Question

Give two examples of situations in which it may be challenging to classify costs. Critically evaluate the role that Activity-Based Costing can play in cost classification.

Answer 1

Classification of costs could be a challenging aspect as it requires both time and well understanding knowledge to differentiate various costs into various categories.

1. Understanding the type of costs would be a challenge for a semi variable costing category. For example, if a company in incuring a costs where the same cost is variable depending upon the consumption and then fixed after reaching a limit could make the categorisation of costs challenging as the company wouldn't understand in what category should it be put. It could called either semi variable or semi fixed making it a confusing part for the company.

2. Another example is the requirement of training, company's knowledge and market analysis you would require to make the proper categorisation of costs. For example, knowing which costs are sunk costs, which are opportunity costs and which are the incremental costs for the growth of rhe company solely depends upon the profits and revenue the company generated from the processes and activities. This requires training and proper knowledge of the market to make the right judgement and decision making.

Activity based costing (ABC) play an important role in categorisation of various costs in the company. This analysis helps in identifying various activities in the organisation and thus assign the right costs for each activity for all services and products according to the actual consumption of the expenses of each activity. More indirect costs are assigned rather than direct costsz More accurate costs are defined and allocated making better decision making. Various costs overheads are assigned as per the expenses incurred of the activities and thus helps in bettes estimation and categorisation of costs.