The boy, wearing a cap, checked pants and a blue shirt, struggles with both arms to hold up the head in the picture reportedly posted on the Twitter account of a Sydney man who is now an Islamic State fighter.
The shocking photo, taken in the northern Syrian city of Raqqa, is believed to be that of Khaled Sharrouf’s son; posted with the words, “Thats my boy!”
Mr Abbott said the picture was further evidence of the barbarism of the Islamic State of Iraq and the Levant, known as ISIL or ISIS.
“I believe there are more photographs in newspapers in Australia today of the kind of hideous atrocities that this group is capable of,” he told ABC radio on Monday.
Defence Minister David Johnston said he was disgusted by the picture.
“I’m obviously revolted,” he told ABC radio.
Senator Johnston said it underscored the importance of the government’s proposed counter-terrorism laws.
However, he stressed it should not be taken out of context and condemned the picture as a “shocking misrepresentation” of Islam and Muslims.
“I’m very upset about this sort of thing completely colouring our view of Muslims,” Senator Johnston said.
“The vast majority of Muslims are peace-loving and peaceful people.”
The picture is one of several photos posted by Sharrouf, who security agencies believe travelled to Syria with his family. One shows Sharrouf also holding the decapitated head.
Another photo shows Sharrouf dressed in camouflage fatigues and posing with his three young sons who are holding guns, the flag of the Islamic State behind them.
They appear to be aged around four, six and seven, News Corps Australia reports.
Sharrouf, a convicted terrorist, is wanted by Australian Federal Police over crimes in Syria and Iraq, which include the shooting execution of a captured Iraqi official in the desert outside the Iraqi city of Mosul.