Cambrige AS and A Level Accounting Notes (9706)/ ZIMSECĀ  Advanced Accounting Level Notes: 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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