The income statement prepared by deducting all the variable costs initially with sales revenue

to get contribution margin and then deducting the fixed costs with contribution margin to get

net profit is known as variable costing income statement. The costs which remain constant in

per unit but are different with respect to the production level is variable cost. The variable

cost is directly related to the production volume. Income statement under variable costing can

be prepared for both manufacturing and service industries (Katija & Matti, 2002). As for an

example, education institution which is a service industry has teachers, lecturers who charge

per class. Thus, the teachers charging per class is variable cost where as the rent paid for the

building of school/college, internet bills etc. comes under fixed cost. So, the variable costs

and fixed costs can be separated under variable and fixed cost overhead, hence, making it

possible to prepare income statement under variable costing for service industry as well.

Thus, income statement under variable costing is applicable to service operations as well.

The hypothetical example for income statement under variable costing for XYZ

Physiotherapy Center which is a service industry:

Costs Amount

Consultant fee $30 per patient

Physiotherapist fee $15 per patient

Ointments charges $20 per patient

Lab test charges $20 per test

Rent $40,000

Other fixed costs $20,000

 
Total patient visited in the physiotherapy center is 200 patients and $700 is charged per

patient.

Income statement under variable costing is given below:

Income Statement under Variable costing of XYZ Physiotherapy Center

 as per year ended 2021.

Particulars Amount Amount

Sales Revenue (200*700)   140,000

Less : Variable cost    

      Consultant fee (200*30) 6000  

      Physiotherapist fee 3000  

       (200*15)

                   Lab test charges    4000  

                    (200*20)

      Ointment Charges 4000  

         (200*20)

Total variable cost   17000

Contribution Margin   123,000

Less: Fixed cost    

           Rent 40,000

           Other fixed cost 20000

Total fixed cost   60,000

Net income   63000

The above-mentioned income statement under variable costing for XYZ Physiotherapy

Center shows the total variable costs, and total fixed costs incurred during the service

provided. Since no production is associated with service industry, there is no mention of

direct material and direct labor and opening stock and closing stock in income statement.

Thus, the income statement under variable costing for service industry is a bit different

compared to income statement of manufacturing industry. The income statement mentioned

above of XYZ Physiotherapy Center shows sales revenue of $140,000 which is generated by

providing services to 200 patients. The variable cost is deducted from sales revenue to

retrieve contribution margin. The variable costs that are incurred in the process are;

Consultant fee $6,000, Physiotherapist fee $3,000, Lab test charges $4,000 and ointment

charges $4,000 and the total variable cost is $17,000. The variable cost is deducted with sales

revenue and contribution margin $123,000 is retrieved. The contribution margin is deducted

with fixed cost $60,000 and the net income $63,000 is generated for XYZ Physiotherapy

Center.

The difference between variable costing income statement and absorption costing income

statement is; the format of variable costing incoming statement and absorption costing

income statement. The variable costs are deducted with sales revenue to get contribution

margin and all fixed costs are deducted with contribution margin to get net profit whereas in
absorption costing, the variable costs as well as fixed costs are deducted with the sales

revenue to get the cost of goods sold and then the non-manufacturing expenses or operating

expenses are deducted with cost of goods sold to get the net income.

The hypothetical income statement in absorption costing format and variable costing format

where the number of units sold is different from the number of units manufactured are as

follows:

Particulars Amount

Total goods manufactured 7000 units

Total sales 4000 units

Direct material $5 per unit

Direct labor $9 per unit

Variable overhead cost $4 per unit

Fixed manufacturing overhead $70,000

Variable selling and admin exp. $3 per unit

Fixed selling and admin exp. $30,000

Selling price per unit $60

Inventory rate for absorption costing = Direct material per unit + direct labor per unit +

variable manufacturing cost per unit + standard fixed manufacturing overhead (SFOR)

SFOR                                      = Fixed manufacturing cost/production unit

                                                = 70,000/7,000
                                                = $10.

Inventory rate                         = $5 + $9 + $4 + $10

                                                = $28.

Income statement under Absorption Costing of ABC Company

as on 31st December 2021

Particulars Amount Amount

Sales Revenue (4000*60)   240,000

Less: Cost of goods sold    

          Direct material (7,000*5) 35,000  

          Direct Labor (7,000*9) 63,000  

          Variable manufacturing cost (7,000*4) 28,000  

          Fixed manufacturing cost (7,000*10) 70,000  

     Total manufacturing cost 196,000  

          Add: Opening stock 0  

          Less: Closing stock (3,000*28) 84,000  

Cost of goods sold 112,000 112,000

Gross Margin   128,000

Less: Nonmanufacturing cost    

           Variable selling and admin. Exp. (4,000*3) 12,000  

           Fixed Selling and admin exp. 30,000  

Total Non-manufacturing cost 42,000 42,000

Net Income   86,000

Inventory rate for absorption costing = Direct material per unit + direct labor per unit +

variable manufacturing cost per unit

Inventory rate                         = $5 + $9 + $4

                                                = $18.

Income statement under Variable Costing of ABC Company

As on 31st December, 2021

Particulars Amount Amount

Sales Revenue (4,000*60)   240,000

Less: Variable Cost    

          Direct material (7,000*5) 35,000  

          Direct Labor (7,000*9) 63,000  

          Variable overhead cost (7,000*4) 28,000  

     Total variable cost 126,000  

     Add: Opening stock -  

      Less: Closing stock (3,000*18) 54,000  

    Variable manf. Cost of Goods Sold 72,000  

     Variable Selling and admin exp. (4000*3) 12,000  

          Total variable cost 84,000 84,000 

Contribution Margin   156,000

Less: Fixed Cost    

           Fixed manufacturing cost 70,000  

           Fixed selling and admin exp. 30,000  

Total Fixed cost 100,000 1,00,000

Net income   56,000

            Here, due to treatment of fixed cost, the absorption costing method treats

manufacturing costs as cost of stock whereas variable costing method treats fixed cost as

period cost. The difference in profit is calculated below:

Difference in cost       = difference in stock (closing stock – opening stock)*SFOR

                                    = (3,000 – 0)*10

                                    = $30,000

Difference in profit     = profit of Absorption costing – Profit of variable costing

                                    = 86,000-56,000

                                    = $30,000
The net income in absorption costing is $86,000 whereas the net income in variable costing is

$56,000. It is because, the fixed cost or Standard Fixed Cost Overhead (SFOR) is absorbed in

the closing stock of absorption costing due to which the amount of closing stock in

absorption costing is $84,000. But, in variable costing, the SFOR is not absorbed because

variable cost treats fixed manufacturing cost as period cost and does not include fixed

manufacturing cost while calculating the inventory rate due to which the closing stock value

is $54,000. Thus the difference amount in net income is $30,000.

            In conclusion, the difference in profit in both income statement is because of different

treatment of fixed manufacturing cost in the respective income statement. This is the main

difference in which the whole concept of absorption costing and variable costing revolves

around.

References:

Katja, T. & Matti, S. (2002). Process- based costing: The best of activity costing. AACE

international transactions; Morgantown, 1(1), 1-6. https://www.proquest.com/scholarly-

journals/process-based-costing-best-activity/docview/208196934/se-2?accountid=158986

Wild, J., & Shaw, K. (2019).  (8th ed.). Financial and managerial accounting: Information

for decisions. McGraw-Hill