What Are Above-the-Line Costs?
Above-the-line costs are the costs incurred by a business to make the product it sells or to provide its service. Above-the-line costs are determined differently for manufacturing and service businesses. For manufacturing-type businesses, above-the-line costs are any costs deducted to arrive at gross profit, namely the cost of goods sold (COGS).
For companies in the service sector, above-the-line costs are costs that are deducted in arriving at operating profit, which includes COGS but also all selling, general, and administrative (SG&A) costs.
- Above-the-line costs include all costs above the gross profit, while below-the-line costs include costs below gross profit.
- Above-the-line costs are often referred to as the cost of goods sold (COGS), while below-the-line is operating and interest expenses and taxes. This definition mostly relates to manufacturers.
- In service industries, above-the-line costs are sometimes referred to as cost of sales (COS).
- Above-the-line costs for service providers or utilities generally include all costs above operating profit.
- There is a wide gray area between these distinctions. What is considered above the line at one company might be below the line at another company.
Understanding Above-the-Line Costs
For manufacturers, above-the-line costs are just another way of saying costs before operating expenses. These are likely to include the costs of raw materials, facilities, wages, and other expenses to manufacture the final product and deliver it to consumers. These costs are subtracted from sales to arrive at gross profit.
After gross profit on the income statement, there is a line, followed by itemized operating expenses, as well as other expenses such as interest and taxes. These are below-the-line costs.
For service businesses, above-the-line costs are any costs incurred before arriving at operating income. Expenses incurred thereafter, such as interest and taxes are considered below the line.
A different interpretation of above the line can refer to all income or expenses related to normal business operations. That's all activity on the income statement that relates to profits and not transactions that only impact the cash flow statement or balance sheet. In that case, below the line would include only extraordinary or non-recurring income or expenses. Or any transaction that does not impact the company’s ongoing revenue or profits.
Above and below the line may also relate to filmmaking or marketing. In filmmaking, above the line refers to the budget for directors, actors, story writers, and the likes, while below the line includes the rest of the production team or crew. In marketing, above the line is related to mass media marketing, while below the line is direct marketing.
"Above the line cost" has different meanings, depending on the industry and company. Some companies consider above-the-line costs to be costs above gross profit, while others consider them as costs above operating profit.
Above-the-Line Costs vs. Below-the-Line Costs
Above-the-line costs are generally considered the cost of creating the company's product, such as worker salaries, equipment, raw materials, and maintenance. Below-the-line costs are the other expenses that keep the company going: the cost of printer paper and fax machines, management and human resources, advertising campaigns, not to mention the salaries of the accounting department itself.
Because above-the-line costs are directly related to the company's final product, they tend to vary more over the short term than above-the-line costs. Office expenses tend to remain constant whether sales are high or low, but production costs will vary (and therefore, attract more managerial attention).
Above the line costs tend to vary more over the short term than below the line costs.
As an example, Nike Inc. reported $37.4 billion in sales in the year ending May 31, 2021. Gross profits were $16.2 billion. Therefore, Nike's above-the-line costs for the quarter were $21.2 billion, which the company labels cost of sales on its income statement.
Also consider Expedia Inc., the travel website, which reported $3.2 billion in revenue in its second quarter of 2019 and an operating income of $265 million. The company is not involved in the production of goods so the company does not use gross profit as a metric in its income statement.
All expenses before operating income are considered above-the-line costs for Expedia, including the cost of revenue and selling and marketing expenses, among others.