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- The Traditional Income Statement (Absorption Costing Income Statement)

The traditional income statement, **also called absorption costing income statement**, uses absorption costing to create the income statement. This income statement looks at costs by dividing costs into product and period costs. In order to complete this statement correctly, make sure you understand product and period costs.

The basic format is to simply show the sales less the cost of goods sold equal gross profit. And also show the gross profit less the selling and administrative expenses and that equals the operating income.

Let’s use the example from the absorption and variable costing post to create this income statement.

When doing an income statement, the first thing I always do is calculate the cost per unit. Under absorption costing, the cost per unit is direct materials, direct labor, variable overhead, and fixed overhead. In this case, the fixed overhead per unit is calculated by dividing total fixed overhead by the number of units produced (see absorption costing post for details).

Once you have the cost per unit, the rest of the statement is fairly easy to complete. All variable items are calculated based on the number of units sold. This includes sales, cost of goods sold, and the variable piece of selling and administrative expenses. The matching principle states that we must match revenue with expenses. Therefore, we can only expense the cost of the units that are sold. The units that are not sold end up in inventory.

Start with sales. Take your price per unit and multiply it by the number of units sold.

Sales = Price X Number of units sold

Sales = $100 X 8,000

Sales = $800,000

Using the cost per unit that we calculated previously, we can calculate the cost of goods sold by multiplying the cost per unit by the number of units sold.

Cost of goods sold = Cost per unit X Number of units sold

Cost of goods sold = $48.80 X 8,000

Cost of goods sold = $390,400

Calculate gross profit by subtracting the cost of goods sold from sales.

Selling and administrative expenses can be variable or fixed. Therefore, you should treat the selling and administrative costs like a mixed cost. In this case, the variable rate is $5 per unit and the fixed cost is $112,000. Write your cost formula and plug in the number of units sold for the activity.

Total selling and administrative expense = $5 X 8,000 + $112,000

Total selling and administrative expense = $40,000 + $112,000

Total selling and administrative expense = $152,000

Last but not least, calculate the operating income by subtracting selling and administrative expenses from gross profit.

Having a solid grasp of product and period costs makes this statement a lot easier to do. Calculate unit cost first as that is probably the hardest part of the statement. Once you have the unit cost, the rest of the statement if fairly straight forward.

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This is very helpful, thank you.

You’re welcome. Glad I could help!

thanku this is very useful

Thanks! I was confused by the sales commission and now I understand 🙂

I’m glad you understand it now! Thanks for taking a moment to comment.

What if you produced 10.000 but only sold 8.000? Do you take variable costs from 8.000 or from 10.000?

Are you asking how many units to include on the income statement? You always include the number of units sold because that’s how much revenue you are including. Revenue units must match expense units.

Why do you multiply the fixed overhead which is $4.80 per unit with the amounts sold $8000, and not with the amounts produced, as we did derive that $4.80 amount with amounts produced (48,000/10000)?

For the income statement, you always use the number of units sold. That’s why there are only 8,000 units.

We divided by 10,000 units because we must allocate fixed overhead to all of the units produced. When we allocate the fixed overhead, we will send $4.80 x 8,000 to the income statement and $4.80 x 2,000 to the balance sheet (inventory).

You helped my find that “AHA” moment – thank you for explaining this costing method in such simple terms and examples.

Hi, what if we want ti find the variable cost of goods sold ? Do we use the units sold (8.000) or use units produced (10.000)

If you are calculating a number on the income statement, like cost of goods sold, you would use units sold.

Hello, I appreciate this!

One question is what if we don’t have variable selling costs and fixed selling cost in the question, how do we calculate selling and adm. part?