Absorption costing or full costing refers to a costing system that treats all the production costs, regardless of whether they are fixed or variable. On the other hand, variable, marginal, or direct costing refers to a costing system where the costs of production that vary with the output are essentially treated as product costs.
If Patty wishes to show the maximum profit to the bank over the preceding two years period, she should present full costing or absorption costing because the profits determined by variable costing method are not proper and true. The reason why they are not proper and true is because of exclusion of the fixed production costs that are a part of inventory and production costs.
This means Stacy Lynn, Inc. disregards the fixed costs hence violating matching costs with revenues principle. Moreover, fixed costs elimination from the inventory will result in lower figure and subsequent reported working capital reduction. Therefore, the reduction in the working capital might weaken the manufacturing plant’s borrowing position hence variable costing method will be suitable.
As mentioned above, if Patty will present direct costing method to the bank, the plant will be violating the Generally Accepted Accounting Principle that requires costs to match with revenues. The violation of this principle is brought about by the disregard of fixed costs when preparing the financial statements when using this method. For that reason, Patty should present variable costing method.
The ethical issues facing Stacy Lynn manufacturing plant by violating GAAP principle of matching revenues with costs are integrity, comparability, and reliability. By doing this, the manufacturing plant will be engaging in a conduct that is illegally prohibited by the law since it will be cheating the general public and the stakeholders.