Marginal Costing & Its Application

Dec 13, 2013

Recently I was talking to a CFO concerning costing methods that might work in his manufacturing plan. We talked about a number of systems and he brought up marginal costing.

This CFO was relatively inexperienced in manufacturing and very inexperienced in various job costing methods. As a result, when he asked about marginal costing, I presume this was from some conversation he had with one of his colleagues or something in which he had read. In any event, he began the discussion with a statement that he thought marginal costing was a stand alone costing method and mutually exclusive of any other method.

I have used marginal costing techniques with other clients, but never as a stand alone process that is not supported by a complete costing system including full absorption techniques on a part of the system. The reason is very simple, most companies cannot afford and would not want to use multiple costing systems to do significantly different functions in their operation. For example, for inventory valuation purposes both GAAP and income tax have costing methods that include full absorption concepts although they might be different from each other, they both have requirements that include recognition of differing sets of overhead.

It is common to need marginal costing techniques for certain components of management needs as opportunities or problems present themselves. In my past experience, if a company is thinking about their options they will require some time in the future as they design their costing model. This way they can build in certain options to allow products to be costed in several different ways including marginal costing. This would allow for a company to do an analysis of one or more of its product lines in addition to extracting cost from its cost system relative to those products on a marginal costing concept.

If the next problem to be addressed includes analysis of complete product cost including full absorption, then the same cost model can be queried in another way to provide full absorption costing on the same exact products.

Depending on the complexity of the manufacturing processes, the number of products in inventory and the complexity of the cost band associated with each product, this analysis can be relatively simple or very complex.

The end result of our conversation was that his current cost model may well have the capabilities to do this analysis and he was going to spend some time to delve into more of the reporting capabilities of his system and how the cost bands were configured to see if this marginal costing analysis is possible.

Categories: Cost Accounting