Need for Marginal Costing, Against and in favour of marginal costing

Need for Marginal Costing

Variable cost per unit remains constant; any increase or decrease in production changes the total cost of output.

Total fixed cost remains unchanged up to a certain level of production and does not vary with increase or decrease in production. It means the fixed cost remains constant in terms of total cost.

Fixed expenses exclude from the total cost in marginal costing technique and provide us the same cost per unit up to a certain level of production.

Against and in favour of marginal costing

Favour

• Easy to operate and simple to understand.
• Marginal costing is useful in profit planning; it is helpful to determine profitability at different level of production and sale.
• It is useful in decision making about fixation of selling price, export decision and make or buy decision.
• Break even analysis and P/V ratio are useful techniques of marginal costing.
• Evaluation of different departments is possible through marginal costing.
• By avoiding arbitrary allocation of fixed cost, it provides control over variable cost.
• Fixed overhead recovery rate is easy.
• Under marginal costing, valuation of inventory done at marginal cost. Therefore, it is not possible to carry forward illogical fixed overheads from one accounting period to the next period.
• Since fixed cost is not controllable in short period, it helps to concentrate in control over variable cost.

Against

1. The total costs cannot be easily segregated into fixed costs and variable costs.

2. Moreover, it is also very difficult to per-determine the degree of variability of semi-variable costs.
3. Under marginal costing, the fixed costs remain constant and variable costs are varying according to level of output. The fixed costs do not remain constant and the variable costs are not varying according to level of output.
4. There is no meaning in the exclusion of fixed costs from the valuation of finished goods since the fixed costs are incurred for the purpose of manufacture of products.
5. In the case of loss by fire, the full amount of loss cannot be recovered from the insurance company since the stocks are undervalued.
6. Tax authorities do not accept the valuation of stock since the shock does not show true value.
7. The calculation of variable overheads does not include all the variable overheads.
8. The profit fluctuates as per the fluctuation of sales volume. Hence, the preparation of periodic operating statements becomes unrealistic.
9. The elimination of fixed costs renders cost comparison of jobs difficult.
10. The management cannot take a quality decision with the help of contribution alone. The contribution may vary if new techniques followed in the production process.
11. The fixed costs are constant only for short period. In the long run, all the costs are variable.
12. Firms may find it difficult to cover up costs and earn a fair return on capital employed when they follow marginal cost principle in times of recession when demand is slack and price reduction becomes inevitable to retain business.
13. Marginal cost pricing requires a better understanding of marginal cost technique. Some accountants are not fully conversant with the marginal techniques themselves. Therefore, they are not capable of explaining their use to the management.

In spite of its advantages, due to its inherent weakness of not ensuring the coverage of fixed costs, marginal pricing has not been adopted extensively. It is confined to cases of special orders only.