Marginal costing is a method of cost accounting and decision-making used for internal reporting in which only marginal costs are charged to cost units and fixed costs are treated as a lump sum. It is also known as direct, variable, and contribution costing.
In marginal costing, only variable costs are used to make decisions. It does not consider fixed costs, which are assumed to be associated with the time periods in which they were incurred.
Disadvantages and Limitations of Marginal Costing
1.Classifying costs: It is very difficult to separate all costs into fixed and variable costs clearly, since all costs are variable in the long run. Hence such classification sometimes may give misleading results. Furthermore, in a firm with many different kinds of products, marginal costing can prove less useful.
2.Semi-variable costs: Semi-variable costs are either excluded or incorrectly analyzed, leading to distortions.
3.Recovery of overheads: With marginal costing, there is often the problem of under or over-recovery of overheads, since variable costs are apportioned on an estimated basis and not on actual value.
4.External reporting: Marginal costing cannot be used in external reports, which must have a complete view of all indirect and overhead costs.
5.Increasing costs: Since it is based on historical data, marginal costing can give an inaccurate picture in the presence of increasing costs or increasing production.
6.Accurately representing profits: Since the closing stock consists only of variable costs and ignores fixed costs (which could be considerable), this gives a distorted picture of profits to shareholders.
7.It does not provide any standard for the evaluation of performance.
8.In marginal costing historical data is used while management decisions are related to future events.
9.Assessment of profitability on the marginal cost base can be used only in the short period of time.