Marginal Costing as Decision Making tool

Marginal Costing as Decision Making tool

Marginal costing is consider to provide more information to management for decision making.

1. Direct Relationship

Marginal costing establish a direct relationship between sales volume and profit as one additional unit sold will bring additional contribution. This relationship can be used by management to determine the profit level.

2. Expected Cash flow

Marginal costing provides vital information about the expected cash flow from the sales and cash availability for meeting the fixed cost and other operation.

3. Less Manipulation of Profit

Marginal costing there are less chances of profit manipulation as compared to absorption costing where the profit can be manipulated by valuation of stock.

4. Decision Making tools

Marginal costing concept of contribution can be used in various quantitative techniques of decision making like break even analyses.

Marginal Costing

What is Marginal costing

Marginal costing takes into account only the variable cost and fixed cost are ignored. The marginal costing treats the fixed cost as period cost. The concept is really helpful in decision making. The inventories are calculated on the bases of variable cost. In other word marginal cost takes into account only those cost which vary with level of activity.

The marginal costing provides helpful information to the management for the purposes of budget preparation, short term planning, cost control etc. The other important aspect of marginal costing that it provides management the bases for mathematical calculation for decision making like break even analyses.

Limitation of marginal costing

It does not give a true picture of product cost. Especially when the fixed overhead form a major portion of product cost then the marginal costing is of little use as decision making tool.

It ignores the fixed cost so management has no controlling procedures for fixed cost and management plan or over plans about the variable cost of the product and the fixed cost remains the un touched area .Because the focus remains on the variable cost so management adopt more controls for the variable cost and the fixed cost may jump un expectedly.

This method the inventories can not be accurately calculated and therefore the figure can not be used to report in the financial statements.