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SAC currently uses a basic standard cost system. Management knows very little about other concepts of costing and the benefits of having multiple costing methods. Your superior has asked that you and your team put together a presentation to management explaining various costing concepts as it relates to SAC (explain the usage and benefits of each).
Write a response to include the following:
the definition of the concept
how and when the concept could be used by SAC
how the application of the concept differs from the other concepts
its advantages and disadvantages
full costing/absorption costing
The Sparklin Automotive Company (SAC) has been in business since 1930. It began business in the United States supplying spark plugs to automotive manufacturers (OEM, the original equipment market) and the automotive aftermarket.
SAC has introduced a new spark plug manufacturing process in the United States that produces a higher quality spark plug guaranteed to last 100,000 miles. The introduction of this spark plug has been very successful in the United States.
In addition to these types of projects, your responsibilities include creating and analyzing the monthly performance of each plant and consolidating the results into a set of financial statements footnoted with explanations.
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Full costing means that all manufacturing costs are absorbed by the unit produced. The method is called absorption method because all the costs are absorbed. This means that the units produced have in their costs direct materials, direct labor, fixed and variable costs. The term true cost accounting is also used for full costing. All direct costs and indirect costs are allocated.
The concept of full cost accounting can be used by SCA when it accounts for a spark plug for automotives. The cost of making the spark plugs in case of full cost accounting will include the direct costs. This includes direct material, direct labor, and other direct costs. In addition, the costs will include other hidden costs, externalities, overheads, indirect costs, past costs, future outlays, and costs in accordance to the product lifecycle of each spark plug. This is a very comprehensive method of costing.
For instance, the cost that has gone into the development of the spark plug also is included in this cost of the spark plug. If there is a cost that is likely to be incurred in the future, that is also included. This means that the machinery that is used for the production of spark plugs is depreciated and that cost is also included. Hidden costs are also included. Since the spark plug is guaranteed to last 100, 000 miles, SAC receives some equipment from an environmental agency. In case of full costing the cost of this equipment will also be fully reflected in the cost of the spark plugs. The different costs incurred by SAS will also be included in the full cost method. These costs include the fixed overhead, and fixed administration expense. The future costs in incurred in the production of spark plugs like the cost of equipment removal, after closure costs, and post-employment health and retirement benefit will also be included in the cost of spark-plugs.
The advantage of full costing is that this method is used in financial reporting and for income tax reporting and for financial reporting in accordance with the law. other advantages are that since stock is not undervalued, the internal revenue department accepts this method. Further, this method does not show any unnatural fluctuation in the net profit. The disadvantages of full costing are that this method cannot easily be used for decision making. The relationship between cost volume profit is not included in this method. These costs are difficult to use for planning, monitoring, and controlling.
The difference between full costing and variable costing is that fixed manufacturing overheads are not absorbed in variable costing.
The second method that we consider is variable cost. In this method only the variable manufacturing costs are regarded as product costs. Fixed manufacturing costs are treated as period costs. This method is called direct costing. Variable costs are expenses that change in proportion to the ...
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