Marginal costing technique has the following limitations:
- In marginal costing, costs are classified into fixed and variable. Segregation of costs into fixed and variable is rather difficult and cannot be done with precision.
- Marginal costing assumes that the behavior of costs can be represented in straight line. This means that fixed costs remains completely fixed over a period at different levels and variable costs change in linear pattern i.e. the change is proportion to the change in volume. In real life, fixed costs are liable to change at varying levels of production especially when extra plant and equipments are introduced and hence variable costs may not vary in the same proportion as the volume.
- Under marginal costing technique fixed costs are not included in the value of stock of finished goods and work-in-progress. As fixed costs are incurred, these should also form part of the costs of the product. Due to this elimination of fixed costs from finished stock and work-in-progress, the stocks are understated. This affects the results of profit and loss account and the balance sheet. Thus, profit may be unnecessarily deflated.
- In the marginal costing system monthly operating statements will not be as realistic or useful as under the absorption costing system. This is because under this system, marginal contribution and profits vary with change in sales value. Where sales are occasional, profits fluctuate from period to period.
- Marginal costing fails to give complete information, for example rise in production and sales may be due to extensive use of existing machinery or by expansion of the resources or by replacement of the labour force by machines. The marginal contribution of P/V ratio fails to bring out reasons for this.
- Under marginal costing system the difficulties involved in the apportionment and computation of under and over absorption of fixed overheads are done away with but problem still remains as far as the under absorption or over absorption of variable overheads is concerned.
- Although for short term assessment of profitability marginal costs may be useful, long-term profit is correctly determined on full costs basis only.
- Marginal costing does not provide any standard for the evaluation of the performance. Marginal contribution data do not reveal many effects which are furnished by variance analysis. For example, efficiency variance reflects the efficient and inefficient use of plant, machinery and labour and this sort of valuation is lacking in the marginal cost analysis.
- Marginal costing analysis assumes that sales price per unit will remain the same on different levels of production but these may change in real life and give unrealistic results.
- In the age of increased automation and technology advancement, impact of fixed costs on product is much more than that of variable costs. As a result a system that does not account the fixed costs is less effective because a substantial portion of the cost is not taken into account.
- Selling price under the marginal costing technique is fixed on the basis of contribution. This may not be possible in the case of ‘cost plus contracts’.
Thus the above limitations indicate that fixed costs are equally important in certain cases.
