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Costing Techniques: Absorption, Marginal and ABC Costing for ACCA SBL

Updated 11 October 2026 · Fact-checked

Absorption costing includes fixed production overheads in unit cost, using a rate per unit or hour. Marginal costing includes only variable costs and treats fixed costs as a period expense. ABC assigns overheads to products using cost drivers of the activities that cause them. Choose the method to fit the decision.

Understand Costing Techniques: Absorption, Marginal and ABC

Every product has direct costs, such as materials and labour, and overheads, such as factory rent, supervision and machine maintenance. Costing methods differ in how they treat overheads.

Absorption costing shares all production overheads across units. You work out an overhead absorption rate (OAR), usually per labour hour or machine hour, and add it to each unit. Stock is valued at full production cost. It is needed for external reporting under IAS 2, which requires production overheads to be allocated on the basis of normal capacity.

Marginal costing counts only variable costs in unit cost. Fixed costs are charged in full to the period. Contribution (sales less variable cost) is the key measure. It is better for short-term decisions such as accepting a special order, because fixed costs do not change with the decision.

Activity based costing (ABC) starts from the idea that overheads are caused by activities, not by volume. You group overhead costs into cost pools by activity, such as machine set-ups, purchase orders or quality inspections. You pick a cost driver for each pool and divide the pool cost by the driver volume. Products are charged for the activities they use. Low-volume, complex products usually take more cost than a labour-hour rate suggests.

In SBL you are not just calculating. You must advise. Say which method suits the decision, what the numbers show, and what the business should do next, such as reviewing prices or product ranges.

Key rules to remember

Overhead absorption rate (OAR): OAR = budgeted production overhead ÷ budgeted activity level (e.g. labour hours or machine hours); Use budgeted figures for both. Pick the basis that best drives the overhead.
Overhead absorbed: Overhead absorbed = OAR × actual activity; Compare with actual overhead to find under- or over-absorption.
Under/over-absorption: Over/(under)-absorbed = overhead absorbed − actual overhead incurred; Under-absorption is added to cost of sales, over-absorption is deducted from it.
Contribution: Contribution = sales − variable costs; Marginal costing profit = total contribution − fixed costs for the period.
Profit difference between methods: Absorption profit − marginal profit = change in inventory units × fixed overhead absorbed per unit; Absorption profit is higher when inventory rises and lower when inventory falls. Assumes the same fixed overhead rate per unit in the period.
ABC cost driver rate: Cost driver rate = cost of activity pool ÷ total driver volume; Product overhead = Σ (driver rate × driver units used by that product).

How to solve Costing Techniques: Absorption, Marginal and ABC questions

Use this order for any costing question, whether it asks for calculations, comparison or advice.

1Read the requirement. Note which method is asked for and what decision or audience is involved.
2List the cost data. Separate direct costs, variable overheads and fixed overheads.
3For absorption costing, calculate the OAR from budgeted overhead and budgeted activity. Apply it to the units or hours given.
4For marginal costing, compute contribution per unit and in total. Deduct total fixed costs as a period cost.
5For ABC, set up cost pools, choose a driver for each, and compute each driver rate. Then multiply by each product's driver usage.
6Convert to a cost per unit by dividing by units produced. Compare with the traditional figure and check totals reconcile to the overhead pool.
7Interpret the results. Say which products were over- or under-costed and how that could affect pricing, mix or discontinuation.
8Add limits and recommendations, such as cost of data collection, non-financial factors and the need for a long-run versus short-run view.

Quickest way: Reconcile and compare in two passes

When to use it: When time is short and you must compare ABC with absorption costing and give advice.

Calculate each ABC driver rate first and write them in a small list.
Compute total overhead per product under ABC and check that the products' totals add up to total overhead.
Compute the traditional overhead per unit using the single OAR.
Show the difference per unit, with a plus or minus sign, and name the product that was undercosted.
Write two or three advice sentences linking the difference to pricing or product decisions.

Common mistakes in Costing Techniques: Absorption, Marginal and ABC

Using actual overhead or actual hours to calculate the OAR.
Students rush and take the first numbers they see.
Fix: Use budgeted overhead divided by budgeted activity. Use actual activity only when absorbing the overhead.
Including fixed overheads in marginal cost per unit.
Habit from absorption costing.
Fix: Unit cost in marginal costing has variable costs only. Deduct fixed costs once in total.
Explaining the profit difference with the wrong sign.
Students forget which way inventory moved.
Fix: If closing inventory is higher than opening inventory, absorption profit is higher. If it falls, absorption profit is lower.
Choosing cost drivers that do not cause the cost.
Students pick volume measures by default.
Fix: Ask what makes the cost rise. Set-up costs follow number of set-ups, not units.
Giving ABC figures without advice.
Calculation feels like the full answer.
Fix: State what the change in cost means for pricing, product mix or profitability, and earn the professional skills marks.
Claiming ABC always gives better decisions.
Textbook advantages are repeated without balance.
Fix: Mention the cost of collecting data, subjective cost-pool choices and the fact that some costs have no clear driver. ABC suits businesses with high overheads and diverse products.

Worked examples

Example 1

Zeta Ltd makes products A and B. Budgeted production overhead is ₹6,00,000, absorbed on direct labour hours. A uses 2 hours per unit and B uses 3 hours per unit. Budget output is 10,000 units of A and 20,000 units of B. Calculate the OAR and the overhead per unit for each product.

Show the solution

Budgeted hours: A = 10,000 × 2 = 20,000. B = 20,000 × 3 = 60,000. Total = 80,000 hours.
OAR = ₹6,00,000 ÷ 80,000 = ₹7.50 per hour.
Overhead per unit of A = 2 × ₹7.50 = ₹15.
Overhead per unit of B = 3 × ₹7.50 = ₹22.50.
Check: (10,000 × ₹15) + (20,000 × ₹22.50) = ₹1,50,000 + ₹4,50,000 = ₹6,00,000.

Answer: OAR is ₹7.50 per labour hour. Overhead is ₹15 per unit for A and ₹22.50 per unit for B.

Example 2

Using the Zeta Ltd data, the overhead of ₹6,00,000 is split into set-up costs of ₹3,00,000 and inspection costs of ₹3,00,000. A needs 50 set-ups and 100 inspections. B needs 100 set-ups and 200 inspections. Calculate the overhead per unit under ABC and compare with absorption costing.

Show the solution

Total set-ups = 50 + 100 = 150. Rate = ₹3,00,000 ÷ 150 = ₹2,000 per set-up.
Total inspections = 100 + 200 = 300. Rate = ₹3,00,000 ÷ 300 = ₹1,000 per inspection.
Overhead for A = (50 × ₹2,000) + (100 × ₹1,000) = ₹1,00,000 + ₹1,00,000 = ₹2,00,000.
Overhead for B = (100 × ₹2,000) + (200 × ₹1,000) = ₹2,00,000 + ₹2,00,000 = ₹4,00,000.
Check: ₹2,00,000 + ₹4,00,000 = ₹6,00,000.
Per unit: A = ₹2,00,000 ÷ 10,000 = ₹20. B = ₹4,00,000 ÷ 20,000 = ₹20.
Compare: absorption gave A ₹15 and B ₹22.50. ABC raises A by ₹5 and lowers B by ₹2.50.

Answer: ABC overhead is ₹20 per unit for both products. Absorption costing understated A's overhead by ₹5 and overstated B's by ₹2.50, so A may be underpriced and B overpriced if prices follow cost.

Exam tips

Show every driver rate and check that the allocated total equals the overhead pool. Markers reward visible workings.
Always add a short comment after calculations. State what the figures mean for pricing, mix or profitability.
When asked to evaluate ABC, give both advantages and disadvantages, then tie them to the scenario's business type.
For marginal versus absorption questions, state the inventory movement before explaining the profit difference.
Use scenario facts such as product complexity, rising overheads or competition to justify the method you recommend.

Practice questions from Cost and management accounting

Costing Techniques: Absorption, Marginal and ABC in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Costing Techniques: Absorption, Marginal and ABC: frequently asked questions

What is the difference between absorption costing and marginal costing?

Absorption costing includes fixed production overheads in unit cost, so they sit in inventory until goods are sold. Marginal costing charges fixed costs to the period and values inventory at variable cost only. Profits differ when inventory levels change.

How do I calculate the ABC cost per driver?

Divide the cost of each activity pool by the total volume of its cost driver. For example, ₹3,00,000 of set-up costs over 150 set-ups gives ₹2,000 per set-up. Then multiply by the driver units each product uses.

What are the advantages and disadvantages of ABC?

ABC gives more accurate product costs when overheads are large and products differ in complexity, and it highlights costly activities for control. It can be expensive to set up, depends on judgement in choosing pools and drivers, and some costs have no clear driver.

When should a business use marginal costing?

Use it for short-term decisions such as special orders, make-or-buy and limiting factor analysis, where fixed costs do not change. Use absorption or ABC for full-cost pricing and for long-run product profitability.