Application of Marginal Costing in Decision Making
1. Cost Control:
Marginal costing divides the total cost into fixed and variable cost. Fixed cost can be controlled by the top management and that to a limited extent. Variable costs can be controlled by the lower level of management. Marginal costing by concentrating all efforts on the variable costs can control and thus provides a tool to the management for control of total cost.
There may be situations where the profits of the concern are decreasing in-spite of increase in sales. If the data is presented on the basis of absorption costing basis, the management may not be able to comprehend the results. Marginal costing analysis will correctly bring out the reasons as to why the profits are decreasing in-spite of increase in sales.
Moreover, it should be noted that in marginal costing fixed costs are not eliminated at all. These are shown separately as a deduction from the contribution instead of merging with cost of sales and inventories. This helps the management to have control on fixed costs also in the long period as these costs are programmed in advance.
2. Profit Planning:
Marginal costing helps the profit planning i.e., planning for future operations in such a way as to maximise the profits or to maintain a specified level of profit. Absorption costing fails to bring out the correct effect of change in sale price; variable cost or product mix on the profits of the concern but that is possible with the help of marginal costing.
Profits are increased or decreased as a consequence of fluctuations in selling prices, variable costs and sales quantities in case there is fixed capacity to produce and sell.
3. Evaluation of Performance:
The different products, departments, markets and sales divisions have different profit earning potentialities. Marginal cost analysis is very useful for evaluating the performance of each sector of a concern.
Performance evaluation is better done if distinction is made between fixed and variable expenses. A product, department, market or sales division giving higher contribution should be preferred if fixed expenses remain same.
4. Decision Making:
The information provided by the total cost method is not sufficient in solving the management problems. Marginal costing technique is used for providing assistance to the management in vital decision-making, especially in dealing with the problems requiring short-term decisions where fixed costs are excluded.