Introduction to the High-Low Method

The high-low method is a valuable cost accounting technique that aids in estimating fixed and variable costs for business operations. This method is particularly useful when data is limited, providing a quick and accessible way to manage budgets and analyze production costs.

Components of Costs

Fixed costs remain constant regardless of production levels, encompassing expenses like rent, loan interest, and insurance. Variable costs, on the other hand, fluctuate based on production quantities and include expenses like labor and shipping costs.

Total Cost Calculation

Total cost is the sum of fixed and variable costs. The high-low method formula involves three key steps:

1. Variable Cost per Unit Calculation:
• Formula: (Highest activity cost – Lowest activity cost) / (Highest activity units – Lowest activity units)
2. Fixed Cost Determination:
• Formula 1: Fixed cost = Highest activity cost − (Variable cost per unit * Highest activity units)
• Formula 2: Fixed cost = Lowest activity cost − (Variable cost per unit * Lowest activity units)
3. Total Cost Using Cost-Volume Model:
• Formula: Total cost = Fixed cost + (Variable cost * number of units)

High-Low Method Calculator – Practical Example

Let’s consider a scenario for an events management company preparing a payroll budget based on past-year costs:

1. Identify the highest and lowest activity values (work hours).
2. Adjust costs for a 5% pay raise for the new quarter.
3. Calculate variable cost per unit.
4. Evaluate fixed cost using the high-low method.
5. Determine total variable cost for the new quarter.
6. Calculate the total cost (payroll budget).

• Quick and easy method for cost modeling.
• No need for sophisticated tools.
• Accessibility with limited data.

• Oversimplifies the relationship between costs and production activity.
• Relies on extreme values, neglecting other influencing factors.
• Ignores the impact of inflation on costs in the long term.

FAQs

1. Major Disadvantage of the High-Low Method:
• Oversimplification of the cost-production relationship.
2. Calculating Fixed Cost with the High-Low Method:
• Multiply variable cost per unit by the highest activity unit and subtract from the highest activity cost.
3. Alternative Methods for Cost Estimation:
• Scatter plot method, accounting, and regression analysis.
4. Example Calculation:
• Highest cost: $1000 at 100 units, Lowest cost:$700 at 50 units.
• Variable cost per unit: $6, Total fixed cost:$400.

Conclusion

While the high-low method provides a quick estimation tool, it’s crucial to recognize its limitations. Alternative methods may offer more nuanced insights into cost behaviors. Use the high-low method calculator for swift results in your cost estimation endeavors.

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