Limitations of Marginal Costing in Decision Making

08/04/2020 1 By indiafreenotes
  1. Difficulty to analyse overhead: Separation of costs into fixed and variable is a difficult problem. In marginal costing, semi-variable or semi-fixed costs are not considered.
  2. Time element ignored: Fixed costs and variable costs are different in the short run; but in the long run, all costs are variable. In the long run all costs change at varying levels of operation. When new plants and equipment are introduced, fixed costs and variable costs will vary.
  3. Unrealistic assumption: Assumption of sale price will remain the same at different levels of operation. In real life, they may change and give unrealistic results.
  4. Difficulty in the fixation of price: Under marginal costing, selling price is fixed on the basis of contribution. In case of cost plus contract, it is very difficult to fix price.
  5. Complete information not given: It does not explain the reason for increase in production or sales.
  6. Significance lost: In capital-intensive industries, fixed costs occupy major portions in the total cost. But marginal costs cover only variable costs. As such, it loses its significance in capital industries.
  7. Problem of variable overheads: Marginal costing overcomes the problem of over and under-absorption of fixed overheads. Yet there is the problem in the case of variable overheads.
  8. Sales-oriented: Successful business has to go in a balanced way in respect of selling production functions. But marginal costing is criticised on account of its attaching over- importance to selling function. Thus it is said to be sales-oriented. Production function is given less importance.
  9. Unreliable stock valuation: Under marginal costing stock of work-in-progress and finished stock is valued at variable cost only. No portion of fixed cost is added to the value of stocks. Profit determined, under this method, is depressed.
  10. Claim for loss of stock: Insurance claim for loss or damage of stock on the basis of such a valuation will be unfavourable to business.
  11. Automation: Now-a-days increasing automation is leading to increase in fixed costs. If such increasing fixed costs are ignored, the costing system cannot be effective and depend­able.

Marginal costing, if applied alone, will not be much use, unless it is combined with other techniques like standard costing and budgetary control.