Above the Line Costs – Definition

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Above-The-Line Costs Definition

Here the “line” refers to the line that divides gross profit from operating costs. For the companies providing services, this indicates to the line that separates the operating income from other expenses.

Above-The-Line is used by the companies for characterizing their earning and expenses during normal operations that impact the profit but do not have any effect on the capital. On an income statement of the manufacturing company, the above-the-line costs are generally known as COS (cost of sales) or COGS (cost of goods sold). The service providing companies consider the expenditure that is above the line as an expense at the top of the line.

A Little More on What is Above-The-Line Costs

The companies that produce goods, deduct the above-the-line-costs from sales to estimate the gross profit. Basically, the above-the-line cost is the company’s sales in a specific period minus the gross profit in that period. It is a way to estimate the costs before incurring costs. On an income statement of the manufacturing companies, there is a line after the gross profit. The detailed operating expenses which are hidden expenses are written after this line. Service providing companies provide the details of their sales and expenses in the revenue report. All the expenses that are beyond the line of operating income are considered to be the “over-limit” costs.

Here are a few examples to explain the idea of Above-The-LIne-Costs.

Here are a few examples to explain the idea of Above-The-LIne-Costs.

Suppose A is a manufacturing company. It reports sales of $ 20 billion in a quarter and its gross profit in this period is $ 9 billion. So, the company’s above-the-line-costs is this quarter will be calculated as $ 11 billion.

B is a service providing company and doesn’t produce any good. It reports revenues of $ 5 billion in a quarter and its operating income is $ 300 million in that quarter. As it is not a manufacturing company there is not COGS or COS involved in the calculation of gross profit. All the costs above the operating income are considered to be the above-the-line-costs.

C is a utility company. It reports its operating revenue as $ 3 billion and operating income as 8 million in a quarter. The major costs including the cost of electricity, operation, maintenance, and depreciation and amortization are above the line of operating income.

References for Above the Line Costs

  • https://www.accountingtools.com/articles/2017/8/27/above-the-line
  • http://www.business-literacy.com/financial-concepts/above-line-below-line/
  • https://www.investopedia.com/terms/a/above-the-line-cost.asp

Academic Research for Above the Line Costs

  • Accounting discretion in fair value estimates: An examination of SFAS 142 goodwill impairments, Beatty, A., & Weber, J. (2006). Journal of Accounting Research, 44(2), 257-288. It is a study that delves into the Statement of Financial Accounting Standards 142 adoption decisions. The study examines the accounting choices a company makes while keeping in mind various potentially important economic incentives. Based on its data the study concludes that a company’s preferences for above-the-line and below-the-line accounting treatment are affected by its equity market concerns. This study examines the role of the manager’s discretion in the adoption of mandatory accounting changes and contributes to the accounting choice literature.
  • The relation between nonrecurring accounting transactions and CEO cash compensation, Gaver, J. J., & Gaver, K. M. (1998). Accounting Review, 235-253. The study examines how the CEO cash compensation function gets affected by the alternative earning components. The study finds, if the results are positive the cash compensation significantly impacts the above the line earnings positively and compensations do not get affected by the above the line losses. The study based on its data concludes that gains flow through compensation, but it does not have that impact on losses. The study asserts, the gains and losses resulted from non-recurring or extraordinary transactions or discontinued operations do not qualify for below the line presentation. The data clearly shows compensation flows the gain but does not flow the losses. On an income statement, the importance of classification of the gain or loss is comparatively less here.
  • Write-offs as accounting procedures to manage perceptions, Elliott, J. A., & Shaw, W. H. (1988). Journal of accounting research, 91-119. This paper examines the role of write-offs as an accounting procedure in managing the perceptions. One of the aims of this paper was to characterize the disclosure in ways that clarify the policy issues. The paper also examines the relations among material loss provisions, underlying economic events and goals of management regarding financial disclosure.
  • The use of accounting flexibility to reduce labor renegotiation costs and manage earnings, D’Souza, J., Jacob, J., & Ramesh, K. (2000). Journal of Accounting and Economics, 30(2), 187-208. The paper examines the factors that decisively affects the nature of discretionary SFAS 106 choices made by the non-regulated firms. The study finds, the firms which have more unionized labors are likely to use immediate recognition, consistent with incentives for avoiding higher labor renegotiation costs. The study concludes that immediate recognition is mostly used in post-adoption plan modifiers, especially when their transition obligation is high, and it is consistent with incentives for increasing future reported earnings.  On the other hand, in companies with more potential debt contracting costs, immediate recognition is used less frequently.
  • The effect of compensation committee quality on the association between CEO cash compensation and accounting performance, Sun, J., & Cahan, S. (2009). Corporate Governance: An International Review, 17(2), 193-207. The study uses 812 US firms as a sample to determine how the quality of the compensation committee affects the association between CEO cash compensation and accounting earnings. It also studies the moderating effects of growth opportunities and earning status. The study concludes, in the companies having high compensation committee quality the CEO cash compensation is more positively associated with accounting earnings.
  • An empirical investigation of accounting methods for goodwill and identifiable intangible assets: 1985 to 1989, Wines, G., & Ferguson, C. (1993). Abacus, 29(1), 90-105. The study investigates the accounting choices made by the companies for goodwill and identifiable intangible assets. The study is based on the data of 150 Australian Stock Exchange listed companies over a period of five years (1985 to 1989). The data shows, in this study period the diversity of goodwill accounting policies has decreased but for the identifiable intangible policies, it has conversed. It particularly reveals, more companies are deciding against amortizing identifiable intangibles. Based on its research the study concludes that in order to reduce the effect on reported operating profits required for accounting standard for amortizing goodwill, the firms recognize the identifiable intangibles.
  • The economic determinants of accounting choices: The unique case of equity carve-outs under SAB 51, Hand, J. R., & Skantz, T. R. (1997). Journal of accounting and economics, 24(2), 175-203. The study deals with two unusual accounting choices faced by the parents carving out subsidiaries. The first one is if they should record the carve-out gain as income or directly as equity. The second one is if they should pay book tax on the gain or not. The study results conclude efficient contracting, management of earnings and information signaling theories of accounting choices affect the parent’s SAB 51 decisions.
  • Discussion of accounting discretion in fair value estimates: An examination of SFAS 142 goodwill impairments, Bens, D. A. (2006). Journal of Accounting Research, 44(2), 289-296. The accounting choices made by the managers upon the adoption of Statement of Financial Accounting Standards 142 are analyzed and examined by Beaty and Weber. Here the choices are whether the goodwill impairment should be recorded as a cumulative effect of an accounting alteration at the time of adoption or if they should delay the recognition to an indefinite future while recording those as expenses in earnings from continuing operations. In examining this, several factors that influence the decisions of the management’s reporting of transition effects are considered by the authors. In 2005 Journal of Accounting Research Conference questions were raised about the capability of capturing such an intricate accounting decision with simple linear models and noisy proxy variables, while speculations are made whether the other settings would be generalized by the results. This discussion summarizes the research work of Beatty and Weber, discusses how it contributes towards the accounting literature and describes the issues raised in the conference in this regard.
  • Evidence on the effects of unverifiable fair-value accounting, Ramanna, K., & Watts, R. L. (2007). According to SFAS 142, goodwill impairments of a firm are determined by using the fair-value estimates. Watts (2003) and Ramanna (2007) argues as those fair-value estimates are unverifiable in nature, the firms can use their discretion in managing impairments. This paper test that argument with a sample of firms that have book goodwill and a ration of market-to-book ratio below one. The research finds out the frequency of non-impairment in the sample firms is about 71%. The study further looks into whether industries having higher average information asymmetries rises the non-impairment. Although the paper couldn’t find any evidence that supports this claim.
  • ACCOUNTING PRACTICE AND BUSINESS FINANCE: SOME CASE STUDIES FROM THE IRON AND COAL INDUSTRY 1865—1914, Edwards, J. R., & Boyns, T. (1994). Journal of Business Finance & Accounting, 21(8), 1151-1178. The study is based on the archival data of four major coal and iron companies. It argues, during late nineteenth and early twentieth century the British companies used secret reserves for manipulating the content of published reports and influencing perceptions of the investors and this phenomenon has attracted much attention in the historical inquiry, but similar objectives can be achieved through exploitation of fixed asset accounting practices but the later did not get much attention from the researchers. The authors of the paper states they aim to address this imbalance. The paper concludes that in the nineteenth century the firms used to overestimate their profitability that resulted in stimulating growth in economy and investment in the business.

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