definition backgroundAll you need to know about traditional income statement

All you need to know about traditional income statement

By Nguyen Oanh
Published: 11/15/21

The income statement is an accounting document providing all the income and expenses of a company during an accounting year.

Traditional income statement or absorption costing income statement is one of the types of income statement figuring the detailed information of the financial health of the company.

But exactly what is a traditional income statement? What is it used for? How to calculate different types of value of income statements? What is the difference between the traditional income statements and contribution margin income statements?

Let’s discover all in this article!

What is a traditional income statement?

The absorption cost is a method of management accounting for capturing all the fixed costs associated with the manufacture of a particular product.

Companies prepare a traditional income statement for reporting to entities or persons outside the company. A traditional statement requires a company to record all of its overheads in record. This means that fixed costs associated with the manufacturing process, such as labor or materials, are counted in the cost of product inventories borne by the business.

When goods are sold, in a traditional income statement, the fixed costs associated with manufacturing the goods are transferred from the inventory costs of the company to the costs of the products sold by the company.

With a traditional income statement, a company's net income is calculated using both production costs and the amount of units sold by the company. A company's net income line is therefore affected by the amount of accounts it has of specific products during the period covered by a financial report.

Because of its approach, a traditional income statement can also be referred to as a full cost. In calculating variable costs, fixed production costs are not included in the cost of producing goods or services. Because the traditional income statement takes fixed manufacturing costs into account in calculating the cost of manufacturing products, it is viewed by some as a complete or more complete picture of the financial performance of the company.

Format of the traditional income statement

Here is the simplest format of the traditional income statement:

Sales $ xxx
Less cost of goods sold $ xxx
Goods profit $ xxx
Less selling and administrative expenses $ xxx
Net profit (operating income) $ xxx

Sales - the cost of goods sold = good profit - selling and administrative expenses = net profit

Gross margin is an essential indicator of your income statement. Expressed in monetary units, gross margin represents the difference between the selling price and the cost of your products or services. The gross margin shows whether a particular activity is likely to generate income or not.

Example of the traditional income statement

Calculate the cost per uni

To calculate the cost per uni, all you need to do is divide the total amount by the amount of units. Usually, you have to calculate the cost per uni of direct materials, direct labor, variable overhead, and fixed overhead.

Calculate the sales

To calculate the sales, you multiply the cost and the amount of units:

Sales = Price per unit x total of units

For example, you sold 500 products and the price of each product is $10. So you have made 500 x $10 = $5000 of sales.

Calculate the cost of goods sold for the traditional income statement

To calculate the cost of goods sold, you multiply the cost per unit by the number of units sold (It’s the same cost per unit that we calculated previously):

Cost of goods sold = Cost per unit x the number of units sold

Calculate the gross profit

To calculate the gross profit, you subtract the cost of goods sold from the total sales that you made:

Gross profit = Sales - the cost of goods sold

Calculate the selling expense and the administrative expense

The selling expenses and administrative expenses mix also fixed and variable costs together:

Total of administrative expenses and selling expenses = Cost per unit x number of units sold + the fixed costs

Calculate the operating income

To calculate the operating income, you subtract the total of selling and administrative expenses from gross profit:

Operating income = Gross profit - the total of selling and administrative expenses

The difference between Traditional Income Statement Vs. Contribution Margin Income Statement

The contribution margin income statement is an alternative to the traditional income statement. The difference is that this profit and loss statement separates the variable and fixed expenses involved in running a business. Then, at the end of the contribution margin income statement, we can obtain the revenue after deducting or paying all the fixed and variable expenses and costs.

The format of the traditional income statement and the contribution income statements is also different. Compared to a traditional income statement, the expenses of the contribution margin income statement are divided according to the behavior of the fixed cost. It’s the expenses fixed instead of production costs.

Companies use the traditional income statements to establish external reporting while they use contribution margin income statements to analyze the performance of each category of product.

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