Marginal Costing:Advantages,Disadvantage

Meaning & Definition of Marginal Costing

Marginal costing defines as “The ascertainment of variable costs and of the effect on profit of changes in volume or type of output by differentiating between fixed costs an variable costs”.__Institute of Cost and Management Accountants,London___” 

Advantages of Marginal costing

1. Simple to use and understand: Marginal cost technique is simple and convenient to use.

2. Avoid under-absorption of overheads: This technique does not use the process of allocation,absorption or apportionment of fixed costs and thus reduces the issue related to under-absorption of fixed cost.

3. Aid in production planning: Variable costs per unit are constant in nature and remain same regardless of the level of activity. The use of these costs simplifies the process of production management.

4. No over-valuation of stocks: Marginal costing does not carry forward fixed costs in the form of inventory valuation and thus avoid the possibility of over-inflating profit by inflated closing stock valuation.

5. Facilitates calculation: Marginal cost helps in the calculation of various important factors such as key factor,make or buy decision,pricing decision,optional sales mix,etc.

6. Helps to management: It helps the management in taking key decision. These decisions may related to shut down,designing of optional production and sales mix and performance evaluation.

Disadvantage of Marginal Costing

1. Segregation of Costs: Marginal costing works by dividing costs into fixed and variable categories. However, in many cases,such segregation is not clear.

2. No cognizance of fixed overhead: Marginal costing ignores fixed overheads and thus is unrealistic.

3. Not designed for contract costing: It cannot be used for job or contract costing purpose.

4. Unrealistic assumption: It tends to make unrealistic assumption while making analysis.

5. Apportionment of fixed costs: Marginal costing requires calculation of separate break-even points for different products. This leads to the problem of apportionment of fixed expenses.

6. Multiple assumptions: It uses various assumptions for analysis. Such assumptions may not be true in the real-life scenario.