Under both the German Commercial Code and the International Financial Reporting Standards (IFRS), the income statement can be prepared using either the nature of expense method or the cost of sales method. Both methods lead to identical results, as income and expenses differ by the same amount. The difference between the two methods lies solely in the treatment of changes in inventories.
The total cost method is a production income statement. This means that the units of measure produced are used for the accrual of income and expenses. Income and expenses are reported in relation to the units of measure produced in the period under review.
Increases in inventories of finished goods and work in progress and internally generated property, plant and equipment are recognized as income. The related expenses are recognized by reference to the units of measure produced. Decreases in inventories are deducted from revenues.
The cost of sales method is an income statement. This means that the units of measure sold are used to accrue income and expenses. Income and expenses are not recognized when products are produced, but only when they are sold. Increases in inventories of finished goods and work in progress and internally generated property, plant and equipment are not recognized as income and the related expenses are not recognized as expenses. Decreases in inventories of finished goods and work in progress are recognized as expenses for goods sold.
Expenses are not broken down by type of expense (materials, personnel, depreciation) but by functional area (production, administration, sales). This method is thus very closely oriented to the cost center structure. Cost and activity accounting is therefore a prerequisite.