Limitations of Marginal costing

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Despite its superiority over absorption costing, the marginal costing technique has its own limitations.

(a)  Segregation of all costs into fixed and variable costs is very difficult. In practice, a major technical difficulty arises in drawing a sharp line of demarcation between fixed and variable costs. the distinction between them holds good only in the short run. In the long-run, however, all costs are variable.

(b)  In marginal costing, greater importance is attached to the sales function thereby relegating the production function largely to a secondary position. But, the real efficiency of a business is to be assessed only by considering the selling and production functions together.

(c)  The elimination of fixed costs from the valuation of inventories is illogical since fixed costs are also incurred in the manufacture of goods. Further, it results in the understatement of the value of stock, which is neither the cost nor the market price.

(d)  Pricing decision cannot be based on contribution alone. Sometimes, the contribution will be unrealistic when increased production and sale are effected, either through extensive use of existing machinery or by replacing  manuallabour by machines. Another possibility is that there is danger of too many sales being effected at marginal cost, resulting in denial to the business of inadequate profits.

(e)  Although the problem of over or under absorption of fixed overheads can by overcome to a certain extent, the same problem still persist with regard to variable overheads.

(f)   The application of this technique is limited in the case of industries in which according to the nature of business, large stocks have to be carried by way of work-in-progress (e.g. contracting firms)

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