ICAB Accounting Notes: Absorption Costing, ABC, and Costing Methods
ICAB students need clear understanding of costing methods to excel in exams. This guide covers Absorption Costing, Activity-Based Costing (ABC), and other important methods like job, batch, contract, and process costing. Learn practical examples, exam tips, and how to handle overheads efficiently.
1. Absorption Costing (Full Costing)
Absorption costing, also called full costing, calculates the full cost of a unit as the sum of its prime cost (direct materials, labour, expenses) plus allocated overheads.
1.1 Calculating Absorption Cost
| Component | Explanation |
|---|---|
| Direct Materials | Raw materials used in production |
| Direct Labour | Wages of production workers |
| Direct Expenses | Special tools, royalties |
| Total Direct Cost | Sum of above (Prime Cost) |
| Indirect Costs | Allocated overheads |
| Absorption Cost | Prime Cost + Allocated Overheads |
Formula: Absorption Cost per Unit = Prime Cost + Share of Overheads
1.2 Overhead Allocation & Apportionment
Overheads are first allocated directly to departments, then apportioned across cost centres based on fair basis like floor area or labour hours.
1.3 Service Cost Centre Apportionment
Service centre costs (e.g., canteen, maintenance) must be reapportioned to production departments before absorption.
1.4 Overhead Absorption Rate
Overheads absorbed using a predetermined rate:
Overhead Rate = Budgeted Overhead ÷ Budgeted Level of Activity
1.5 Over & Under Absorption
Over absorption: charged > actual
Under absorption: charged < actual
2. Activity-Based Costing (ABC)
ABC links overhead costs to activities rather than volume. It uses cost drivers to assign costs fairly.
- Identify major activities
- Determine cost drivers
- Collect costs into pools
- Assign to products based on usage
Exam Tip: ABC gives fairer cost allocation for low-volume or high-overhead products.
3. Costing Methods
Other costing methods include:
3.1 Job Costing
Used for custom or short-duration jobs. Costs accumulated per job. Example: custom furniture.
3.2 Batch Costing
Costs measured per batch of identical units. Example: shoes, printed leaflets.
3.3 Contract Costing
Used for long-duration projects. Example: construction of schools, hospitals.
3.4 Process Costing
Used for continuous flow production. Each process is a cost centre. Example: bottled sauces (Mixing → Cooking → Bottling → Packing).
ICAB Practice MCQs
-
1. Which is a direct cost?
a) Factory rent
b) Material used in a product
c) Advertising
d) Supervisor wages
Answer: b) Material used in a product -
2. ABC assigns costs based on:
a) Product volume
b) Activity usage
c) Random allocation
d) Labour hours only
Answer: b) Activity usage -
3. Job costing is suitable for:
a) Mass production
b) Custom orders
c) Continuous process
d) Standardized batches
Answer: b) Custom orders
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