What it means
An income statement subtracts different expenses at different stages. Revenue less cost of sales produces gross profit, and further operating expenses lead to an operating profit.
If gross profit is the chosen line, production or purchase costs sit above it, while selling and administration costs sit below. If operating profit is the line, ordinary operating expenses may also be described as above it.
For that reason, state the subtotal before using the phrase in a board report or a comparison. A manufacturer may include direct materials, production labour and factory overhead in cost of sales, while a service firm's presentation can look quite different.
Classification should follow accounting standards and the substance of the spending, not management's wish for a higher margin. Moving a valid cost from one subtotal to another does not change total pre-tax profit, but it can change gross or operating margin.
That can distort peer comparison or a bonus target. Some management presentations exclude unusual or restructuring charges from an "adjusted" profit figure, placing them below the line.
That choice needs a clear reconciliation to the reported accounts and an honest explanation. A store closure charge that repeats every year may not be a genuine one-off for judging operating performance, and "below the line" never means ignorable when planning cash or valuing the business.
Other fields use the same phrase differently. In advertising, above-the-line activity traditionally means broad-reach mass media such as television, while below-the-line means more targeted work such as direct promotions.
In film and television budgeting, above-the-line costs are the creative and rights costs, such as writers, directors, producers and lead cast, agreed before production begins. For managers, keep a chart of accounts that records the economic purpose of each cost and a reporting policy that maps it to the statements.
When comparing businesses, use the same line and the same cost definitions. Above-the-line is shorthand that helps a conversation only after everyone knows where the line is drawn.
In practice
Real-world examples.
Example
A retailer treats the cost of the inventory it sells as cost of sales, above its gross profit subtotal. Rent, marketing and head office salaries sit below that line as operating expenses.
Example
A board asks why a recurring store closure expense is excluded from an adjusted operating measure. The finance director agrees to show a reconciliation to the full reported result in every board pack.
Example
A film producer builds a budget in which the director, writers and lead actors are above-the-line costs, with crew, equipment and locations below the line. The financier reads the two totals separately because they behave differently when the shoot overruns.
Formula
Calculation
Gross profit = Revenue - Cost of sales. Operating profit = Gross profit - Operating expenses included in that subtotal.
Worked example. A fictional company records revenue of $10,000,000, cost of sales of $6,000,000 and operating expenses of $2,500,000. Gross profit = $10,000,000 - $6,000,000 = $4,000,000. Operating profit = $4,000,000 - $2,500,000 = $1,500,000. If gross profit is the line, only the $6,000,000 of cost of sales is above it; if operating profit is the line, both the $6,000,000 and the $2,500,000 are above it. The example ignores other income and expenses, and real presentation follows the applicable accounting standards.Case study
Seen in the real world.
This illustrative and entirely fictional example follows Horizon Retail Group, an invented chain that reports an adjusted operating result to its board. For several years, store closure costs were described as exceptional and placed outside that management subtotal. An outside adviser reconciled the measure with the full accounts and found that the closures recurred every year and were important to performance.
Management restated its internal comparisons on a consistent basis. In the invented figures, the adjusted operating profit had been $5,000,000 while the full measure including $1,000,000 of closure costs was $4,000,000, which is 20% below the old highlighted figure.
The board reviewed store targets and explained the adjustment openly, rather than claiming that the reclassification had changed total profit. The marketing team separately labelled a mass-media campaign "ATL" without confusing it with financial statement classification, and the case shows why the chosen line and its definition matter more than a familiar phrase.
Watch out
Common mistakes.
- Using "above the line" without naming the profit subtotal. The phrase has no fixed meaning until the line is defined.
- Treating regularly recurring costs as irrelevant because an adjusted measure excludes them. Costs that repeat every year are part of how the business really performs.
- Confusing mass-media marketing terminology with income statement placement. An advertising invoice does not move on the statement because a campaign is called "ATL".
Questions
People also ask.
What is an above-the-line cost?
It is an expense counted before a specified profit subtotal, and the answer depends on which subtotal is meant.
Does its placement change total profit?
Reclassifying a cost among subtotals does not change total pre-tax profit, but it can change reported gross and operating margins.
What does above the line mean in advertising?
Traditionally it means broad-reach mass-media activity such as television, not an accounting cost category.
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