It shows the amount of profit at every output level with the help of the cost-volume-profit relationship. (vi) The technique can be used along with other techniques such as budgetary control and standard costing. (ii) It also avoids the carry forward of a portion of the current period’s fixed overhead to the subsequent period. (iii) Variable costs alone are charged to production. Marginal Costing, particularly in periods of trade depression, helps in deciding whether the product in the plant should be suspended temporarily.

The separation of expenses into fixed and variable presents certain technical difficulties whereas marginal costing technique assumes that all expenses can be divided into fixed and variable. In fact, no variable cost is completely variable and no fixed cost is completely fixed. Actually, most of the expenses are semi-variable and it is difficult to segregate them into fixed and variable. (e) Increased automation and mechanization has resulted the reduction in labour costs and increased fixed costs like installation, maintenance and operation costs, depreciation of machinery. The use of marginal costing creates a tendency to disregard the need to recover cost through product pricing.

Marginal Costing – 6 Major Limitations

However, variable cost per unit of production remains the same irrespective of increase or decrease in volume of production. Marginal costing plays its key role in decision making. It is a technique which provides presentation of cost data in such a way that true cost-volume-profit relationship is revealed.

Marginal Costing: Meaning, Features and Advantages

But the problem of apportionment of variable costs still arises. (i) The profit and loss statement is not distorted by changes in stock levels. Stock valuations are not burdened with a share of fixed overhead, so profits reflect sales volume rather than production volume. This is not true for firms operating in other market structures.

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Marginal cost of different products may be the same, still the manufacture of a particular product may not be profitable on account of heavy fixed costs. (6) Cost of all the factors of production are changing continuously. In such a situation, any decision based on marginal costing system (where it is assumed that there is no change in material price, labour cost or selling prices) may not be useful at all. Less Effective Cost Control – Marginal costing ignores the fact that fixed costs are also controllable. By placing fixed overheads in a separate category, the importance of their controllability is reduced. Moreover, marginal costing is not as effective as standard costing and budgetary control in controlling costs.

What is marginal costing and its features?

Definition: Marginal Costing is a costing technique wherein the marginal cost, i.e. variable cost is charged to units of cost, while the fixed cost for the period is completely written off against the contribution. Marginal cost is the change in the total cost when the quantity produced is incremented by one.

(c) The significance of prevailing level of fixed overhead costs. (e) Prices are determined with reference to marginal cost and contribution margin. For example, if you price each jacket at $90, you’d make a profit of $45 per jacket. By producing and selling 10 more jackets, you would increase profits by $450. The marginal cost of making one additional bracelet is $5.

Marginal Costing Advantages and Disadvantages

Certain overheads have no relation to volume of output or even with the time; thus, they cannot be categorised either as fixed or variable. Management’s decisions regarding bonus to workers, facilities to administrative staff, etc., are taken without any consideration of time or production volume. (4) In highly seasonal businesses, for example, winter garment manufacturing stock is build up during the ‘off-season’, in order to cope with the peak seasonal demand. In this situation, profit under marginal costing system may fluctuate widely if there is change in stock level and sales. (5) The departmental performance can be evaluated more scientifically by using marginal costing system. Fixed costs are kept outside the evaluation process as the department has no role to play for the incurrence of common fixed costs.

The validity of safety always depends on the accuracy of cost estimates. The wide margin of safety is advantageous for the company. Margin of safety depends on level of fixed cost, rate of contribution and level of sales. The statement that P/V ratio is 40% means that contribution is Rs.40, if size of the sale is Rs.100. One important characteristic of P/V ratio is that it remains the same at all levels of output.

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The variable cost and marginal cost are also known as direct costs, activity costs, or volume costs. Thus, marginal costs relate to future costs and can be determined by subtracting the total at one level of output or sale from that at another level. The fixed costs are treated as period costs and are charged to Profit and Loss Account directly.

Marginal Costing: Meaning, Features and Advantages

Therefore it ignores time element and is not suitable for long-term decisions. Marginal costing is helpful in determining the profitability of products, departments, processes and cost centres. While analysing the profitability, marginal costing interprets the cost on Marginal Costing: Meaning, Features and Advantages the basis of nature of cost. Better presentation – The statements and graphs prepared under marginal costing are better understood by management executives. The break-even analysis presents the behaviour of cost, sales, contribution etc. in terms of charts and graphs.

Marginal costing, being a technique, can be used in conjunction with any method of cost ascertainment. It can also be used in combination with other techniques such as budgeting and standard costing. (e) Inventory valuation – Inventory valuation becomes more realistic when it is based on marginal cost. The level of output which is most profitable for a running concern can be determined. Therefore, the production capacity can be utilised to the maximum possible extent. This technique is not recognised by the income tax authorities for valuation of stock.

Marginal costing, if applied alone, will not be much use, unless it is combined with other techniques like standard costing and budgetary control. Helpful in budgetary control – The classification of expenses is very helpful in budgeting and flexible budget for various levels of activities. Exclusion of fixed cost from inventory valuation does not conform to accepted accounting practice. (i) Selling price equal to marginal cost or even below it has not been through ignorance. To overcome the period of depressing prices – Sometimes a trend of depressing prices sets in and company finds no alternative but to follow suit in order to remain in business. P/V ratio heavily leans on excess of revenues over variable cost.

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