Advantages and Disadvantages of Marginal Costing

Advantages of Marginal Costing:

Cost Control: Practical cost control is greatly facilitated. By avoiding arbitrary allocation of fixed overhead, efforts can be concentrated on maintaining a uniform and consistent marginal cost useful to the various levels of management. Simplicity: Marginal Costing is simple to understand and operate; it can be combined with other forms of costing, such as, budgetary costing, standard costing without much difficulty. Elimination of varying charge per unit: In marginal Costing fixed overheads are not charged to the cost of production due to this the effect of varying charges per unit is avoided. Short-Term Profit Planning: It helps in short-term profit planning by break-even charts and profit graphs. Comparative profitability can be easily assessed and brought to the notice of the management for decision-making. Prevents Illogical Carry forwards: It prevents the illogical carry-forwards in stock-valuation of some proportion of current years fixed overhead. Accurate Overhead Recovery Rate: It eliminates large balances left in overhead control accounts, which indicate the difficulty of ascertaining an accurate overhead recovery rate. Maximum return to the business: The effects of alternative sales or production policies can be more readily appreciated and assessed, and decisions taken will yield the maximum return to the business.

Disadvantages of Marginal Costing:

Misleading Results: It is very difficult to segregate all costs into fixed and variable costs very clearly, since all costs are variable in the long run. Hence such segregation sometimes may give misleading results. Distorted Picture of Profits: The closing stock consists of variable cost only and ignores fixed costs. This gives Distorted Picture of Profits. Avoids Semi-Variable Costs: Semi-Variable costs are not considered in the analysis. Problem of Recovery of Overheads: There is problem of under or over-recovery of overheads, since variable costs are apportioned on estimated basis and not on the actuals. Ignorance of Time Factor: Since the time factor is completely ignored; comparison of performance between two periods on the basis of contribution alone will give the misleading results.

Advantages and Disadvantages of Marginal Costing

Posted by Vinish Parikh on Jan 15, 2010 in Accounting | 1 comment Marginal costing can be defined as an accounting technique whereby small increase or decrease in output result in change in total cost. For example suppose it takes $1000 to produce 1000 units and next 1 unit is produced at $2 then marginal cost will be $2 for that unit. Here are some of the advantages of marginal costing technique 1. It is simple to understand and easy to calculate and hence anybody can understand it easily. 2. It helps in decision making like for calculation of profitability, for determining selling price of the product, to decide whether to buy or make a product, whether to utilize the idle capacity available with the company. 3. It helps in cost control by showing variable and fixed cost separately. Disadvantages of marginal costing 1. Under marginal costing all costs are classified as either fixed or variable and it ignores the semi variable costs. 2. It is not suitable for companies which have high fixed cost per unit because it takes into account only variable cost per unit. 3. It is suitable only where production is of uniform size and shape and hence it is of limited use for companies which produce goods of different shapes and sizes. Hence companies should take into account above factors before deciding whether they want to adopt marginal costing or not.

What are the limitations of Marginal Costing?

The limitations of Marginal Costing: - The classification of total costs into fixed and variable cost is difficult. - In this technique fixed costs are totally eliminated for the valuation of inventory of finished and semi-finished goods. Such elimination affects the profitability adversely. - In marginal costing historical data is used while management decisions are related to future events. - It does not provide any standard for the evaluation of performance. - Selling price fixed on the basis of marginal cost will be useful only for short period of time.

- Assessment of profitability on the marginal cost base can be used only in the short period of time.

Advantages And Disadvantages Of Marginal Costing Components and spare parts may be made in the factory instead of buying from the market. In such cases, the marginal cost of manufacturing the components or spare parts should be compared with market price while taking decision to make or buy. If marginal cost is lower than the market price, it is more profitable to make than purchasing from market. Additional or specific fixed cost may be a relevant cost. Following are the advantages of Marginal Costing:

Variable cost remains constant per unit of output and fixed costs remain constant in total during short period. Thus control over costs becomes more effective and easier. Standards can be set for variable costs, while Budgets can be established for fixed cost in order to exercise full control over the total activities. Marginal costing brings out contribution or profit margin per unit of output, and clearly brings out the effect of change in activity. It facilitates making policy decisions in a number of management problems, such as determining profitability of products, introducing a new product, discontinuing a product, fixing selling price, deciding whether to make or buy, utilising spare capacity, profit-planning, etc. The distinction between product cost and period cost helps easy understanding of marginal cost statements. Closing inventory of work-in-progress and finished goods are valued at marginal or variable cost only. This method leads to greater accuracy in arriving at profit as it eliminates any carry over of fixed costs of the previous period through inventory valuation. As a corollary to above, since fixed costs do not enter into product-cost, it eliminates the process of allocating, apportioning and absorbing overheads, and adjusting underand over-absorbed overheads. Therefore, the method is simpler to operate.

Disadvantages or Limitations of Marginal costing are as follows:

The technique is based on the segregation of costs into fixed and variable ones, while many expenses are neither totally fixed nor totally variable at various levels of activity.Thus, classifying all expenses into two categories of either fixed or variable is a difficult task. The assumptions regarding behaviour of costs, such as, fixed cost remains static, are often not realistic. Contribution is not the only index to take decisions. For example, where fixed cost is very high, selling price should not be fixed on the basis of contribution alone without considering other key factors such as capital employed. Marginal cost, if confused with total cost while fixing selling price may lead to a disaster.

Inventory valuation at marginal cost will understate profits and may not be acceptable by tax-authorities. Any claim based on cost will be very low, as it will not have a share of fixed cost.

The Disadvantages of Marginal Costing

X By Daphne Adams, eHow Contributor

Marginal costing is a technique used in reporting costs and profits of a firm. Marginal costs are extra costs incurred in producing one extra unit of output. All variable costs are marginal costs. In some situations fixed costs are marginal costs, too -- for example, in expansion of production facilities and capacities, stepped fixed costs such as rent and depreciation are marginal costs. Marginal costing uses historical data in decision-making and charges only direct costs to the cost unit of production, ignoring fixed costs. Because of this, the method has disadvantages as a method of reporting costs.
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