Marginal costing is a cost accounting approach that focuses on the behavior of variable costs in relation to changes in volume or activity. In this approach, only variable costs are considered in decision-making, as they are directly affected by changes in production or sales volume. Fixed costs, on the other hand, are treated as sunk costs that cannot be recovered and are therefore not relevant in decision-making.
One of the main advantages of the marginal costing approach is that it allows for a better understanding of the cost structure of a business and the impact of changes in production or sales volume on profitability. This can be particularly useful for businesses that operate in a highly competitive environment, where the ability to make quick and informed decisions is crucial for success.
Another advantage of marginal costing is that it can help managers to identify opportunities for cost savings by focusing on the incremental costs of producing additional units of a product or providing additional services. This can involve analyzing the costs of different production processes or sourcing materials from different suppliers, for example.
However, it is important to note that the marginal costing approach has some limitations. One potential drawback is that it ignores the impact of fixed costs on the overall profitability of the business. This can lead to distorted decisions if the business relies heavily on fixed costs to generate profits. Additionally, the marginal costing approach may not be suitable for businesses with high fixed costs, as the focus on incremental costs may not accurately reflect the overall cost structure of the business.
In conclusion, the marginal costing approach is a useful tool for analyzing the behavior of variable costs and making informed decisions in a highly competitive environment. However, it is important to consider the limitations of this approach and to use it in conjunction with other cost accounting methods to obtain a complete understanding of the cost structure and profitability of a business.
Advantages of Marginal Costing
Decision to make or buy 7. By outlining the total contribution; Most conveniently for financial and tax reporting; Conclusion From the discussion above, it is clear that absorption costing is a better method than marginal costing in usefulness. Product mix will remain unchanged. It can be used in conjunction with any method of costing, such as job costing or process costing. To dispose of the perishable goods. Price Change: It is contended that price in short term should cover total cost and profit. Sales-oriented — Successful business has to go in a balanced way in respect of selling production functions.
Raw materials, work in progress, and final goods are all included on a broad level. Fixed cost are also effective in treating the profits. The management comes to know about the exact trend of cost behaviour in respect of each and every item. Low angle of incidence indicates that variable costs form a major part of cost of sales. As such the valuation of the finished goods and work-in-progress is made on the basis of variable costs only. Thus, an increase in output will reflect how much extra funds will be available for additional output. A customer offers to buy 6,000 units at the company's best price.
Valuable adjunct to other techniques — Marginal costing is a valuable adjunct to budgeting and standard costing techniques. It is variable, depending on the inclusion of resources required to produce or deliver additional unit s of a product or service. The marginal cost of production in economic terms is the change in the total cost of production from the production or production of an additional unit. One additional-unit of production is known as marginal unit and the change in total cost on account of adding or subtracting one unit is known as marginal cost. A special form of cost sheet is used. Controllable costs can be given prime attention by the management. This exercise, in itself, opens the eyes of management in respect of the need for controlling costs.
It is not a simple problem. Inter-firm comparison is possible. So as the volume of production and salesincreases total variable costs rise proportionately. Fixation of Selling Price 3. Forthis reason, the contribution concept is frequently employed bymanagement accountants. An increase or decrease in the volume of goods produced translates to To determine the changes in quantity, the number of goods made in the first production run is deducted from the volume of output made in the following production run. Certain overheads have no relation to volume of output or even with the time; thus, they cannot be categorised either as fixed or variable.
Unreliable stock valuation — Under marginal costing stock of work-in-progress and finished stock is valued at variable cost only. Evaluation of Marginal Cost Pricing This method is useful only in a specific situation where a company can earn additional profits from using up excess production capacity. In real life, they may change and give unrealistic results. None of the methods employed for allocation of overheads is scientific and accurate and as such an arbitrary value of overheads is placed on different products due to which cost and price decisions become unrealistic. For example, rent would become payable only when the management takes a decision to acquire a leasehold property instead of freehold property. Sometimes, the contribution will be unrealistic when increased production and sales are effected, either through extensive use of existing machinery or by replacing manual labour by machines. More emphasis on selling function — This technique provides much emphasis on selling function and it ignores production function.
What is Marginal Costing? definition, characteristics, approach and facts
When any other factor is the key factor, the product with the largest contribution per unit of the key factor is the most lucrative. Moreover, external reporting criteria do not meet minimal costs. The management must assess the profitability of different sale plans, which may include trade discounts, free presents, additional commission, and price reductions, among other things. Difference between Marginal Costing and Variable Costing Both marginal costing and variable costing are the techniques of product costing. Profit Maximisation: The technique of marginal costing can be applied to maximise the profits of a company in the following ways: i Profit Planning: It is the planning of future operations to attain maximum profit. These days, there is a cut-throat competition in market and management has got to know its cost structure thoroughly.
This happens particularly in case of seasonal factories. The contribution analysis is very significant in this respect. Variable costs are those that alter when the level of output changes. Marginal Costing — 6 Major Limitations In recent years, there has been a widespread interest in marginal costing. Products-mix means combination of products which is intended for production and sales. An advantage of Marginal cost is that it assists the management to pick the optimum production plan by making the most useful use of scarce resources and optimizing profit. Such information can help management improve the relationship between these variables.
But this step may help the organisation to overcome the situations under which recovery of even full cost appears a difficult proposition. It is based primarily on the behavioural study of cost. ImporÂtance of selecting proper measure of volume should not be ignored. But, the real efficiency of a business is to be assessed only by considering the selling and production functions together. This is due to the non-inclusion of overheads in the value of closing work-in-progress.
