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The primary objective of The Serious Reader Company is to become profitable which means that it will generate income for distribution to its owner. The financial statement, which provides details of the company’s sales, costs, expenses, and profit, is the income statement. There are different types of the income statement that companies prepare for internal purposes, which are discussed in this paper along with the reasons for making them. Furthermore, this paper describes scenarios in which understanding how costs behave is useful.
Internal Income Statements
The preparation of Internal Income Statements does not require companies to follow the rules and guidelines established by the Financial Accounting Standards Board (FASB). They are prepared to provide more details that are not included in the external income statement. Moreover, they contain confidential information which is not disclosed to the external users of financial reports (Tracy & Tracy, 2014).
The internal income statement contains information that is accessible to the top management, finance managers, and employees of a company. Businesses prepare internal income statements for various reasons. However, the primary objective is to estimate the impact of their decisions on profitability. The purpose of these statements is to provide financial information specific to a product or venture that the company is pursuing. It helps in identifying the areas which can be improved to reduce costs or expenses.
There are different approaches adopted for preparing internal income statements. These approaches differ on the basis of the treatment of fixed and variable costs. The internal income statement uses variable costing and considers fixed costs related to the manufacturing process as period costs. It implies that this type of income statement is prepared to estimate the contribution margin of a product(s) sold by the company.
Evaluating cost behavior is essential to make informed decisions that could affect the future performance of the company. The cost behavior can be explained on the basis of a linear function which could be used for estimating total costs affected by three types of costs including fixed, variable, and mixed costs (Mowen, Hansen, & Heitger, 2016). The first scenario in which it is important to determine the cost behavior is the change in total costs caused by the change in the activity level. In this case, the number of units produced affects the total costs which include the variable cost per unit. Moreover, the variable cost may vary according to the level of activity, which means that it could rise when the production level increases.
In the second scenario, certain variable costs may include a fixed portion such as the telephone bill which includes the variable cost of calls made and also the fixed-line rent. The third scenario is based on a longer time horizon in which fixed costs may also be considered as variable costs by the business (Drury, 2013). Therefore, it could be stated that costs behave differently depending on the period selected for analysis.
It could be concluded that businesses prepare different types of the income statement for internal use as they help in making business decisions which have a direct impact on their profitability. Moreover, managers are interested in determining how different costs behave which could affect their decisions and outcomes. There are three types of costs included in the cost function including fixed, variable, and mixed variables which behave differently and affect the profitability of a company.
Drury, C. (2013). Management and cost accounting (4 ed.). Berlin, Germany: Springer.
Mowen, . M., Hansen, D. R., & Heitger, D. L. (2016). Managerial accounting: The cornerstone of business decision-making. Boston, MA: Cengage Learning.
Tracy, J. A., & Tracy, T. (2014). The comprehensive guide on how to read a financial report. New York, NY: John Wiley & Sons.