The cost method is one of two methods that can be used for profit and loss. The cost method is designed to perform the calculation on the basis of cost types. For this purpose, it focuses, among other things, on production costs, i.e. material and personnel costs. This makes the overall cost method particularly suitable for manufacturing businesses in Germany. In foreign countries, on the other hand, the cost of sales procedure applies. This is why larger German companies of international standing also prefer the cost of sales method, although the cost method has the advantage that the value of all finished and unfinished products produced can be presented to the outside world. Ultimately, however, both the turnover and the cost method always lead to the same annual net profit or annual deficit.

1. Total Cost Procedure – Introduction

What are entrepreneurs looking forward to at the end of a successful business year? Right, on the profit and loss account, the latter account being irrelevant in this case. But how exactly do you calculate the profit or loss of a company? One might simply think that one calculates the profit by subtracting the costs and expenses from the proceeds. For an annual financial statement, however, this is too simple. In fact, there are special procedures by which such a profit and loss statement is carried out. One of them is the cost method. We now ask you to pay attention to this procedure and its specifics.

2.Legal provisions on the cost method

In addition to the total cost procedure, the Commercial Code (HGB) also provides for the cost of sales procedure in the profit and loss account. The corresponding provision requiring the application of one of the two procedures is § 275 (1) sentence 1 HGB. There, in § 275 HGB, the legislature provides instructions on how to apply the total cost method and the turnover cost method. However, since this is a right to vote, there is, of course, no specification as to when to use which of the two procedures. It merely stipulates that the profit and loss account must be drawn up in staggered form in accordance with a structure prescribed by the same law. § 275 HGB provides a separate structure for both calculation methods. The requirements for the preparation of the profit and loss account according to the total cost method can be found in § 275 paragraph 2 HGB.

What is the total cost method?

The peculiarities of approaching the cost method for profit and loss are that the calculation is made taking into account all types of costs. As a result, as the name suggests, you have to take all costs, but also all other positions associated with the profit or loss of a company. This therefore also takes into account aspects which, while not having a direct impact on the revenues generated, nevertheless represent a profit for the company. The same applies accordingly to losses.

This is done in order to be able to take into account costs associated with products produced within an accounting period, but which lead to a revenue only in a later accounting period. The same applies to own contributions that serve the own company.

4th Profit and Loss Accounting Procedure

Now let’s look in detail at how to perform the profit and loss statement in the overall cost method. For this purpose, the turnover is first used. However, the second position in the profit and loss statement is also important. This is because it involves stock changes in finished or unfinished products. In addition, there are other capitalised own contributions and other operating income. The next point is again particularly important. This concerns production costs. A distinction is made between material and personnel costs. Depreciation shall also be taken into account. Both depreciation on fixed assets and current assets are recognised under the provisions of the HGB. Additional income from investments, securities transactions and interest and similar income, accompanied by possible depreciation on financial assets, are also relevant. Interest payments, income and income taxes gradually round off the list. At the end, the result after taxes is to be counted against other taxes before we finally quantify the annual net profit or the annual deficit.

5. The Total Cost Procedure – Final Considerations

What is striking when analyzing the positions in the cost method is that we are dealing with production costs here. Indeed, production costs and inventory changes play a central role in the profit and loss accounting process in the cost method. So this process is used in manufacturing. For other industries, one must therefore use the cost of sales method.

Despite this limitation, which is subject to the total cost method, it is quite widespread in Germany in the manufacturing middle class. It has the advantage that in this way it is also possible to present the assets on the finished and unfinished products produced but still in stock in the profit and loss account. This can also be quite advantageous for the external presentation of such a company. The turnover cost method, on the other hand, excludes this. However, compared to international practice, where the cost method is preferred, the cost method plays a minor role. This is why large German companies prefer the cost of sales method even if they could alternatively also use the cost method. After all, their external impact is also geared towards the international market.

Apart from this, however, the choice between the turnover method and the total cost method is of little importance, because in both cases the result of the calculations is the same.