Variable Costing Income Statement: What Is It and How to Prepare

The variable costing income statement provides valuable insights to improve a company’s financial position.

It offers insights into product variable costs and aids in making decisions regarding them.

In this article, you will learn everything about the variable costing income statement, including its format, how to create it, and examples.

Let’s dive into the article.

What Is a Variable Costing Income Statement

The Variable Costing Income Statement is a type of financial statement that illustrates the various components of variable costs within a company.

Understanding the Variable Costing Income Statement aids in decision-making processes related to product costing and determining which products to prioritise or discontinue.

It begins with the revenue generated by the company, followed by the inclusion of all variable costs as single-line items.

Variable costs encompass a variety of expenses, such as raw material costs, wages, and other variable expenditures associated with production.

Next, the statement calculates the contribution margin, which represents the amount of revenue remaining after deducting variable costs. This metric is crucial as it highlights the product’s contribution to the company’s overall revenue.

Following the contribution margin, fixed costs are listed in the statement. Fixed costs are expenses that remain constant regardless of the level of production or sales. Examples include rent, salaries, and utilities.

The Variable Costing Income Statement concludes with the net income of the company, which represents the profit or loss remaining after all expenses, including fixed costs, have been deducted from the revenue.

Format of the Variable Costing Income Statement

The format of the Variable Costing Income Statement is relatively simple and easy to understand. It typically consists of a few single-line items arranged as follow:

1. Revenue

Revenue represents the total income generated by the company from selling its products or services.

Formula:

\text{Revenue} = \text{Price of the products or service} \times \text{Number of sold units}

It serves as the starting point in the income statement, indicating the company’s top-line earnings.

2. Variable Costs

Variable costs are expenses that fluctuate depending on the level of production or sales. Examples include raw material costs, wages, and overhead expenses that vary with changes in production volume or sales.

When production levels increase, variable costs also increase accordingly.

3. Contribution Margin

The contribution margin is the amount of revenue remaining after subtracting variable costs.

formula:

\text{Contribution Margin} = \text{Revenue} - \text{Variable Costs}

It indicates the portion of revenue that contributes to covering fixed costs and generating profit. The contribution margin is a key metric for assessing product profitability and overall financial performance.

4. Fixed Costs

Fixed costs are expenses that remain constant regardless of changes in production levels or sales volume. Examples include rent, salaries, insurance etc. Fixed costs do not vary with production output and remain consistent over time.

5. Net Income

Net income is the final profit or loss earned by the company after deducting all expenses from revenue.

formula:

\text{Net Income} = \text{Contribution Margin} - \text{Fixed Costs}

It represents the company’s bottom-line profitability and indicates whether the company is generating a profit or incurring a loss. A positive net income indicates a profit, while a negative net income indicates a loss..

How to Create a Variable Costing Income Statement

Creating a variable costing income statement is straightforward. You will only need some financial figures.

When you create a variable costing income statement, it contains more components compared to what is shown in the format.

Some examples include variable marketing costs, variable production costs, fixed marketing costs, etc.

To understand this, let’s create a variable costing income statement using the example of a hypothetical company named XYZ, which sells smartwatches. Here is the company’s data:

• The company sold 8,000 units of the watch.
• The per-unit price is $100.
• The selling variable cost is $500 per unit.
• Fixed costs amount to $40,000 for the given time period.

Let’s start by calculating the variable costing income statement.

For revenue, multiply the price per unit by the number of units sold:

Revenue = 8,000 × $100 = $800,000

Now, gather all of the variable costs, including overhead costs, selling costs, and administrative costs. Also, account for the inventory.

Variable selling cost = 500 × 100 = $50,000

Variable administrative cost = 300 × 100 = $30,000

Now calculate the cost of goods sold (COGS):

COGS = Beginning Inventory + Purchases – Ending Inventory

COGS = $100,000 + $400,000 – $120,000 = $380,000

Total variable cost = selling cost + administrative cost + costs of COGS = $460,00.

Now let’s find out the contribution margin. For this ad, we use the formula:

Contribution margin = revenue – variable costs = $340,000

This metric is used to decide the price of the product based on variable costs. Many companies prefer to express the contribution margin as a fixed percentage. 

For this scenario, the contribution margin is 42.5%.

Now, let’s calculate fixed costs the same way we calculated the variable cost. However, variable costs depend on the product, so they are calculated per unit, whereas fixed costs are based on an annual basis.

Here are the different types of fixed costs:

• Fixed Manufacturing Overhead: $100,000
• Fixed Selling Expenses: $40,000
• Fixed Administrative Expenses: $20,000

Simply sum all fixed costs:

Fixed costs = $160,000

Now, subtracting the value of fixed costs from the contribution margin will give us the net income of the company.

Net income = contribution margin – fixed costs

$340,000 – $160,000 = $180,000

Here is XYZ company’s variable costing income statement.

Why Is a Variable Costing Income Statement Important

The variable costing income statement is helpful to professionals in various ways. Here are some important aspects to consider:

Product Decision

When a company reviews the variable costing income statement, it provides insight into which products generate sufficient revenue to sustain the business and which ones do not.

For example, when a company offers two products and decides to continue one while discontinuing the other, using this statement, the company can determine which product will cover both its variable and fixed expenses.

Price Management

One of the great benefits of the variable costing income statement is that it provides insight into the pricing of your products.

As you know, having the ideal price in the market is important; otherwise, the company will face a cash crisis.

Therefore, the variable costing income statement provides a view of how much the product price should be to cover both its variable and fixed expenses.

It is necessary because costs vary for products, so based on that and considering the contribution margin, the company can make decisions regarding price.

Cost Management

The variable costing income statement provides insight into product costs as well as their relation to product price.

If a product’s variable costs are high, the company can consider cutting some variable expenses to decrease costs. Otherwise, the company may need to increase the product price, which could negatively impact the business.

Another aspect is that the company can identify products with higher variable costs but lower sales. Thus, the company can decide whether to continue running the product or shut it down.

Conclusion

In conclusion, I hope you found this article informative and insightful.

Are you considering creating a variable costing income statement for your company?

Share your thoughts in the comment section below.