Variable costing income statement is an income statement, where contribution margin is represented separately. It is done by deducting fixed expenses and removing from the revenue with variable expenses appearing with corresponding contribution margins.
When withdrawing marginal profit, expenses are divided into fixed and variable categories. Variable expenses are then deducted from the amount of sales proceeds, the amount obtained and makes up the marginal profit. Further, fixed costs are deducted from the margin profit, as a result of which net profit is revealed. Derived values from variable costing income statement is equal to margin profit divided by the size of sales revenue. The profit and loss statement on the basis of marginal profit reflects the dynamics of costs. Variable costing income statement shows the ratio of variable and fixed costs, regardless of the nature of the function with which this cost item is associated. This information helps determine whether to start production of this type of product, or better to abandon it. Variable costing income statement is also useful in order to evaluate possible solutions related to production, the features of an advertising campaign. In addition, this allows an assessment of performance.
In particular, the margin analysis will show how to optimally use the production capacity, how to formulate the offer price under the contract, whether it is worth accepting the terms of the order at the proposed selling price below the normal level. The profit and loss statement form with margin profit derivation has key components such as sales, variable costs as part of cost of sales, production margin profit, variable trading and administrative expenses, margin profit, fixed costs, and net profit. It is important to remember that not all costs are of equal importance for decision making, therefore, it is necessary to identify those that are essential for this decision. Such costs are called significant costs. Significant costs are expenses and, accordingly, income of the future period, which differ from each other on the basis of decision options.
Therefore, the costs of the past period, completed and irreversible expenses cannot be considered significant for the decision. Significant expenses for a specific period are incremental or differential costs. The decision-making process on this basis includes such steps as combining all kinds of costs associated with a particular solution and eliminating costs of the past period. In addition, this includes eliminating costs that are common to all options and selecting the best option based on an estimate of the data on the remaining costs. Sometimes a company or firm have to deal with the need to decide on further processing of the product. The decision will be positive if profit growth is expected. One of the variations in the formulation of this question is to determine the feasibility of selling the product at the point of separation of production costs or its further processing and sale at the final point of production.
The advantages of the variable costing income statement with the withdrawal of marginal profit are that with its help a decision is made to refuse production or to continue production of this type of product. It helps to decide whether to set a selling price below the normal price level. In conditions when production capacities are not fully utilized, it is advisable to set the selling prices for accepted orders below the normal level. This is done as long as a positive margin profit is provided, because fixed costs remain the same. The disadvantages of the variable costing income statement with the withdrawal of profit margin are that it is not used for external reporting and tax purposes. In addition, this does not reflect fixed overhead as part of the production cost. With variable costing income statement’s help, it is difficult to strictly differentiate between fixed and variable costs.