CMA costing systems: job, process, ABC and absorption costing
Costing systems answer different questions. Job and process costing decide how costs accumulate; activity-based costing changes how overhead is assigned; absorption and variable costing differ in fixed manufacturing-overhead treatment. These are related choices, not one list of mutually exclusive systems.
- 1. Accumulate
Job or process
- 2. Assign overhead
Volume driver or ABC
- 3. Value inventory
Absorption or variable
| Decision | Methods | What changes |
|---|---|---|
| Where do costs accumulate? | Job order vs process costing | Distinct jobs versus a continuous flow of similar units. |
| How is overhead assigned? | Volume-based allocation vs activity-based costing (ABC) | One broad driver versus multiple activity pools and drivers. |
| What enters inventory? | Absorption vs variable costing | Fixed manufacturing overhead enters inventory under absorption costing. |
| How is performance evaluated? | Actual and standard cost comparisons | Compare actual results with an appropriate standard and activity base. |
Worked ABC example: volume is not always the driver
Assume overhead contains a $60,000 setup pool and a $40,000 inspection pool. Products A and B together use all activities. The arithmetic below is an original teaching example.
| Activity pool | Total activity | Rate | Product A usage | A allocation |
|---|---|---|---|---|
| Setups: $60,000 | 30 setups | $2,000 per setup | 20 setups | $40,000 |
| Inspections: $40,000 | 200 hours | $200 per hour | 50 hours | $10,000 |
| Total | - | - | - | $50,000 |
Original worked example
Product A makes 1,000 units. What overhead per unit does ABC assign?
$50,000 / 1,000 = $50 per unit.
Product B receives the remaining $50,000. A high setup requirement can consume substantial overhead even at low volume. This is an allocation model; whether it improves decisions depends on the relevance of the chosen pools and drivers.
Absorption versus variable costing: where fixed overhead goes
When production exceeds sales, absorption costing can defer some fixed manufacturing overhead in inventory. Variable costing expenses fixed manufacturing overhead in the period. That difference can affect reported operating income without changing cash.
Original worked example
Assume a $6 fixed manufacturing-overhead rate, no beginning inventory and 200 units produced but not sold. All other assumptions are equal and there are no overhead variances.
Absorption-costing income is $1,200 higher: 200 × $6 of fixed manufacturing overhead remains in ending inventory.
This simplified reconciliation depends on the stated assumptions. It does not mean producing unnecessary inventory creates economic value.
Choose a system for the information needed
A bespoke construction project is naturally tracked by job. A continuous homogeneous chemical process needs process-costing concepts. A firm with diverse setup and support requirements may investigate ABC even while using a job or process system.
| Common mistake | Correction |
|---|---|
| Treating ABC as the opposite of absorption costing | ABC concerns overhead assignment; absorption concerns inventory-cost inclusion. |
| Using units as the driver for every support activity | Choose a driver that reflects resource consumption. |
| Using allocated full cost for every short-term decision | Identify which costs change under the actual alternative. |
Job costing and process costing: choose the cost object first
In job costing, the cost object is a distinct engagement, batch or project. Trace direct materials and labor to that job and assign manufacturing overhead using the chosen basis. The job record should explain what the customer or project consumed, not merely divide total factory cost by all output.
In process costing, similar units move through a common production process. The challenge is to account for completed output and partially completed work. Material completion and conversion completion may differ, so a physical unit is not always a full unit of work for both categories.
Original worked example
A process has no beginning work in progress. It completes 900 units and retains 100 ending units. Materials are added at the start; ending units are 40% complete for conversion. What are the equivalent units?
Materials: 900 + 100 = 1,000 equivalent units. Conversion: 900 + 100 × 40% = 940 equivalent units.
The same 1,000 physical units require two completion measures. Dividing conversion cost by 1,000 would understate the cost per equivalent conversion unit. This example excludes spoilage and beginning inventory to isolate the completion logic.
Check the allocation before using it to judge a product
An allocation should reconcile: the total overhead assigned across products should equal the total allocated pool, allowing for any explicitly identified under- or overapplied overhead. Check units too. A rate per setup cannot be multiplied by machine hours.
Next check interpretation. ABC can change which product appears to consume support resources without changing the amount the business spends today. A product that receives more allocated overhead may still make a positive contribution. To decide whether to discontinue it, identify the costs that can actually be avoided and any alternative use of released capacity.
Finally, ask whether the system encourages the right behavior. An absorption-costing profit increase caused by extra unsold production can conceal inventory storage and obsolescence problems. Review operating measures alongside the accounting result instead of assuming that a higher reported margin means the process improved.
Common questions
- Can ABC be used with absorption costing?
- Yes. ABC assigns overhead through activity pools; absorption costing determines which manufacturing costs enter inventory. They answer different questions.
- Is a higher allocated cost always avoidable?
- No. An allocated share of common overhead may remain even if a product is dropped. Analyze the decision separately.
- Which part tests cost management?
- Cost Management is a 15% Part 1 domain. Related cost reasoning also supports Part 2 business decisions.
Sources and editorial notes
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