What Is the High-Low Method?

In cost accounting, the high-low method is a way of attempting to separate out fixed and variable costs given a limited amount of data. The high-low method involves taking the highest level of activity and the lowest level of activity and comparing the 澳洲幸运5开奖号码历史查询:total costs at each level.

If the variable cost is a fixed charge per unit and fixed costs reꦆmain the same, it is possible to determine the fixed and variable costs by solꦇving the system of equations. It is worth being cautious when using the high-low method, however, as it can yield more or less accurate results depending on the distribution of values between the highest and lowest dollar amounts or quantities.

Understanding the High-Low Method

Calculating the outcome for the high-low method ܫrequires a few formula steps. First, you must calculate the v༺ariable-cost component and then the fixed-cost component, and then plug the results into the cost model formula.

First, determine the variable-cost component:

$\begin{aligned} &\text{Variable Cost} = \frac { \text{HAC} - \text{Lowest Activity Cost} }{ \text{HAUs} - \text{Lowest Activity Units} } \\ &\textbf{where:} \\ &\text{HAC} = \text{Highest activity cost} \\ &\text{HAUs} = \text{Highest activity units} \\ &\text{Variable cost is per unit} \\ \end{aligned}$​Variable Cost=HAUs−Lowest Activity UnitsHAC−Lowest Activity Cost​where:HAC=Highest activity costHAUs=Highest activity unitsVariable cost is per unit​

Next, use t🐷he following formula to determine the fixed-cost component:

$\begin{aligned} &\text{Fixed Cost} = \text{HAC} - ( \text{Variable Cost} \times \text{HAUs} ) \\ \end{aligned}$​Fixed Cost=HAC−(Variable Cost×HAUs)​

Use the results of the first two formulas to calculate the high-low cost result us🅺ing the following formula:

$\begin{aligned} &\text{High-Low Cost} = \text{Fixed Cost} + ( \text{Variable Cost} \times \text{UA} ) \\ &\textbf{where:} \\ &\text{UA} = \text{Unit activity} \\ \end{aligned}$​High-Low Cost=Fixed Cost+(Variable Cost×UA)where:UA=Unit activity​

What the High-Low Method Tells You

The costs associated with a product, product line, equipment, store, geographic sales region, or subsidiary consist of both 澳洲幸运5开奖号码历史查询:variable costs and 澳洲幸运5开奖号码历史查询:fixed costs. To 🎀determine both c🍸ost components of the total cost, an analyst or accountant can use a technique known as the high-low method.

The high-low method is used to calculate the variable and fixed costs of a product or entity with mixed costs. It takes two factors into consideration. It considers the total dollars of the mixed costs at the highest volume of activity and the total dollars of the 澳洲幸运5开奖号码历史查询:mixed costs at the lowest volume of activity. The total amount of fixed costs is assumed to be the same at both points of activity. The change in the total costs is thus the variable cost rate times the change in the numberꦯ of units of activity.

Example of How to Use the High-Low Method

For example, the table below depicts the activity♎ for a cake bakery for each of the 12 months of a given year.

Below is an example of ꦗthe high-low method of cost accounting:

The highest activity for the bakery occurred in October, when it baked the highest number of cakes, while August had the lowest activity level, with only 70 cakes baked at a cost of $3,750. The cost amounts adjacent to these activity levels will b🤪e used in the high-low method, even though these cost amounts are not necessarily the highest and low♌est costs for the year.

We calculate the fixed and variable costsℱ using the follo♐wing steps:

1. Calculate variable cost per unit using identified high and l༒ow activity levels

 $\begin{aligned} &\text{Variable Cost} = \frac{ \text{TCHA} - \text{Total Cost of Low Activity} }{ \text{HAU} - \text{Lowest Activity Unit} } \\ &\text{Variable Cost} = \frac { \$5,550 - \$3,750 }{ 125 - 70 } \\ &\text{Variable Cost} = \frac { \$1,800 }{ 55 } = \$32.72 \text{ per Cake} \\ &\textbf{where:} \\ &\text{TCHA} = \text{Total cost of high activity} \\ &\text{HAU} = \text{Highest activity unit} \\ \end{aligned}$​Variable Cost=HAU−Lowest Activity UnitTCHA−Total Cost of Low Activity​Variable Cost=125−70$5,550−$3,750​Variable Cost=55$1,800​=$32.72 per Cakewhere:TCHA=Total cost of high activityHAU=Highest activity unit​

2. Solve for fixed costs

To calculate the total fixed costs, plug either the high or low costꦕ and the variable cost into the totꩲal cost formula:

 $\begin{aligned} &\text{Total Cost} = ( \text{VC} \times \text{Units Produced} ) + \text{Total Fixed Cost} \\ &\$5,550 = ( \$32.72 \times 125 ) + \text{Total Fixed Cost} \\ &\$5,550 = \$4,090 + \text{Total Fixed Cost} \\ &\text{Total Fixed Cost} = \$5,550 - \$4,090 = \$1,460 \\ &\textbf{where:} \\ &\text{VC} = \text{Variable cost per unit} \\ \end{aligned}$​Total Cost=(VC×Units Produced)+Total Fixed Cost$5,550=($32.72×125)+Total Fixed Cost$5,550=$4,090+Total Fixed CostTotal Fixed Cost=$5,550−$4,090=$1,460where:VC=Variable cost per unit​

3. Construct total co𓆏st equation based on high-low calculations above

Using all of the🗹 information above, the total cost ✨equation is as follows:

 $\begin{aligned} &\text{Total Cost} = \text{Total Fixed Cost} + ( \text{VC} \times \text{Units Produced} ) \\ &\text{Total Cost} = \$1,460 + ( \$32.72 \times 125 ) = \$5,550 \\ \end{aligned}$​Total Cost=Total Fixed Cost+(VC×Units Produced)Total Cost=$1,460+($32.72×125)=$5,550​

This can be used to calc♒ulate the total cost of various units for the bakery.

The Difference Between th🅷e High-Low Method and Regression Analysis

The high-low method is a simple anal🤪ysis that takes less calculation work. It only requires the high and low points of the data and can be worked through with a simple calculator. It also gives analysts a way to estimate future unit costs.

However, the formula does not take inflation into consideration and provides a very rough𒆙 estimation because it only considers the extreme high and low values, and excludes the influence of any outliers.

澳洲幸运5开奖号码历史查询:Regression analysis helps forecast costs as well, by comparing the influence of one predictive variable upon another value or criteria. It also considers outlying values that help refine the results. However, re💟gression analysis is only as good as the set of data points used, and 😼the results suffer when the data set is incomplete.

It’s also possible to draw incorrect conclusions by assuming that just because two sets of data 澳洲幸运5开奖号码历史查询:correlate with each other, one must cause changes in the other. Regression analysis is also best performed using a spreadsheet program or 澳洲幸运5开奖号码历史查询:statistics program.

Limitations of the High-Low Method

The high-low method is relatively unreliable because it only takes two extreme activity levels into consideration. The high or low points used for the calculation may not be representative of the costs normally i🐽ncurred at those volume levels due to outlier costs that are higher or lower than would normally be incurred. In this case, the high-low method will produce inaccurate results.

The high-low method is generally not preferred, as it can yield an incorrect understanding of the data if there are changes in variable- or fixed-cost rates over time or if a tiered pricing system is employed. In most real-world cases, it should be possible to obtain more information so the variable and fixed costs can be determined directly. Thus, the high-low method should only be used when it is not possible to obtain actual billing data.

The Bottom Line

The high-low method is a simple way in💟 cost accounting to segregate costs with minimal information. The high-low method involves comparing total costs at the highest level of activity and the lowest level of activity, after each level is determined.