Saturday, January 30, 2010

Advantages and Disadvantages of Marginal Costing Technique

  1. Marginal costing is simple to understand.
  2. By not charging fixed overhead to cost of production, the effect of varying charges per unit is avoided.
  3. It prevents the illogical carry forward in stock valuation of some proportion of current year’s fixed overhead.
  4. The effects of alternative sales or production policies can be more readily available and assessed, and decisions taken would yield the maximum return to business.
  5. It eliminates large balances left in overhead control accounts which indicate the difficulty of ascertaining an accurate overhead recovery rate.
  6. 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. It is useful to various levels of management.
  7. It helps in short-term profit planning by breakeven and profitability analysis, both in terms of quantity and graphs. Comparative profitability and performance between two or more products and divisions can easily be assessed and brought to the notice of management for decision making.
  1. The separation of costs into fixed and variable is difficult and sometimes gives misleading results.
  2. Normal costing systems also apply overhead under normal operating volume and this shows that no advantage is gained by marginal costing.
  3. Under marginal costing, stocks and work in progress are understated. The exclusion of fixed costs from inventories affect profit, and true and fair view of financial affairs of an organization may not be clearly transparent.
  4. Volume variance in standard costing also discloses the effect of fluctuating output on fixed overhead. Marginal cost data becomes unrealistic in case of highly fluctuating levels of production, e.g., in case of seasonal factories.
  5. Application of fixed overhead depends on estimates and not on the actuals and as such there may be under or over absorption of the same.
  6. Control affected by means of budgetary control is also accepted by many. In order to know the net profit, we should not be satisfied with contribution and hence, fixed overhead is also a valuable item. A system which ignores fixed costs is less effective since a major portion of fixed cost is not taken care of under marginal costing.
  7. In practice, sales price, fixed cost and variable cost per unit may vary. Thus, the assumptions underlying the theory of marginal costing sometimes becomes unrealistic. For long term profit planning, absorption costing is the only answer.

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