Management Accounting: Seminar On The Topic of Advantages and Disadvantages of Marginal Costing

Management accounting
Seminar on the topic of advantages and

disadvantages of Marginal Costing
By Abhishek
17-ubu-051
Marginal Costing
• Marginal costing is a method of cost accounting and decision-making used
for internal reporting in which only marginal costs are charged to cost units
and fixed costs are treated as a lump sum. It is also known as direct, variable,
and contribution costing.
• In marginal costing, only variable costs are used to make decisions. It does
not consider fixed costs, which are assumed to be associated with the time
periods in which they were incurred.
Marginal costs include
• The costs actually incurred when you manufacture a product

• The incremental increase in costs when you ramp up production
• The costs that disappear when you shut down a production line
• The costs that disappear when you shut down an entire subsidiary
Common use of Marginal Costing
Marginal costing can be a useful tool for evaluating some types of decisions.
Here are some of the most common scenarios where marginal costing can
provide the most benefit:
• Automation investments: Marginal costing is useful to determine how much
a firm stands to gain or lose by automating some function. The key costs to
take into consideration are the incremental labor cost of any employees who
will be terminated versus the new costs incurred from equipment purchase
and subsequent maintenance.
• Cost reporting: Marginal costing is very useful for controlling variable costs,
because you can create a variance analysis report that compares the actual
variable cost to what the variable cost per unit should have been.
• Customer profitability: Marginal costing can help determine which customers
are worth keeping and which are worth eliminating.
• Internal inventory reporting: Since a firm must include indirect costs in its
inventory in external reports, and these can take a long time to complete,
marginal costing is useful for internal inventory reporting.
• Profit-volume relationship: Marginal costing is useful for plotting changes in
profit levels as sales volumes change. It is relatively simple to create a marginal
costing table that points out the volume levels at which additional marginal
costs will be incurred, so that management can estimate the amount of profit
at different levels of corporate activity.
• Outsourcing: Marginal costing is useful for deciding whether to manufacture
an item in-house or maintain a capability in-house, or whether to outsource it.
Advantages of Marginal Costing
• Cost control: Marginal costing makes it easier to determine and control costs of
production. By avoiding the arbitrary allocation of fixed overhead costs,
management can concentrate on achieving and maintaining a uniform and
consistent marginal cost.
• Simplicity: Marginal costing is simple to understand and operate and it can be
combined with other forms of costing (e.g. budgetary costing and standard costing)
without much difficulty.
• Elimination of cost variance per unit: Since fixed overheads are not charged to the
cost of production in marginal costing, units have a standard cost.
• Short-term profit planning: Marginal costing can help in short-term profit
planning and is easily demonstrated with break-even charts and profit graphs.
Comparative profitability can be easily assessed and brought to the notice of
the management for decision-making.
• Accurate overhead recovery rate: This method of costing eliminates large
balances left in overhead control accounts, which makes it easier to ascertain an
accurate overhead recovery rate.
• Maximum return to the business: With marginal costing, the effects of
alternative sales or production policies are more readily appreciated and
assessed, ensuring that the decisions taken will yield the maximum return to the
business.
Disadvantages of Marginal Costing
• Classifying costs: It is very difficult to separate all costs into fixed and variable costs
clearly, since all costs are variable in the long run. Hence such classification
sometimes may give misleading results. Furthermore, in a firm with many different
kinds of products, marginal costing can prove less useful.
• Accurately representing profits: Since the closing stock consists only of variable
costs and ignores fixed costs (which could be considerable), this gives a distorted
picture of profits to shareholders.
• Semi-variable costs: Semi-variable costs are either excluded or incorrectly analyzed,
leading to distortions.
• Recovery of overheads: With marginal costing, there is often the problem of
under or over-recovery of overheads, since variable costs are apportioned on
an estimated basis and not on actual value.
• External reporting: Marginal costing cannot be used in external reports,
which must have a complete view of all indirect and overhead costs.
• Increasing costs: Since it is based on historical data, marginal costing can give
an inaccurate picture in the presence of increasing costs or increasing
production
Conclusion
• Marginal costing is a useful analysis tool which usually helps management make decisions
and understand the answer to specific questions about revenue.
• That said, it is not a costing methodology for creating financial statements. In fact,
accounting standards explicitly exclude marginal costing from financial statement reporting.
Therefore, it does not fill the role of a standard costing, job costing, or process costing
system, all of which contribute actual changes in the accounting records.
• Still, it can be used to discover relevant information from a variety of sources and aggregate
it to help management with a number of tactical decisions. It is most useful in the short
term, and least useful in the long term, especially where a firm needs to generate sufficient
profit to pay for a large amount of overhead.

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Management accounting

Seminar on the topic of advantages and

• The costs actually incurred when you manufacture a product

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