The main advantages of marginal costing are given below:
(1) By using marginal costing technique, the assessment of various sales or production alternatives options becomes more convenient and easy which helps in generating optimum return.
(2) It facilitates in short-term decision making process.
(3) Marginal costing is simple and easy to understand as it avoids the complexities of arbitrarily charging fixed overheads to the units of output.
(4) Cost control can be exercised in a better way by putting more efforts in maintaining a contrast and consistent marginal cost as fixed cost are assumed to be constant.
(5) There is no need to calculate overhead absorption rate which makes calculations easy and simple.
(6) It avoids the complication of under or over absorption of overheads.
(7) Fixed costs incur on time basis and are independent of volume of output. To avoid misleading calculations only marginal costs are considered for product costing.
(8) Inventories carried forward to the next year do not include an element of current period’s fixed overheads.
(9) It also helps to compare performance between two or more products and departments.
The following are the drawbacks of marginal costing technique:
(1) It assumes that all expenses can be categorized as fixed or variable. There are, however, some expenses like employees’ bonuses, etc., which do not relate to volume of output or time period.
(2) Sometimes it becomes difficult to separate costs as fixed and variable and occasionally gives inaccurate results.
(3) Under marginal costing, inventories are undervalued due to exclusion of fixed costs from the valuation. Moreover use of marginal costing is normally not acceptable for tax purposes.
(4) Under International Accounting Standard 2 (IAS 2) a proportion of fixed cost must be taken into account for inventory valuation, so it also restricts usefulness of marginal costing.
(5) Calculations based on marginal cost data may be misleading for seasonal businesses.
(6) Control offered through budgetary control and standard costing is much more effective than marginal costing as the latter does not give any standard for the performance evaluation.
(7) It assumes of constant total fixed cost,per unit sales price and variable cost but in reality they may vary. This sometimes makes the whole theory of marginal costing unrealistic.
(8) Usefulness of marginal costing is normally restricted to short term period. For long term decision making absorption costing is the most appropriate option.