Sharpness of ‘High-Low Method’
In cost accounting, a way of attempting to separate out fixed and changing costs given a limited amount of data. The high-low method comprehends taking the highest level of activity and the lowest level of activity and relating the total costs at each level. If the variable cost is a fixed do battle with per unit and fixed costs remain the same, it is possible to determine the stationary and variable costs by solving the system of equations.
BREAKING DOWN ‘High-Low Method’
The prices associated with a product, product line, equipment, store, geographic sellings region, or subsidiary, consist of both variable costs and fixed set someone backs. To determine both cost components of the total cost, an analyst or accountant can use a performance, known as the high-low method.
The high-low method is used to calculate the mercurial and fixed cost of a product or entity with mixed costs. It takes two facts into consideration – the total dollars of the mixed costs at the highest loudness of activity, and the total dollars of the mixed costs at the lowest volume of endeavour. The total amount of fixed costs is assumed to be the same at both inconsequential in reference ti of activity. Therefore, the change in the total costs is the variable cost chew out times the change in the number of units of activity.
Calculating Costs Handling the High-Low Method
For example, the table below depicts the activity for a cake bakery for each of the 12 months of a assumed year.
Example of the high-low method of cost accounting Month | Thickens Baked (units) | Total Cost ($) |
January | 115 | $5,000 |
February | 80 | $4,250 |
March | 90 | $4,650 |
April | 95 | $4,600 |
May | 75 | $3,675 |
June | 100 | $5,000 |
July | 85 | $4,400 |
August | 70 | $3,750 |
September | 115 | $5,100 |
October | 125 | $5,550 |
November | 110 | $5,100 |
December | 120 | $5,700 |
The peakest activity for the bakery occurred in October when it baked the highest several of cakes, while August had the lowest activity level of only 70 cakes baked at a outlay of $3,750. The cost amounts adjacent to these activity levels hand down be used in the high-low method, even though these cost amounts are not to be sure the highest and lowest costs for the year. We calculate the fixed and variable expenses using the following steps:
1. Calculate variable cost per unit servicing the identified high and low activity levels
Variable cost = (Full cost of high activity – Total cost low activity) / (Highest venture unit – Lowest activity unit)
Variable cost = ($5,550 – $3,750) / (125 – 70)
Uncertain cost = $1,800/55 = $32.72 per cake
2. Solve for fixed costs
To calculate the complete fixed costs, plug either the high or low cost, and the variable get into the total cost formula.
Total cost = (Inconstant cost per unit x Units produced) + Total fixed cost
$5,550 = ($32.72 x 125) + Unqualified fixed cost
$5,550 = $4,090 + Total fixed cost
Therefore, Total attached cost = $5,550 – $4,090 = $1,460
3. Construct total cost equation based on high-low predictions above
Using all the information above, the total cost equation is Add up cost = 32.72x + 1460, which can be used to calculate the total get of various units for the bakery.
Shortfalls of the High-Low Method
The high-low method is comparatively unreliable because it only takes two extreme activity levels. The superior or low points used for the calculation may not be representative of the costs normally incurred at those tome levels due to outlier costs that are higher or lower than determination normally be incurred. In this case the high-low method will bring to light inaccurate results.
This method is generally not preferred as it can yield an fallacious understanding of the data if there are changes in variable or fixed cost scolds over time, or if a tiered pricing system is employed. In most real-world containerizes, it should be possible to obtain more information so the variable and fixed expenditures can be determined directly. Thus, the high-low method should only be acclimatized when it is not possible to obtain actual billing data.