Uses & Limitations of Marginal Costing (Cambridge (CIE) AS Accounting): Revision Note

Uses & limitations of marginal costing

What are the uses of marginal costing?

• The contribution can be assessed to see whether it is positive or not to assist: 

  • Make or buy decisions 

  • Whether to accept special one-off orders 

  • Whether to close a department or not

• Products can be ranked in order of contribution per limiting factor for: 

  • Strategising production plan when there is a limiting factor 

• It can be used to analyse if existing customer sales cover fixed costs to assess whether: 

  • Penetration pricing can be implemented when entering a new market 

    • to see if it is financially viable for selling price to be set very low so it only covers variable costs 

• It can be used to analyse how target profits can be met 

  • The contribution minus the fixed costs gives the profits 

What are the limitations of marginal costing?

• Inaccuracy in grouping fixed costs and variable costs can lead to incorrect analysis 

• Fixed costs are excluded from product cost 

• Not useful for long-term decision-making as this requires full cost information 

• Cannot be used for inventory valuation because closing inventory is only valued at variable cost only

  • This is not acceptable under financial accounting standards 

• Some assumptions are unrealistic, for example: 

  • Selling price per unit is constant 

  • Fixed costs remain unchanged 

  • Variable cost per unit remains constant

What are non-financial factors?

• Non-financial factors are qualitative aspects of a business that cannot be measured directly in monetary terms but affect business performance

What is the significance of non-financial factors?

• Product quality 

  • Decisions based purely on contribution may reduce product quality to cut variable costs 

  • Poor quality can damage brand image and future sales

• Customer satisfaction 

  • Decisions such as discontinuing a product due to unprofitability may be financially better for the business but could lead to loss of loyal customers 

• Employee morale 

  • Decisions such as wage cuts may improve contribution but lower morale and motivation of workers, leading to decline in efficiency 

• Marginal costing only focuses on short-term profitability 

  • Management must consider long-term factors such as growth, market leadership and sustainability