Marginal Costing: Its Features, Advantages And Disadvantages.

What is Marginal Costing?

It is a costing technique where only variable cost or direct cost will be charged to the cost unit produced.

Marginal costing also shows the effect on profit of changes in volume/type of output by differentiating between fixed and variable costs.

Salient Points:

• Marginal costing involves ascertaining marginal costs. Since marginal costs are direct cost, this costing technique is also known as direct costing;

• In marginal costing, fixed costs are never charged to production. They are treated as period charge and is written off to the profit and loss account in the period incurred;

• Once marginal cost is ascertained contribution can be computed. Contribution is the excess of revenue over marginal costs.

• The marginal cost statement is the basic document/format to capture the marginal costs.

Features of Marginal Costing System:

• It is a method of recording costs and reporting profits;

• All operating costs are differentiated into fixed and variable costs;

• Variable cost –charged to product and treated as a product cost whilst

• Fixed cost treated as period cost and written off to the profit and loss account

Advantages of Marginal Costing:

• It is simple to understand re: variable versus fixed cost concept;

• A useful short term survival costing technique particularly in very competitive environment or recessions where orders are accepted as long as it covers the marginal cost of the business and the excess over the marginal cost contributes toward fixed costs so that losses are kept to a minimum;

• Its shows the relationship between cost, price and volume;

• Under or over absorption do not arise in marginal costing;

• Stock valuations are not distorted with present years fixed costs;

• Its provide better information hence is a useful managerial decision making tool;

• It concentrates on the controllable aspects of business by separating fixed and variable costs

• The effect of production and sales policies is more clearly seen and understood.

Disadvantages Of Marginal Costing

• Marginal cost has its limitation since it makes use of historical data while decisions by management relates to future events;

• It ignores fixed costs to products as if they are not important to production;

• Stock valuation under this type of costing is not accepted by the Inland Revenue as it’s ignore the fixed cost element;

• It fails to recognize that in the long run, fixed costs may become variable;

• Its oversimplified costs into fixed and variable as if it is so simply to demarcate them;

• It’s not a good costing technique in the long run for pricing decision as it ignores fixed cost. In the long run, management must consider the total costs not only the variable portion;

• Difficulty to classify properly variable and fixed cost perfectly, hence stock valuation can be distorted if fixed cost is classify as variable.