The High Low Method: How to Split Variable and Fixed Costs

Additionally, as already mentioned, the high-low method can even be used with a limited set of data. There are also other cost estimation tools that can provide more accurate results. The least-squares regression method takes into consideration all data points and creates an optimized cost estimate. It can be easily and quickly used to yield significantly better estimates than the high-low method. Let’s take a more in-depth look at the cost equation by examining the costs incurred by Eagle Electronics in the manufacture of home security systems, as shown in Table 2.9. After a certain level of production, a firm requires more fixed investments, which cannot be covered by this method; therefore, this method should be used with extreme caution.

It is a simple technique that can be used even with a limited set of data. As you might expect, the cost of sales or manufacturing typically goes up the higher the level of activity is. While it is easy to apply, it can distort costs and yield more or less accurate results because of its reliance on two extreme free electronic filing values from one data set. Understanding the various labels used for costs is the first step toward using costs to evaluate business decisions. You will learn more about these various labels and how they are applied in decision-making processes as you continue your study of managerial accounting in this course.

The High-Low Method Formula

Once each of the independent variables has been determined, they can be used to predict the amount of effect that the independent variables have on the dependent variable. The effect is represented on a straight line to approximate each of the data points. No, there are other methods apart from the high-low method accounting formula. Some popular methods are the scatter plot method, accounting, and regression analysis.

• The high-low method is used to calculate the variable and fixed cost of a product or entity with mixed costs.
• But the high-low cost method provides a simple approach to achieve it.
• Finally, a trend line is added to the chart in order to assist managers in seeing if there is a positive, negative, or zero relationship between the activity level and cost.
• Even if you own the building that houses your operations, you’d still incur costs in the form of depreciation.

Maintenance costs are plotted on the vertical axis (Y), while flight hours are plotted on the horizontal axis (X). For instance, one point will represent 21,000 hours and $84,000 in costs. The next point on the graph will represent 23,000 hours and $90,000 in costs, and so forth, until all of the pairs of data have been plotted. Finally, a trend line is added to the chart in order to assist managers in seeing if there is a positive, negative, or zero relationship between the activity level and cost. The variable cost per unit is equal to the slope of the cost volume line (i.e. change in total cost ÷ change in number of units produced). It is important to remember here that it is the highest and lowest activity levels that need to be identified first rather than the highest/lowest cost.

High Low Method Formula

Management accounting refers to identifying, analyzing, and communicating financial information to a firm’s managers to achieve the company’s future goals. Whether it’s to figure out the profitability of a product, or getting an overview of the overall financial health of your business. There are a number of accounting techniques used throughout the business world. A company needs to know the expected amount of factory overheads cost it will incur in the following month.

Step 1: Find Out the Highest and Lowest Activity Level

This technique provides a simple and straightforward way to split fixed and variable components of combined costs. Such a cost function may be used in budgeting to estimate the total cost at any given level of activity, assuming that past performance can reasonably be projected into future. Simply adding the fixed cost (Step 3) and variable cost (Step 4) gives us the total cost of factory overheads in April. In contrast to the High Low Method, Regression analysis refers to a technique for estimating the relationship between variables.

Step 5: Calculate the Total Cost

Highest activity level is 21,000 hours in Q4.Lowest activity level is 15,000 hours in Q1. So the highest activity happened in the month of Jun, and the lowest was in the month of March. So the highest activity happened in the month of April, and the lowest was in the month of October. This can be used to calculate the total cost of various units for the bakery. The high-low method involves three main steps to calculate the cost for any level of production. Let’s compute for the donut shop’s variable and fixed using the high-low method.

The high-low method involves taking the highest level of activity and the lowest level of activity and comparing the total costs at each level. The High-Low method of costing provides a useful cost splitting method. The method is a simple mathematical equation that splits the semi-variable costs into variable and fixed costs. The analysis can also provide useful forecasts for future activity level cost analysis. However, the reliability of the variable costs with two extreme activity levels poses questions over the effectiveness of the method.

The activity is considered the independent variable since it is the cause of the variation in costs. Regent’s scatter graph shows a positive relationship between flight hours and maintenance costs because, as flight hours increase, maintenance costs also increase. This is referred to as a positive linear relationship or a linear cost behavior.

You may decide to use the second highest level of activity, if the related costs are more representative. Once variable cost per unit is found, you can calculate the fixed cost by subtracting the total variable cost at a specific activity level from the total cost at that activity level. If the variable cost is a fixed charge per unit and fixed costs remain the same, it is possible to determine the fixed and variable costs by solving the system of equations. In many cases, the variable costs identified under the high-low method can be different from other cost methods. The direct costing methods of calculating the variable cost per unit provide accurate figures that consider costs related to the production.

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This can be remedied by redoing the computation if there are any changes within the costs. The high-low method also does not take into account any changes within the costs (e.g. increase in the price of raw materials, rent, etc.). The thing is, Allen became too involved with his other businesses that he wasn’t able to monitor the costs of his donut shop. It’d be bad if you were planning to manufacture a certain amount of products, yet couldn’t fully understand the costs that come with it. However, to identify these costs, we need to observe the cost behaviors strongly. It can be calculated by subtracting the present realizable salvage value from the book value.

Since the fixed costs are the total costs minus the variable costs, the fixed costs will be calculated to a negative $400. The biggest advantage of the High-Low method is that uses a simple mathematical equation to find out the variable cost per unit. Once a company calculates the variable cost, it can then assign the fixed cost for any activity level during that period. As the company can use it to predict the portion of fixed costs with fluctuating activity levels.