Uses and Limitations of Marginal Costing

• According to research by CIMA the leading Management Institute
• Traditional costing methods such as Absorption costing are still in widely used by manufacturing businesses throughout the world
• There is are reasons for this:

Uses/Advantages of Absorption costing

• Marginal costing is easy to understand there are none of the complexities of absorption costing for example calculating OARs etc
• It is thus simple to operate
• It can be combined with standard costing and budgetary control and thereby makes the control mechanism more effective
• The problem of over or under absorption of overheads is avoided completely
• A clear distinction of costs into fixed and variable elements makes the flexible budgetary control system easy and effective and thereby facilitates greater practical cost control
• It helps profit planning through break-even charts and profit graphs
• It is used to aid the decision making processes for example pricing decisions, make or buy decisions, creating a product mix as well as profit planning
• Contribution per unit is constant unlike profit per unit which is used under absorption costing
• Cost per unit is constant and does not change with production volumes

Limitations and drawbacks of marginal costing

• Inventories are not valued in accordance with IAS2 as they do not include fixed costs
• Does not ensure that all costs are recovered as each only contributes towards total fixed costs-this may ultimately be not enough
• Pricing decisions cannot be based on contribution alone
• Treating fixed costs as period costs can lead to inaccurate profit calculations and is against the matching principle
• Profits might vary wildly especially in businesses that have seasonal sales.

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