Marginal Costing is a costing technique wherein the marginal cost, i.e. variable cost is charged to units of cost, while the fixed cost for the period is completely written off against the contribution.
Disadvantages of using marginal or direct costing include the following:
Separation of costs into fixed and variable costs might be difficult, especially when such costs are semi variable in nature. Moreover, all costs—including fixed costs—are variable at some level of production and in the long run.
Long-range pricing of products and other long range policy decisions require knowledge of complete manufacturing cost which would require additional separate computations to allocate fixed overhead.
The pricing of inventories by the direct costing method is not acceptable for income tax computation purposes.
Direct costing has not been recognized as conforming to generally accepted accounting principles (GAAP) applied in the preparation of financial statements for stockholders and general public.
Profits determined by direct costing are not “true and proper” because of the exclusion of fixed production costs which are a part of total production costs and inventory. Production would not be possible without plant facilities, equipment, etc. To disregard these fixed costs violates the general principle of matching costs with revenues.
The elimination of fixed costs from inventory results in a lower figure and consequent reduction of reported working capital for financial analysis purposes. The decrease in working capital may also weaken the borrowing position.