixed manufacturing expense cost- $ 3,00,000 per year
Marketing and administrative expenses-
- Variable expenses- $5 per kg of sale
- Fixed expense- $2,50,000 per year
Through the above information, we have prepared a variable cost income statement.
Let us understand how this variable costing income statement is prepared
Sales are calculated which is a total sale in kgs i.e. 80000 multiply by per kg cost i.e. $30.
=Total Sale*Rate per kg
Calculate variable Opening Inventory
Opening Inventory that is finished goods inventory at the beginning of the period i.e. 15000 kgs multiplies by manufacturing variable cost i.e. $ 10. So,
= finished goods inventory at the beginning of the period* manufacturing variable cost
The variable cost of manufactured goods is
=(Total sale + Finished goods inventory at the closing of the period – Finished goods inventory at the beginning of the period)*manufacturing variable cost
The variable cost of good available for sale
=Variable cost of manufacture goods + Opening Inventory
Calculate closing inventory that is
=Finished goods inventory at the closing of the period* manufacturing variable cost
Now, we will get Gross contribution margin
Gross contribution margin = Total Sales – Variable cost of goods available for sales – closing inventory
Calculate variable marketing and administration expense which is
=Total sale*Variable Marketing and administrative expenses
Contribution margin calculated i.e.
=Gross contribution margin – variable marketing and administration expenses
Now, we have to calculate fixed expenses
= Fixed manufacturing expense cost + Fixed marketing and administrative expenses
Finally, we will get net operating income
= Contribution margin – Fixed expenses
Total Production during year = Total sales + Closing inventory – Opening Inventory
Manufacturing expenses per unit=Variable expense + Fixed Expense
Hence, we found that net operating income with variable costing income principle.
Normal Income vs Variable Costing Income Statement
There are mainly three difference between variable costing income statements and normal income statements are:-
- Normal income statement has gross margin whereas variable costing income statements have contribution margin.
- In variable costing income statements, all variable selling and administrative expenses are grouped with variable productions cost and this is a part of contribution margin.
- All fixed production costs are aggregated lower in a statement, after the contribution margin in variable costing income statements.
The key difference between gross margin and contribution margin is that in gross margin fixed production costs are included in the cost of goods, whereas in contribution margin fixed production costs are not included in the same calculation. This means that variable costing income statements is shorted based on the variability of the underlying cost information, rather than by functional areas or expenses categories that are found in a typical income statement.
Under both variable costing income statements and a normal statement, the net profit or loss will be the same.
Advantages of Variable Costing Income Statement
Advantages of the Variable cost income statement are as follows:-
- Variable cost provides a better understanding of the effect of fixed costs on the net profit in variable cost income statements.
- Through variable cost income statements companies one necessary income for cost volume profit (CVP) analysis. This data cannot be extracted from traditional methods.
- The net operating income figure is close to the flow of cash. It is useful for business which faces problem in cash flow.
- Other method changes with a change in inventory level, period etc. Sometimes sales and income move in the opposite direction but this does not happen in variable cost method.
Disadvantages of Variable Costing Income Statement
The disadvantages of the Variable cost income statement are as follows:-
- The variable cost income statement is not as per standard of GAAP (Generally accepted accounting principle).
- Tax law of many countries uses other method statements like absorption costing.
- It does not assign a fixed cost to a unit of production. Hence, a production cost cannot be matched with revenue.
Variable cost income statement help companies in various analyses like cost volume profit, to prepare flexible budgets for better variance analysis and help in decision making to accept or reject special orders.
This has been a guide to Variable Costing Income Statement. Here we discuss steps to prepare the variable costing income statement along with practical examples and also its advantages and disadvantages. You may learn more about Accounting from the following articles –