Marginal Costing and Cost Volume Profit Analysis
By distinguishing between fixed costs and variable costs, the marginal costing technique can be used to determine marginal costs as well as the impact of changes in output volume and type on profit.
Assumption of Marginal Costing
- All elements of overheads/costs i.e. production, administration, selling, and distribution can be segregated into fixed and variable costs.
- Production level directly affects variable costs.
- The selling price remains unchanged.
- Fixed cost remains unchanged.
Advantages of Marginal Costing
- Simple to operate and easy to understand.
- Removes complexities of under over absorption of overheads.
- Help management in production planning.
- No possibility of fictitious profits by overvaluing stock.
- Facilitates calculation of important factors like B.E.P.
- Valuable tools in the hands of management in decision-making.
- Facilitate study of relative profitability.
- Help in cost control.
- Profit planning.
- Management Reporting.
Limitations or Disadvantages of Marginal Costing
- Marginal costing relies on a variety of assumptions, some of which may not hold true in all situations.
- Not all expenses can be divided into fixed and variable costs.
- Variable cost does not always vary in direct proportion.
- The selling price does not remain constant.
- Fixed cost does not remain constant.
- The exclusion of fixed costs from the stock of finished goods and in work-in-progress is illogical.
- Marginal costing completely ignores the time factor.
- With the use of additional strategies, cost reduction can be more effectively accomplished.
- Fixation of the selling price, in the long run, cannot be done without considering the fixed cost.