In order to prepare the annual financial statements, accounting entities must make a profit and loss statement. You can choose one of two legally proposed methods. One of them is the cost of sales method. In addition to revenue, the cost of sales method uses parameters for costs that can be assigned to functions within the company. However, they only come into effect if they are related to revenues realised by an accounting entity within the same accounting period. This peculiarity can therefore result in the assignment of certain costs to another accounting period, which for the time being are not taken into account when applying the method of cost of sales. Nevertheless, both profit and loss procedures always lead to the same result. The turnover cost method is internationally the most important method for profit and loss accounting. This is why large German corporations clearly prefer the cost of sales method in their profit and loss statements.

1. The Revenue Cost Procedure – Introduction

Companies that are required by the Commercial Act to draw up a trade balance must also present a profit and loss statement in their annual accounts. The same also applies to those companies that voluntarily decide to draw up a trade balance. Such a profit and loss statement is not a simple comparison of expense and revenue. So there is more to consider here. But you even have a choice of how to do it. Although it is a choice narrowly defined by numerous provisions, we would like to present here one of the two methods available, namely the method of cost of sales.

2. statutory provisions on the procedure for the cost of sales

So if there are regulations that dictate how to draw up the profit and loss account, then you will find them in the law. In this case, the provisions on the manner of the profit and loss account are in § 275 HGB. First of all, this law stipulates that one should make a list in staggered form for the profit and loss account. Furthermore, this paragraph elects the two profit and loss methods that may be used, namely the cost of sales method and the cost of ownership method. In addition, § 275 HGB regulates in detail how the individual positions have to be set up in the total cost procedure but also in the turnover cost procedure. For this purpose, this legal standard also contains its own structure, which must be adhered to in the profit and loss statement. For the sales cost procedure, the structure according to § 275 paragraph 3 HGB applies.

What is the turnover cost method?

Now let’s get to the details of the revenue cost procedure. What are the differences with the total cost method? In any case, let us betray at this point, we will not notice any difference in the result of the two calculation methods. This would hardly make sense because otherwise this would contradict the basic idea of the HGB, namely the protection of creditors. Thus, if the result is the same in both the total and the cost of sales method, the differences must lie in the individual items they contain.

In fact, the differences are fundamental. The cost method is based on the presentation of all cost types, while the cost method is based on the functional types. This means that when approaching the cost of sales method, one asks which function caused costs and provided services here. In this respect, the structure in § 275 (3) HGB is also to be understood. It contains items that are assigned to functional areas of companies. Functional areas can be production, warehousing, distribution or administration. Thus, the turnover cost method is closely based on the cost center calculation, which is also based on the criterion of function.

To put it more concretely, the cost method involves all costs incurred within an accounting period in relation to the actual revenues generated. So there is a close correlation between the functions required and the results that condition them. Other services and costs, which were also incurred in the course of an accounting period but only lead to income at a later date, are thus not taken into account.

4th Profit and Loss Accounting Procedure

The structure of the HGB to the revenue cost method begins with the proceeds. From them, the production costs are deducted, which are directly related to the revenue. Unfinished or unsold products or services are therefore excluded. This gives us a gross result at this point. However, there are other costs associated with this. First of all, we must take into account distribution costs and general administrative costs. Next, other operating income and expenses are recognised. Income from participations, securities transactions and interest and related income follows one after another. Depreciation on financial assets or current assets are also relevant here. Then we have to estimate the interest and similar expenses paid by the accounting company, followed by taxes on income and income. Thus, the result after taxes is fixed. But also other taxes now come to the approach before the annual profit or the annual deficit emerges from all the calculation.

5. The Revenue Cost Procedure – Final Considerations

The cost of sales method impresses by recording the costs leading to the actual revenue, and only these costs. All other costs associated with revenues in other accounting periods are therefore distinguished from those that are relevant exclusively in the current accounting period. This creates some clarity about the success of the company if you limit this view purely to the accounting period to be considered. However, this eliminates the costs that could be associated with potential future revenues in the profit and loss statement. If you want to include them in this calculation, knowing that this results in the same annual surplus or annual deficit, this may favor the overall cost method. However, this is only possible in the case of a manufacturing industry, because only taking into account the stock changes of finished and unfinished products leads to a necessary correction within the calculations.

In contrast to the total cost method, which is preferred in Germany in the manufacturing industry, especially in the middle class, the cost of sales method prevails in other areas. This also includes the fact that the cost of sales method dominates internationally and is largely the only permitted method for determining profit and loss. Accordingly, larger German companies and corporations that also operate cross-border prefer the sales cost method. The profit and loss statements of the Dax companies are a good example of this.