## 4. Absorption, variable, and throughput costing income statements

Having learned how absorption, variable, and throughput costing approaches treat inventory and period costs, let's prepare simple income statements using these methods.

To illustrate an example, let's assume SmarterBooks Company prints and sells college textbooks. In 2009 the company had \$ 2,500,000 in sales. The following information also pertains to the company's operations in 2009:

 Absorption Costing Variable Costing Throughput Costing Cost of goods sold (COGS) \$ 1,000,000 \$ 650,000 \$ 500,000 Fixed factory overhead N/A* 450,000 N/A Variable SG&A** expenses 300,000 300,000 300,000 Fixed SG&A expenses 200,000 200,000 200,000 Product conversion costs*** N/A N/A 800,000

(*) N/A does not mean that a cost is not applicable under certain costing method. It rather means that such a cost is included in other costs. For example, under absorption costing approach, fixed factory overhead cost is included in cost of goods sold; thus, we put N/A next to the fixed overhead cost.

(**) SG&A refers to selling, general and administration expenses.

(***) Product conversion costs are composed of direct labor and factory overhead.

Important to note, direct materials, direct labor, and variable factory overhead differ under absorption, variable, and throughput costing approaches. The same is true for the beginning and ending balance in inventory accounts. However, to make our example easier to understand, we have just provided the results of our calculations rather than the calculations themselves. The results are presented in the table above.

Now let's prepare income statements using different costing methods.

 Absorption Costing SmarterBooks Company Income Statement For the year ended December 31, 2009 Revenue \$ 2,500,000 Cost of goods sold 1,000,000 Gross margin 1,500,000 Selling and administrative expenses 500,000 Operating income 1,000,000

 Variable Costing Format SmarterBooks Company Income Statement For the year ended December 31, 2009 Revenue \$ 2,500,000 Variable costs: Cost of goods sold 650,000 Selling and administrative expenses 300,000 Contribution margin 1,550,000 Fixed costs: Factory overhead 450,000 Selling and administrative expenses 200,000 Operating income 900,000

 Throughput Costing Format SmarterBooks Company Income Statement For the year ended December 31, 2009 Revenue \$ 2,500,000 Cost of goods sold 500,000 Throughput contribution 2,000,000 Other costs: Product conversion costs 800,000 Selling and administrative expenses 500,000 Operating income 700,000

The calculation of the cost of goods sold and preparation of income statements under absorption, variable, and throughput costing approaches are summarized in the table below:

 Absorption Costing Variable Costing Throughput Costing Cost of Goods Sold (+) Beginning Inventory (+) Direct materials (+) Direct labor (+) Variable overhead (+) Fixed overhead = Goods Available for Sale (–) Ending Inventory = Cost of Goods Sold (+) Beginning Inventory (+) Direct materials (+) Direct labor (+) Variable overhead = Goods Available for Sale (–) Ending Inventory = Cost of Goods Sold (+) Beginning Inventory (+) Direct materials = Goods Available for Sale (–) Ending Inventory = Cost of Goods Sold Income Statement Revenue (–) COGS Gross Margin (–) SG&A expenses Operating income Revenue (–) Variable COGS (–) Variable SG&A Contribution margin (–) Fixed overhead (–) Fixed SG&A Operating income Revenue (–) COGS Throughput contribution (–) Direct labor (–) Factory overhead (–) SG&A expenses Operating income
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