PERIOD COST AND ITS IMPACT ON INCOME STATEMENTS / FINANCIAL STATEMENT //DISCLOSURE Alina Magdalena Ilcus Keywords : period costs , treatment in month… [626624]

PERIOD COST AND ITS IMPACT ON INCOME
STATEMENTS / FINANCIAL STATEMENT
//DISCLOSURE

Alina Magdalena Ilcus

Keywords : period costs , treatment in month end closing , financial disclosure,
fringe benefit s, non-wage labour costs and benefits, r etirement plans, private pensions

JEL classification : J31, J32, J33
1. Introduction
In this study we analyse the impact of period costs on income statement.
The author tries to highlight the main difference in period costs tr eatment in
Romania and Germany : the acruall approach of fringe benefits.
The case study exibit the usual transaction s and programs of period costs’
treatment in mo nth end closing in SAP R3 ERP System for a manufacturing
company.

2. Period Cost Delimitation Abstract

In this paper we posit that period costs are extremel y important for financial
disclosure because they are running directly in the P&L account, having an
immediately impact on income statement . In the income statement, period costs are
deducted from revenues without ever having been included as part of inven tory.
Our focus will be on period cost treatment for manufacturing sector,
highlighting main differences between period costs in Romania and in Germany: the
accrual approach of fringe benefits.
In the study case we present some usual transaction and progra ms for treating
period costs in mo nth end closing in SAP R3 ERP System.

The abstract will be approximately 120 -180

Regarding period costs is of param ount importance the value of
expense in a ny given period and not t he detailed structure of it. (Hoitsch&
Lingnau, 2004 , p.14) Horngren, (2012, p.42) states that period costs are all
nonmanufacturing costs. They are typically called selling, gener al, and
administrative expenses in the inco me statement . Thus most of the administrative
costs of a business can be considered period expenses. Inventoriable costs and
period costs flow through the income statement at a manufacturing company
similar to th e way costs f low at a merchandising company. At a merchandising
company, however, the flow of costs is much simpler because the only
inventoriable cost is the cost of merchandise .
Newcomers to cost accounting frequently assume that indirec t costs
such as rent, telephone and depreciation are always costs of the period in which
they are incurred and are not associated with inventories. When these costs are
incurred in marketing or in corporate headquarters, they are period costs. However,
when these costs a re incurred in manufacturing, they are manufacturing overhead
costs and are inventoriable. (Horngr en, Datar, Foster, 2012, p.42). Manufacturing
overhead costs impact Work in Process Inventory as part of total manufacturing
costs incurred and furthermore a s cost of goods manufactured.

Figure xx: Period cost s for a manufacturing sector company (left) versus a
mercha ndising one (right)

Source: Extract from Horngren, Datar, Foster (2012, p.39 and 43)
Some costs such as R&D costs are trea ted as period costs because,
although these costs may benefit revenues in a future period if the R&D efforts are
successful, it is highly uncertain if and when these benefits will occur. Expensing
period costs as they are incurred best matches expenses to revenues. ( 2,p.38) x

The income statement or the profit and loss statement (P&L) sets out the
amount of each function and enables management, stockholders, analysts, and
others to study the changes in function costs over successive accounting periods ,
(28,p. 58 )
Period costs belong classically in the P&L but they are also in
accounting balance exhibited, as Needles , Anderson, Caldwell, (2011,p.110)
explained . Due to double entry principle, labor costs are also in the Balance Sheet
in the Liabilities section detailed.

Figure no.xxx: Relations between accounting balance and P&L
Source: Extract from Needles, Anderson, Caldwell, 2011,p.110

Common period costs for each business, no matter what industry are
labor costs , comprised in general and a dministrative expenses, direct labor and
manufacturing overhead costs . Fringe benefit costs or so -called perks are non –
wage labor costs and and benefits provided by the employe r such as company
car, house allowance , paid vacations, free child care, free p arking, personal
assistants or private secretaries, health care, recreational club memberships,an
office with a view, or flexible work hours. These may include employee medical
health insurance, child care, physical fitness facilities, and retirement plan s and
private pensions as well as flexible fringe benefit programs called cafeteria plans.
These plans contain a “menu” of fringe benefit options including cash
compensation and nontaxable benefits alternatives.
All above mentioned are generally being offe red to middle and top management ,
not to blue -collars . Current bonus arrangements or year -end bonuses may arise
when performance is above some specified quantitative measure . ( 5 Barfield,
Raiborn, Kinney, 1994, p.562, 940;944) .
In authors’ opinion, main d ifferences between Germany’ and Romania’
period costs will be in fringe benefits of c ompensation packages, especially
Nonwage Labor Costs and Benefits, Retirement Plans and Private Pensions.

Fringe Benefits in Germany

Some fringe benefits are regarded part of a taxable income. Company car offers
little or no advantage for many high income earners in Germany according to
PWC study, Doing_Business_in_Germany_Guide_2017.P.55 -57., as the value of
the private use is subject to wage tax (progressive up to 4 5%) as well as to social
security contributions (cca. 40%).
There are two traditional ways for German companies to provide for employees’
retirement or ill health, the relief fund and the unfunded pension plan . The relief
fund was established for the help of present and retired employees in need and is
financed by regular contributions by the employer. These are tax deductible when
made, provided certain limits based on the fund assets and annual outgoings are
adhered to.
Pension plans are invariably of t he defined benefit variety and are reflected in the
financial statements as a provision for future and current pensions payable.
Annual allocations to the provision are tax deductible as current expense provided
the amounts are supported by an actuarial co mputation based on prescribed
formulae and provided the plan, itself, meets certain formalities. Because there is
no funding requirement, granting present employees future pension rights achieves
a current tax deduction without a cash outflow for the emplo yer and without a
corresponding burden on the beneficiaries, who do not tax the income until
receipt .
Taking out insurance policies covering a company’s pension obligations is also
popular, particularly with smaller companies or to provide for individual
managerial employees. If the company is the beneficiary under the policy, the tax
deductible current expense is the premium plus the actuarially calculated annual
accrual minus the increase in the adjusted surrender value of the policy. There is no
immediat e tax effect on the employee. If the employee is the benefici ary, the
premium payment is treated as an employee cash benefit.
Rather more recently, deferral schemes to commute salary increases and future
bonus or other discretionary payments to retirement benefits have gained in
popularity. These schemes are often backed by a pension fund. Provided the
prescribed formalities and limitations are observed, the annual expense is
deductible for the company, but the income is not taxable by the employee until
receipt.
Those wishing to provide for their employees can also do so through a pension
hind. Pension funds are supervised by the official supervisory authority but are not
subject to the same restrictions on investment as insurance companies. Most
pension fu nds are managed by insurance companies, banks and other operators as a
service. Contributions are tax deductible , but the company does not have to
show a future pension liability in its accounts if the pension fund is reinsured .
Present and former employee s with both funded and unfunded pension rights are
protected against employer bankruptcy by a government supported and regulated
Association for the Assurance of Pensions. Employers making pension promises of

all descriptions other than insurance policies taken out in the name of the employee
to benefit must join the Association and pay an annual premium based on their total
commitment. An exception applies for irrevocable direct insurance policies and
pension funds. The Association sets the rates to cover its actual expenditure in the
previous year; thus effectively, it spreads the pension risk from employer
bankruptcy over all contributing employers.
There are also various government sponsored schemes run by insurance companies
for private individuals. The se used to be heavily advertised by the government, but
have not lived up to initial expectations forvarious reasons including a surfeit of
formality and low upper limits.
Legally, employers must continue to pay employees at least their average net pay
for the first six weeks of sickness. Thereafter, the health insurance institutions will
provide sick pay to their members, although only up to a relatively low maximum
amount. Employers will sometimes make up the difference for a not inconsiderable
period the reafter, particularly to long -serving executives, although usually without
a formal obligation to do so.

3. Impact of Accounting Method on Financial Statements

The financial statements in Germany must follow the accrual accounting
principle according to PWC study Doing_Business_in_Germany_Guide_2017 ,
p.68. For financial statements prepared in accordance with generally accepted
accounting principles, the accrual method is required because of the matching
principle . xxx 1
The basic German financial statements are a balance sheet and a profit and
loss account. The notes represent an “appendix” (Anhang) and comprise detailed
explications . The financial statements are accompanied in the annual report by the
auditor’s report an d the proposal or resolution for profit appropriation. Finally, the
annual report includes the directors’ report (the so -called “business report” or
Lagebericht). The directors’ report should discuss the business situation of the
company and also specifica lly mention major risks and opportunities, a description
of the internal control system, the future outlook for the company, any important
subsequent events, anticipated development of the company’s business and any
branches it maintains. The directors’ re port is subject to audit, too.(PWC, p.63.)
Under the accrual method of accounting, period costs such as selling,
general and administrative expenses are reported on the income statement in the
accounting period in which they are used up or expire. They ar e referred to as
period costs because they are not assigned to products, and therefore cannot be
included in the cost of items held in inventory. (2, p.43 xx) Building provisions and
accruals facilitate decision -making and ensure that the company’s decisio ns are
based on the receipts and especially on expenses expected in the future and
moreover are presented within in the financial statements. In the period expenses’

context, we are highlighting the provisions only, because these are made only for
expecte d future expenses whereas accruals are made for both receipts and
payments.
The accounting treatments influence the image of the entity's annual
financial stateme nts (Dǎnescu, 2014, JAA, p.16). Thus, there are differences of
image by using different acco unting models “cash” or "accrual". This image must
be analyzed also in terms of the factors that may affect the user in retrieving
information required. The risk associated with selection of alternative accounting
treatments impacts the manager and the aud itor in the evaluation of the managerial
process . (Dǎnescu, 2007, p.103)
Dǎnescu states that financial statements must be looped with ratio method .
Also the analyse has to be supplemented with detailed assessment and study of the
dependencies between balance sheet, income statement and cash flow and th eir
elements or group of elements. ( a7, Danescu&Rus 2014, p.22)
Quoted German companies must also publish a cash flow statemen t and a
declaration of complience according to the Code of Corporate Governance,
according to PWC study.
Dǎnescu and Rus (2014, p.23) as well as Dumitrescu (2014, p.99) share the
same opinion that “the liberty of choosing the accounting policies by
management lead to either a diminution or an augmentation of the result.” The
author share the same opinion that the accounting poli cies impact the income
statement and moreover the result. Unfortunately the accounting as well as the
fiscal result may be affected and in many cases non -conformities and irregularities
occur, with many catastrophic consequences. ( Dǎnescu, Todea et.al, 2011,p.3)
Speaking of disasters, the Volkswagen scandal raises many questionmarks
concerning what can be hidden in the very detailed and bulky reports that comply
with the highest corporate social responsibility standards. An KPMG stu dy in
2015 reveals that information concerning corporate responsibility is increasingly
relevant to understand risk and opportunities. S tock exchanges and governments
institute requirements for companies concerning the inclusion of corporate
responsibility data in annual reports. ( Chersan, 2015,p. 433)
Variation of provisions including pensions ones may influence the
Operative Cash Flow and in the end, the Free Cash Flow. These are object to
financial disclosure. Treatement of the most frequent provisions will be presented
bottom.

Figure no. xxx: de tradus : Example of Free Cash Flow in a German company

4. Period cost treatment under accrual model in month end closing
(MEC)
Preparation of monthly reporting should ensure financia l reporting
accuracy. Up to reporting activities, closing ones impose review of the month -end
adjustments of accruals and diverse provisions, reconciliation of balance sheet
accounts as well as review of the accounting transactions in order to ensure prop er
classification of transactions according to the profit – respectively cost – centers.
Normally in MEC happens the reversa l of provisions and accruals of prior
period and the reposting of respectively cummulated amounts according to cost
allocations in the current period. According to Needles et.al. the reversal operation s
are not a must, but an option and they adress any accumulated receips or expenses.
(2011,p.152 -153)
Most provisions established under German GAAP may be deducted for tax
purposes. Nevert heless exceptions and restrictions are applied as for example
provisions for anniversary bonuses.
Prudent provision must be made for all foreseeable financial risks, as
consistency and prudence principles are in Germany strongly emphasised.
Expenses alrea dy incurred must be accrued. Provisions for a loss in the value of
assets are deducted from the assets themselves; provisions for claims and other
expenses are shown on the liabilities side of the balance sheet.

Long -term provisions have an expected durati on of over twelve coming months.
These are discounted over the expected period of reversal at the average market
rate of inter est during the past seven years, also with 5,5% discount rate, except
provis ions for pensions: to which the average market rate of interest during the past
ten years will be applied.(6%). Average interest rates for this purpose are published
monthly by the Bundesbank. For pensions an average reversal period of fifteen
years maybe assumed. PWC, p.64-69

Table no. xx: Most common provisions related to period costs

Provisions on the long run
Short run obligations that are only probably
such as not taken vacation should be
declarated in the accruals section
-Retirement benefit obligations
Obligations for current pensions and also for qualifying period
-Provisions non-current
Provisions on the short run
-Provisions current
-Other provisionsBonus arrangements; Social plans and Severance payments;
Waranty; Restructuring; Legal Proceedings risks
For example for fees, for loss suffered or damages, for claims to
compensation, bond risksLong term provisions, for other long term personal related such as
year end bonuses and partial retirement schemes ;
Here could also belong restoration and clearing ones.

5. Period costs treatment in MEC’ manufacturing company ( Study
case) ENG
Deschidere/Inchidere perioada OKP1
Inregistrare Amortizare CJIC
Corectii documente FI F-02
Repostare gaz KSV5
Repostare salarii pe comenzi interne YCO_MEC
(CC->CC) cu precizarea ciclului YKBLOHU1
Transfer costuri consultanta in linia de salarii YCO_MEC
Repostare consultanta in cheltuieli cu salariile YKBEXTUM
Realocare munca directa pe contract
Aliniere cost direct CC cu proiect YCO_MEC
Realocare munca indirecta YKBKST01
Verificare costuri directe cu personalul la nivel de centru de cost si proiect pe fiecare
tip de cheltuiala / departament
Raportare costuri la nivel de proiect YKFPFT01
Raport costuri la nivel de centru de cost ZCSEKSZZWA
Repostare beneficii salarii (fringe benefits) YCO_MEC
1-11: Postare provizion de pe CC initial pe un cc intermediar (dummy)utilizand
procententele bugetate pe tipuri de beneficii pentru munca indirecta ("white collar" ) si
directa ("blue collar"). Postare provizion pentru beneficii pe centru de cost aferent si
pe cel intermediar, astfel incat pe centrul Transfer provizion in bilant. Verificare
centru de cost intermediar zero.
12: recalcul rata alocare conform diferenta buget realizat si stergere provizion in bilant. YCOMECZ_FB
Delimitare provizion pentru beneficii salarii YKBABGR1
Alocare costuri cu pensiile de pe CC direct in contul de profit si pierdere ca cheltuiala
a perioadei KSU5
Raport costuri pentru cc intermediar pentru delimitarea postarii de provizion beneficii (
de exemplu WFRB) pentru toate conturile contabile de salarii (grupa wage de
exemplu ESOFBGE and salaries ESOFBLO) S_ALR_87013611
Raport centre de cost pe un contul contabil selectat (wage and salary financial
account) S_ALR_87013613
Alocare cheltuieli cu deplasarea (travelling) YFI_STEUER
Alocarea discounturilor perioadei direct in cheltuiala perioadei YCO_MEC
Stornare postare luna precedenta si postare automata pentru luna curenta a costului
aferent perioadei YCOMECZ_UMKUM
Raport vizualizare comisioane nealocate contului de profit si pierdere in divizia admin.
Daca exista, acestea se vor posta in FI (pe cc) in costul perioadeiZCSEKSZWBGF

ZCSEKSZW54
Verificare deviatie cost buget – realizat la nivel de centru de cost si/sau cont contabil
sau grupelor acestora S_ALR_87013611
Realocare a cheltuielilor perioadei de tip "Administratie" si "Marketing" de pe centre de
cost direct in contul P/P; Alocare cu introducerea ciclului KSU5
Verificare realocare costuri de pe centru de cost intermediar, in exempu nostru
DUMMY WRFB S_ALR_87013611
Realocare a cheltuielilor indirecte in costul perioadei de tip pe baza de cheite de pe
centre de cost direct in contul P/P; Alocare cu introducerea ciclului KSU5
Raport costuri la nivel de centre de cost. De verificat soldul zero ZCSIKSZSIP
Raport costuri la nivel de centru de profit pentru toate conturile contabile sau pentru
selectii de conturi. De verificat soldul zero ZCSPCEZ8A2Exemple de operatii, tranzactii si programe in ERP SAP R3 pentru procesarea costurilor perioadei in
inchiderea de luna

6. Conclusions
Although i nventoriable costs and period costs fl ow through the income
statement at a manufacturing company simil ar to the way costs f low at a
merchandising company , the period expenses have an impact on the financial
statements through income statement. The image on the financial statement is
influenced by the accounting policies and moreover used accounting methods .
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