Marginal Costing | Advantages and Disadvantages

Advantages of Marginal Costing

The advantages, merits of marginal costing are briefly explained below.

Advantages and Disadvantages of Marginal Costing

Image: Advantages and Disadvantages of Marginal Costing

1. The marginal costing technique is very simple to understand and easy to operate. The reason is that the fixed costs are not included in the cost of production and there is no arbitrary apportionment of fixed costs.

2. The current year fixed costs is not carried forward to the next year. As such, cost and profit are not vitiated. Cost comparisons become meaningful.

3. The contribution is used as a tool in managerial decision-making. It provides a more reliable measure for decision-making.

4. Marginal costing shows more clearly the impact on profit of fluctuations in the volume of sales.

5. Under absorption and over absorption of overheads problems are not arisen under marginal costing.

6. The marginal costing technique can be combined with standard costing.

7. The prevailing relationship between cost, selling price and volume are properly explained in clear terms.

8. It shows the relative contributions to profit that are made by each of a number of products and show where the sales effort should be contracted.

9. The management can take short run tactical decisions with the help of marginal costing information.

10. Marginal cost pricing method is highly useful for public utility undertakings. It helps them in maximizing output or better capacity utilization. This is possible only when lowest possible price is charged. The lowest limit is set by marginal cost of the product. When public utility concerns adopt marginal cost pricing, it helps in maximizing social welfare.

11. This method enables the firms to face competition. This is the reason why export prices are based on marginal costs since international market is highly competitive.

12. This method helps in optimum allocation of resources and as such it is the most efficient and effective pricing technique and it is useful when demand conditions are slack.

13. Marginal cost pricing is suitable for pricing over the life-cycle of a product. Each stage of the life-cycle has separate fixed cost and short-run marginal cost.

Disadvantages of Marginal Costing

The disadvantages, demerits or limitations of marginal costing are briefly explained below.

1. The total costs cannot be easily segregated into fixed costs and variable costs.

2. Moreover, it is also very difficult to per-determine the degree of variability of semi-variable costs.

3. Under marginal costing, the fixed costs remain constant and variable costs are varying according to level of output. In reality, the fixed costs do not remain constant and the variable costs are not varying according to level of output.

4. There is no meaning in the exclusion of fixed costs from the valuation of finished goods since the fixed costs are incurred for the purpose of manufacture of products.

5. In the case of loss by fire, the full amount of loss cannot be recovered from the insurance company since the stocks are under valued.

6. Tax authorities do not accept the valuation of stock since the shock does not show true value.

7. The calculation of variable overheads does not include all the variable overheads.

8. The profit fluctuates as per the fluctuation of sales volume. Hence, the preparation of periodic operating statements becomes unrealistic.

9. The elimination of fixed costs renders cost comparison of jobs difficult.

10. The management cannot take a quality decision with the help of contribution alone. The contribution may vary if new techniques followed in the production process.

11. The fixed costs are constant only for short period. In the long run, all the costs are variable.

12. Firms may find it difficult to cover up costs and earn a fair return on capital employed when they follow marginal cost principle in times of recession when demand is slack and price reduction becomes inevitable to retain business.

13. Marginal cost pricing requires a better understanding of marginal cost technique. Some accountants are not fully conversant with the marginal techniques themselves. Therefore, they are not capable of explaining their use to the management.

In spite of its advantages, due to its inherent weakness of not ensuring the coverage of fixed costs, marginal pricing has not been adopted extensively. It is confined to cases of special orders only.