PROJECT REPORT ON

APPLICATION OF MARGINAL COSTING TECHNIQUE AND

ITS LIMITATION
Submitted to
University of Mumbai
In Partial Fulfillment Of The Requirement
For
M.Com (Accountancy) Semester 2
In the subject
Cost Accounting
By
Name of the student
Roll No.

::-

Ajay santosh patil

14 -7299

Name and address of the college

K. V. Pendharkar College
Of Arts, Science & Commerce
Dombivli (E), 421203

April 2015

DECLARATION
I AJAY SANTOSH PATIL Roll No. 14 7299, the student of M.Com
(Accountancy) Semester I (2014), K. V. Pendharkar College, Dombivli,
Affiliated to University of Mumbai, hereby declare that the project for the subject
Strategic Management of Project report on APPLICATION OF

MARGINAL COSTING TECHNIQUE AND ITS LIMITATION

submitted by me to University of Mumbai, for semester I examination is based on
actual work carried by me.

I further state that this work is original and not submitted anywhere else for any
examination.

Place :Dombivli
Date:

Signature of the Student

Name: - Ajay santosh patil
Roll No:- 14-7299

ACKNOWLEDGEMENT

It is a pleasure to thank all those who made this project work possible.
I Thank the Almighty God for his blessings in completing this task. The
successful completion of this project is possible only due to support and
cooperation of my teachers, relatives, friends and well-wishers. I would
like to extend my sincere gratitude to all of them.
I am highly indebted to Principal A.K.Ranede ,Co-ordinator Limaye
Sir, and my subject teacher Prajakta Karmarkar for their encouragement,
guidance and support.
I also take this opportunity to express sense of gratitude to my parents
for their support and co-operation in completing this project.
Finally I would express my gratitude to all those who directly and
indirectly helped me in completing this project.

Name of the student

Ajay santosh patil

Chapter no

Page no

Topic

CHAPTER 1 Introduction
1.1 Introduction of cost accounting and marginal
costing.

CHAPTER 2 Application of marginal costing

18

CHAPTER 3 Limitation

23

Conclusion

24

CHAPTER4

Bibliography

Table of Contents

CHAPTER 1

INTRODUCTION OF COSTING
Definition
System of computing cost of production or of running a business, by allocating
expenditure to various stages of production or to different operations of a firm.
Cost Accounting
Cost accounting is a process of collecting, analyzing, summarizing and evaluating
various alternative courses of action. Its goal is to advise the management on the
most appropriate course of action based on the cost efficiency and capability. Cost
accounting provides the detailed cost information that management needs to
control current operations and plan for the future.
Since managers are making decisions only for their own organization, there is no
need for the information to be comparable to similar information from other
organizations. Instead, information must be relevant for a particular environment.
Cost accounting information is commonly used in financial accounting
information, but its primary function is for use by managers to facilitate making
decisions.
Unlike the accounting systems that help in the preparation of financial reports
periodically, the cost accounting systems and reports are not subject to rules and
standards like the Generally Accepted Accounting Principles. As a result, there is
wide variety in the cost accounting systems of the different companies and
sometimes even in different parts of the same company or organization.

Origins
All types of businesses, whether service, manufacturing or trading, require cost
accounting to track their activities. Cost accounting has long been used to help
managers understand the costs of running a business. Modern cost accounting
originated during the industrial revolution, when the complexities of running a
large scale business led to the development of systems for recording and tracking
costs to help business owners and managers make decisions.
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In the early industrial age, most of the costs incurred by a business were what
modern accountants call "variable costs" because they varied directly with the
amount of production Money was spent on labor, raw materials, power to run a
factory, etc. in direct proportion to production. Managers could simply total the
variable costs for a product and use this as a rough guide for decision-making
processes.
Some costs tend to remain the same even during busy periods, unlike variable
costs, which rise and fall with volume of work. Over time, these "fixed costs" have
become more important to managers. Examples of fixed costs include the
depreciation of plant and equipment, and the cost of departments such as
maintenance, tooling, production control, purchasing, quality control, storage and
handling, plant supervision and engineering. In the early nineteenth century, these
costs were of little importance to most businesses. However, with the growth of
railroads, steel and large scale manufacturing, by the late nineteenth century these
costs were often more important than the variable cost of a product, and allocating
them to a broad range of products lead to bad decision making. Managers must
understand fixed costs in order to make decisions about products and pricing.
For example: A company produced railway coaches and had only one product. To
make each coach, the company needed to purchase $60 of raw materials and
components, and pay 6 laborers $40 each. Therefore, total variable cost for each
coach was $300. Knowing that making a coach required spending $300, managers
knew they couldn't sell below that price without losing money on each coach. Any
price above $300 became a contribution to the fixed costs of the company. If the
fixed costs were, say, $1000 per month for rent, insurance and owner's salary, the
company could therefore sell 5 coaches per month for a total of $3000 (priced at
$600 each), or 10 coaches for a total of $4500 (priced at $450 each), and make a
profit of $500 in both cases

INVESTOPEDIA EXPLAINS 'Cost Accounting'

While cost accounting is often used within a company to aid in decision making,
financial accounting is what the outside investor community typically sees.
Financial accounting is a different representation of costs and financial
6

performance that includes a company's assets and liabilities. Cost accounting can
be most beneficial as a tool for management in budgeting and in setting up cost
control programs, which can improve net margins for the company in the future.
Cost accounting is the accounting of the cost. It is made of two words- Cost and
Accounting. The term cost denotes the total of all expenditures involved in the
process of production. Thus, it covers the costs involved in the production and the
cost involved while receiving it. Accounting, on the other hand, collects and
maintains financial records of each income and expenditure and make avail of such
information to the concerned officials. Thus, cost accounting is a practice and
process of cost which determines the profitability of a business concern by
controlling the cost with the application of accounting principle, process and rules.
Cost accounting includes the presentation of the information derived there from for
purposes of managerial decision making. Thus, cost accounting is a arts as well as
science. It is science because it is a body of systematic knowledge having certain
principles. It is an art as it requires the ability and skill with which a cost
accountant is able to apply the principles of cost accounting in various managerial
problems.
According to W.W.Bigg- Cost accounting is the provision of such analysis and
classification of expenditure as will enable the total cost of any particular unit of
production to be ascertained with reasonable degree of accuracy and at the same
time to disclose exactly how such total cost is constituted.
According to R.N. Carter, Cost accounting is a system of recording in accounts
the materials used and labour employed in the manufacture of a certain commodity
or on a particular job.
Thus, cost accounting is considered as an art as well as acinece. It is also a prime
part of accounting system which records systematically the cost involved in raw
materials and labour used in the process of production and the same time
determines the total cost and unit cost of product. the process of recording
classifying and analyzing of cost is the cost accounting.

Objectives of Cost accounting.

1.
2.
3.

Cost finding
Cost planning and controlling
Cost analysis for managerial decision

Advantages of Cost accounting

1.

Help in Cost control

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2.
3.
4.
5.
6.

Help in Decision making

Guides in Price fixation
Help in cost reduction
Finds outs profitable and unprofitable operations
Finds out idle capacity

Importance of Cost accounting

Cost accounting has many importance. Specially, the following parties are
benefitted from it.
1.
Importance to management
Management is highly benefitted with the introduction of cost accounting. It helps
to ascertain the cost and selling price of the product. Cost data help management to
formulate the business policies. The introduction of budgetary control and standard
cost would be an aid to analyze cost. Its also helps to find out reasons for profit or
loss. It provides data to submit tender as well. Thus, cost accounting is an aid to
management.
2.

Importance to investors
Investors can obtain benefit fro the cost accounting. Investors want to know the
financial conditions and earning capacity of the business. An investor must gather
information about organization before making investment decision and investor
can gather such information from cost accounting.

3.

Importance of consumers
The ultimate aim of costing is to reduce the cost of production to minimize the
profit of business. Reduction in the cost is usually passed on the consumers in the
form of lower price. Consumers get quality goods at a lower price.
4.
Importance to Employees
Cost accounting helps to fix the wages of the workers. Efficient workers are
rewarded for their efficiency. It helps to induce incentive wage plan in business.
5.

Importance to Government
Cost accounting is one of the prime sources to provide reliable data to internal as
well as external parties. It helps government agencies to determine excise duty and
income tax. Government formulates tax policy, industrial policy, export and import
policy based on the information provided by the cost accounting.

INTRODUCTION OF MARGINAL COST

Definition
The increase or decrease in the total cost of a production run for making one
additional unit of an item. It is computed in situations where the breakeven point
has been reached: the fixed costs have already been absorbed by the already
produced items and only the direct (variable) costs have to be accounted for.
Marginal costs are variable costs consisting of labor and material costs, plus an
estimated portion of fixed costs (such as administration overheads and selling
expenses). In companies where average costs are fairly constant, marginal cost is
usually equal to average cost. However, in industries that require heavy capital
investment (automobile plants, airlines, mines) and have high average costs, it is
comparatively very low. The concept of marginal cost is critically important in
resource allocation because, for optimum results, management must concentrate its
resources where the excess of marginal revenue over the marginal cost is
maximum. Also called choice cost, differential cost, or incremental cost.
marginal cost is the change in the total cost that arises when the quantity produced
has an increment by unit. That is, it is the cost of producing one more unit of a
good. In general terms, marginal cost at each level of production includes any
additional costs required to produce the next unit. For example, if producing
additional vehicles requires building a new factory, the marginal cost of the extra
vehicles includes the cost of the new factory. In practice, this analysis is segregated
into short and long-run cases, so that over the longest run, all costs become
marginal. At each level of production and time period being considered, marginal
costs include all costs that vary with the level of production, whereas other costs
that do not vary with production are considered fixed.
If the good being produced is infinitely divisible, so the size of a marginal cost will
change with volume, as a non-linear and non-proportional cost function includes
the following:
9

 variable terms dependent to volume,

constant terms independent to volume and occurring with the respective lot
size,
jump fix cost increase or decrease dependent to steps of volume increase.
In practice the above definition of marginal cost as the change in total cost as a
result of an increase in output of one unit is inconsistent with the differential
definition of marginal cost for virtually all non-linear functions. This is as the
definition finds the tangent to the total cost curve at the point q which assumes that
costs increase at the same rate as they were at q. A new definition may be useful
for marginal unit cost (MUC) using the current definition of the change in total
cost as a result of an increase of one unit of output defined as: TC(q+1)-TC(q) and
re-defining marginal cost to be the change in total as a result of an infinitesimally
small increase in q which is consistent with its use in economic literature and can
be calculated differentially.

What is Marginal Costing?

It is a costing technique where only variable cost or direct cost will be charged to
the cost unit produced. Marginal costing also shows the effect on profit of changes
in volume/type of output by differentiating between fixed and variable costs.
Salient Points:
Marginal costing involves ascertaining marginal costs. Since marginal costs are
direct cost, this costing technique is also known as direct costing;
In marginal costing, fixed costs are never charged to production. They are
treated as period charge and is written off to the profit and loss account in the
period incurred;
Once marginal cost is ascertained contribution can be computed. Contribution is
the excess of revenue over marginal costs.
The marginal cost statement is the basic document/format to capture the
marginal costs.

Features of Marginal Costing:

It is a method of recording costs and reporting profits;
All operating costs are differentiated into fixed and variable costs;
10

Variable cost charged to product and treated as a product cost whilst

Fixed cost treated as period cost and written off to the profit and loss
Account
Marginal costing is very helpful in managerial decision making. Management's
production and cost and sales decisions may be easily affected from marginal
costing. That is the reason, it is the part of cost control method of costing
accounting. Before explaining the application of marginal costing in managerial
decision making, we are providing little introduction to those who are new for
understanding this important concept.
Marginal cost is change in total cost due to increase or decrease one unit or output.
It is technique to show the effect on net profit if we classified total cost in variable
cost and fixed cost. The ascertainment of marginal costs and of the effect on profit
of changes in volume or type of output by differentiating between fixed costs and
variable costs. In marginal costing, marginal cost is always equal to variable cost
or cost of goods sold. We must know following formulae
a) Contribution ( Per unit) = Sale per unit - Variable Cost per unit
b) Total profit or loss = Total Contribution - Total Fixed Costs
or

Contribution = Fixed Cost + Profit

or

Profit = Contribution - Fixed Cost

c) Profit Volume Ratio = Contribution/ Sale X 100 ( It means if we

sell Rs. 100 product, what will be our contribution margin, more contribution
margin means more profit)
d ) Break Even Point is a point where Total sale = Total Cost
e) Break Even Point ( In unit ) = Total Fixed expenses /
Contribution
f) Break Even Point ( In Sales Value ) = Break even point (in units)
X Selling price per unit
g) Break Even Point at earning of specific net profit margin
= Total Contribution / Contribution per unit

11

or = fixed cost + profit / selling price - variable cost per unit

Direct Costing
The practice of charging all direct costs to operations, processes or products,
leaving all indirect costs to be written-off against profit in the period in which they
arise is called Direct Costing.
This differs from marginal costing in that some fixed costs could be considered to
be direct costs in appropriate circumstances.

Contribution
Contribution is the difference between the sales and the marginal cost of sales. It
contributes towards fixed expenses and profit.
The contribution margin is sales minus variable expenses.
Contribution margin = Sales - Variable Expenses
When the contribution margin is expressed as a percentage of sales it is referred to
as the contribution margin ratio. The contribution margin per unit is the products
selling price minus its variable costs and expenses.

Variable Cost
Variable Cost is a cost which tends to vary directly with volume of output.
Variable costs are sometimes referred to as direct costs in system of Direct Costing.
Variable Expenses mean the total of the companys variable costs plus its variable
expenses.

Fixed Cost
Fixed Cost is a cost which tends to be unaffected by variations in volume of output.
Fixed costs depend mainly on the efflux ion of time and do not vary directly with
volume or rate of output.
Fixed costs are sometimes referred to as period costs in system of Direct Costing.

Fixed Expenses
mean the companys total amount of fixed costs plus its fixed expenses.

Fixed costs and Fixed expenses

Fixed costs and fixed expenses are those which do not change as volume changes.

12

Variable costs and Variable expenses

Variable costs and variable expenses increase as volume increases and they will
decrease when volume decreases. The relationship of contribution to Sales will
remain constant under different levels of sales only if:
1. Variable cost per unit remains constant.
2. Fixed costs remain the same.
3. Selling price per unit does not change.
The cost per unit of an item is important for
Setting the selling price
Valuing stocks
Calculating profitability

Terms and Definitions

Basic Equation:
Variable Cost = Direct Materials + Direct Labor + Direct Expenses
Variable cost per unit = Difference in cost / Difference in Activity level
Variable Cost is also called as Marginal Cost.

Marginal Cost Equation:

Sales (S) = Variable Cost (V) + Fixed Expenses (F) + or Profit (P) / Loss (L)
S = Sales
V = Variable Cost
F = Fixed Expenses
+P = Profit
-P = Loss
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Sales - Variable Cost = Fixed Expenses + or Profit / Loss

S - V = F + or P

Contribution:
Sales Variable Cost = Contribution = S - V
Fixed Expenses + or Profit / Loss = Contribution = F + or P
In simple form, S V = F + or P

Missing Factor:
In the above four factors, if any three factors are known, the remaining one can be
easily found out.
Sales = Variable Cost + Fixed Expenses + Profit
Variable Cost = Sales (Fixed Expenses + Profit)
Fixed Expenses = Sales Variable Cost Profit
Profit = Sales Variable Cost Fixed Expenses

Units sold:
Units sold = Contribution margin / Contribution margin per unit

Break Even Point:

A business is said to break even when its total sales are equal to its total costs.
It is a point where
There is no profit or no loss.
Contribution is equal to Fixed Expenses.
Break Even Point (in Units) = Total Fixed Expenses / (Selling Price per Unit
Marginal Cost per Unit)
The answer will be in units and not in value because break even point is based on
unit cost.

Break Even Sales:

SV = F+P
At Break Even Point Profit equals zero.
Hence, S V = F
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For Break Even Point, the equation is S V = F

Dividing both sides by S V,
( S V) / (S V) =
F / (S V)
i.e. 1 =
F / (S V)
Multiplying both sides by S,
S*1 =
( F * S) / (S V)
Therefore, the formula for the calculation of break even sales is:
( F * S) / (S V)

Calculation of Sales for a desired or expected Profit:

(Fixed Expenses + Profit) / (Selling Price per Unit Marginal Cost per Unit)
Or
(Fixed Expenses + Profit) / Contribution per Unit
The formula for the calculation of Sales to earn an expected or desired profit
is:
( (F + P) * S) / ( S V)

Profit / Volume Ratio or Contribution / Sales Ratio

(P/V Ratio) or (C/S Ratio)
P/V Ratio
Contribution / Sales i.e. C / S
Or
(Sales Variable Cost) / Sales i.e. (S V) / S
Or
(Fixed Expenses + Profit) / Sales i.e. ( F + P) / S
Or
Changes in contribution in two periods / Changes in Sales in two periods
Or
Changes in Profit in two periods / Changes in Sales in two periods
The ratio can be shown in the form of percentage if the formula is multiplied by
100.
This ratio can be used for the calculation of
Break Even Point is Fixed Costs / P/V Ratio = F / P/V Ratio
For the calculation of sales to earn a desired or expected profit is
(Fixed Costs + Profit) / P/V Ratio = F + P / P/V Ratio
Contribution / P/V Ratio
Variable Costs = Sales (1 P/V Ratio)
Contribution is Sales x P/V Ratio
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Margin of Safety (M/S)

It is the difference between the actual sales and the sales at break even point.
Sales or Output beyond break even point is known as margin of safety.
Margin of Safety (M/S) = Present Sales Break Even Sales
Or
= Profit / P/V Ratio

Break-Even and Target Income

Sales = Total Variable Costs + Total Fixed Costs + Target Income
Where Target Income is zero, then
Sales = Total Variable Costs + Total Fixed Costs
Which is the Break even sales.
Break-Even Point in Units = Total Fixed Costs / Contribution Margin Per Unit
Break-Even Point in Sales = Total Fixed Costs / Contribution Margin Ratio

Alternative Methods of Production

The method which gives the greatest contribution is to be adopted keeping the
limiting factor in view.
Diversification of Products
In order to decide about the profitability of the new product, it is assumed
that the manufacture of the new product will not increase fixed costs of the
concern.
If the price realized from the sale of such product is more than its variable
cost of production it is worth trying.
If the data is presented under absorption costing method, the decision will be
wrong.
If with the introduction of new product, there is an increase in the fixed
costs, then such specific increase in fixed costs must be deducted from the
contribution for making any decision.

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 General fixed costs will be charged to the old product/products.

Closing down or suspending activities
The decision to close down or suspend its activities will depend whether products
are making contribution towards fixed costs or not.
ie. Whether the contribution is more than the difference in fixed costs (by working
at normal operations and when the plant or product is closed down or suspended)
If the business is closed down:
There may be certain fixed costs which could be avoided.
There will be certain expenses which will have to be incurred at the time of
closing the operations like redundancy payments, necessary maintenance of
the plant or overhauling of plant on reopening training of personal etc.
Such costs are associated with closing down of business and must be taken
into consideration before taking any decision.
Fixed costs may be general or specific
General fixed costs may nor may not remain constant while specific costs
will be directly affected by closing down of the operations.
Besides, obsolescence if any, retaining the customers, relationship with the
suppliers, non-collection of dues from customers or interest on overdraft for
closing down the operations must be taken into consideration.
Alternative Course of Action
Whatever course of action is adopted, certain fixed expenses will remain
unaffected.
The criterion is the effect of alternative course of action upon the marginal
(variable) costs in relation to the revenue obtained.
The course of action which yields the greatest contribution is the most profitable to
be followed by the management.
Level of activity planning
Maximum contribution at a particular level of activity will show the position of
maximum profitability.

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CHAPTER 2
APPLICATION OF MARGINAL COSTING
This is a well known concept of economic theory. It may be described as the
change in total cost which arises as a result of an increase and decrease by one unit
in volume of output. Marginal cost is an amount at any given volume of output by
which aggregate costs are changed if the volume of output is increased or
decreased by one unit.
Marginal cost is synonymous with variable costs, prime costs plus variable
overheads in the short run but, in a way, would also include fixed cost in the
planning production activities over a long period of time involving an increase in
the productive capacity of business. Thus in decision making problems ,marginal
costs are related to change in output under particular circumstances of a case.
Theoretically marginal cost and differential cost are the same. If there is no change
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in fixed cost then both these cost will be same. Thus marginal cost does not include
fixed cost at all whereas differential cost may include an element of fixed cost as
well if fixed cost changes due to a decision.
Marginal costing is a very important technique of decision making. It is a
comparatively new area in the field of accounting but it is gradually gaining more
and more acceptance. It is the method of matching cost with revenue to determine
periodic income. It is the ascertainment of marginal cost and of the effect on profit
of changes on volume or type of output by
differentiating fixed costs and variable cost. In this context it is to be noted that it is
not a system of costing like process or job costing but it is simply an approach to
the presentation of accounting information meaningful to management. in this all
cost are segregated into fixed and variable components. only the variable costs are
regarded as product cost and are used to value inventory and cost of goods sold.the
fixed cost are treated as period cost and are charged directly to profit and loss
account. thus no part of fixed manufacturing cost is deferred to the next period as
inventory. while preparing a profit and loss account on marginal costing basis, the
variable or marginal cost of sales is deducted from sales value and the difference is
termed as contribution margin.
Marginal costing application in managerial decision making:
The technique of marginal costing is a valuable aid to management in taking
various policy decisions. Following are the few problems where managerial
costing analysis is useful:
1) Pricing of products: product pricing is usually considered to be a difficult
problem,particularly in non-repetitive production. the problem is to equate the
demand and supply in such cases marginal costing is very helpful. This technique
can help management in fixing prices in such circumstances:
a) A trade depression in industry
b) Dumping
c) A seasonal fluctuations

How is the concept of marginal costing practically applied?

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The concept of marginal costing is practically applied in the following situations:

- Evaluation of Performance : The evaluation of the performance of various
departments or products can be evaluated with the help of marginal costing which
is based on contribution generating capacity.
- Profit Planning : This technique through the calculation of P/V Ratio helps the
management to plan the activities in such a way that the profit can be maximised.
- Fixation of Selling Price : The technique of marginal costing assists the
management to fix the price in such a way so that prices fixed can cover at least the
variable cost.
- Make or Buy decision : Marginal cost analysis helps the management in making
or buying decision.
Decision Making
o Fixation of selling prices
o In house make or buy decisions
o Selecting production with Key or limiting factor
o Effect of change in sales price
o Maintaining a desired level of profits
o Selection of a suitable product mix
o Alternative methods of production
o Diversification of products
o Accepting an additional order
o Dropping a product
o Closing down or suspending activities
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o Alternative course of action

o Level of activity planning

- Optimizing Product Mix : To maximise profits and increase sales volume it is

necessary to decide an optimized mix or proportion in which various products of a
company can be sold.
- Cost Control : Marginal Costing is a technique of cost classification and cost
presentation which enable the management to concentrate on the controllable costs.
- Flexible Budget preparation: As the marginal costing particularly classifies
costs as fixed and variable costs which facilitates the preparation of flexible
budgets.

Advantages and Disadvantages of Marginal Costing

Advantages and Benefits of Marginal Costing

Cost control: Marginal costing makes it easier to determine and control costs of
production. By avoiding the arbitrary allocation of fixed overhead costs,

21

management can concentrate on achieving and maintaining a uniform and

consistent marginal cost.
Simplicity: Marginal costing is simple to understand and operate and it can be
combined with other forms of costing (e.g. budgetary costing and standard costing)
without much difficulty.
Elimination of cost variance per unit: Since fixed overheads are not charged to
the cost of production in marginal costing, units have a standard cost.
Short-term profit planning: Marginal costing can help in short-term profit
planning and is easily demonstrated with break-even charts and profit graphs.
Comparative profitability can be easily assessed and brought to the notice of the
management for decision-making.
Accurate overhead recovery rate: This method of costing eliminates large
balances left in overhead control accounts, which makes it easier to ascertain an
accurate overhead recovery rate.
Maximum return to the business: With marginal costing, the effects of
alternative sales or production policies are more readily appreciated and assessed,
ensuring that the decisions taken will yield the maximum return to the business.

Disadvantages and Limitations of Marginal Costing

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
22

sometimes may give misleading results. Furthermore, in a firm with many different
kinds of products, marginal costing can prove less useful.
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.
Semi-variable costs: Semi-variable costs are either excluded or incorrectly
analyzed, leading to distortions.
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.
External reporting: Marginal costing cannot be used in external reports, which
must have a complete view of all indirect and overhead costs.
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.

23

CHAPTER 3

THE LIMITATION OF USING THE MARGINAL COSTING

TECHNIQUE
Marginal costing is defined as the ascertainment of marginal cost and of the effect
on profit of changes in volume or type of output by differentiating between fixed
costs and variable costs.

Limitations of Marginal Costing Techniques:

1. It is difficult to classify exactly the expenses into fixed and variable category.
Most of the expenses are neither totally variable nor wholly fixed.
2. Contribution itself is not a guide unless it is linked with the key factor.
3. Sales staff may mistake marginal cost for total cost and sell at a price; which
will result in loss or low profits. Hence, sales staff should be cautioned while
giving marginal cost.
4. Overheads of fixed nature cannot altogether be excluded particularly in large
contracts, while valuing the work-in-progress. In order to show the correct position
fixed
overheads
have
to
be
included
in
work-in-progress.
5. Some of the assumptions regarding the behaviour of various costs are not
necessarily true in a realistic situation. For example, the assumption that fixed cost
will remain static throughout is not correct.

24

CHAPTER 3

CONCLUSION
Marginal costing is a useful analysis tool which usually helps management make
decisions and understand the answer to specific questions about revenue.
That said, it is not a costing methodology for creating financial statements. In fact,
accounting standards explicitly exclude marginal costing from financial statement
reporting. Therefore, it does not fill the role of a standard costing, job costing, or
process costing system, all of which contribute actual changes in the accounting
records.
Still, it can be used to discover relevant information from a variety of sources and
aggregate it to help management with a number of tactical decisions. It is most
useful in the short-term, and least useful in the long-term, especially where a firm
needs to generate sufficient profit to pay for a large amount of overhead.
Furthermore, direct costing can also cause problems in situations where
incremental costs may change significantly, or where indirect costs have a bearing
on the decision.

Bibliography
World Wide Web
http://www.scribd.com/
http://www.wikipedia.org/
http://www.slideshare.net/
http://www.academia.edu/

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