Subtitles section Play video Print subtitles Okay now let's talk about variable verse absorption costing. Now these are two different basic ways of presenting an income statement for a manufacturing company. Looking at this we're gonna have absorption costing which absorbs certain costs. This is what GAP says. This is for external reporting purposes. This is product versus period costs versus direct variable prime contribution margin income statement. This is sales minus variable equals contribution margin minus fixed equals your pretax operative income. This one separates variable from fixed costs. So let�s setup what our income statements look like. Here I'll put absorption and this is called absorption costing or full costing. And then over here we'll do variable costing. Now under your absorption and full costing, what are we doing here? This is going to be your sales minus costs of goods sold. That looks familiar. But costs and goods sold are going to be both your variable costs of goods sold and your fixed. That equals your gross profit minus SGNA, selling general administrative. Those are going to be both variable and fixed. Equals your pretax operating income. Notice this is your regular GAP income statement. Right this is GAP. This is what we use for external reporting purposes. This is the one that you're used to seeing. What are we doing here? We're separating out our product costs from our period costs. Cause remember when we defined it, what did we say? We said a product costs is the cost of creating the product that gets capitalized or absorbed into ending inventory. And then expensed as you sell it so it's a product cost. SGNA is a period cost if it expensed in the period in which it occurs, that's a period cost. Okay! Let's talk about absorption versus direct. This is called direct prime. This is also called your contribution margin income statment. So you'll see here there were direct variable prime contribution. So, also variable cause what we're really looking at are variable versus fixed. Now one of the things that you'll see is this is really for more management sides only. This is for internal reporting purposes. Here we're going to start out with the same number sales, but we're gonna take out our variable costs of goods sold, and our variable SGNA. That'll give us something called CM. That's called a contribution margin, I'll come back to that. Minus our fixed manufacturing costs, minus our fixed SGNA equals same pretax operating income. Now I say same cause it�s the same term but the amount won't be the same and you'll see why in just a minute. Okay, so what we're doing here is in this case we're separating out what variable costs from fixed costs. So here it's called variable direct prime contribution. Why? Because in this case what it assumes is fixed costs are a sunk costs. I got these fixed sunk costs. So what I'm really concerned with is my variable costs. So it's sales minus variable costs is CM. What does CM mean? It stands for contribution margin. We're going to use this in the next section for break even analysis. Basically cause you'll see in the next part of this section is break even analysis we use CM or contribution margin. CM means how much money is left over after deducting variable costs to contribute to fixed costs and profit. How much is left over from revenue sales after deducting variable costs to contribute. What is the margin left to contribute to fix and profit. That's what the difference is, that's what they're saying. Now, when you look at these two formulas the numbers are all going to be the same except two important numbers. Fixed costs of goods sold and fixed manufacturing costs. These two numbers are gonna be different and you'll see why in just a minute. Those two numbers are going to be different. So, everything else will be the same. It's just the difference between these two numbers. These two numbers. That's what's really gonna be the difference, that's how it's going to affect our calculations. So, when you look in your notes you'll see these formulas in there. You'll see two income statements for a manufacturing company and you've got sales minus variable minus fixed. Costs of goods sold is gross margin. Variable STNA fixed STNA is operative income. Again, I separated out what product from period. Versus direct variable prime contribution for internal purposes separates out variable from fixed. Variable from fixed. Okay! The real difference is going to be the treatment of our items such as fixed costs of goods sold and fixed manufacturing costs.