High-Low Method Definition, Formula, Calculate

The high-low method comprises the highest and the lowest level of activity and compares the total costs at each level. In cost accounting, the high-low method is a technique used to split mixed costs into fixed and variable costs. Although the high-low method is easy to apply, it is seldom used because it can distort costs, due to its reliance on two extreme values from a given data set. The fixed cost can be calculated once the variable cost per unit is determined. 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. 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.

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2. The high-low method only requires the high and low points of the data and can be worked through with a calculator.
3. The high-low method is a simple way in cost accounting to segregate costs with minimal information.
4. Help the company accountant calculate the expected factory overhead cost in March 2019 using the high-low method.
5. 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.

For complex scenarios, alternate methods should be considered such as scatter-graph method and least-squares regression method. It’s also possible to draw incorrect conclusions by assuming that accounts payable software just because two sets of data correlate with each other, one must cause changes in the other. Regression analysis is also best performed using a spreadsheet program or statistics program. Our goal is to deliver the most understandable and comprehensive explanations of financial topics using simple writing complemented by helpful graphics and animation videos.

Construct total cost equation based on high-low calculations above

It only requires the high and low points of the data and can be worked through with a simple calculator. Its drawback, however, is that not all data points are considered in the analysis. Other methods such as the scatter-graph method and linear regression address this flaw. High Low Method provides an easy way to split fixed and variable components of combined costs using the following formula. Because of the preceding issues, the high-low method does not yield overly precise results.

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Regression analysis helps forecast costs as well, by comparing the influence of one predictive variable upon another value or criteria. However, regression analysis is only as good as the set of data points used, and the results suffer when the data set is incomplete. ABC International produces 10,000 green widgets in June at a cost of $50,000, and 5,000 green widgets in July at a cost of $35,000. There was an incremental change between the two periods of $15,000 and 5,000 units, so the variable cost per unit during July must be $15,000 divided by 5,000 units, or $3 per unit.

Variable Cost per Unit

High-low method is a method of estimating a cost function that uses only the highest and values of the cost driver within the relevant range. In other words, it does not account for any influence of outliers which are the data that vary to a significant extent from the normal set of data. It also does not account for inflation, thus providing a very rough estimation. It is a very simple and easy way to divide the costs of the entity in a methodical manner, even if the information available is very less. Due to its unreliability, high low method should be carefully used, usually in cases where the data is simple and not too scattered.

The high-low method is used to calculate the variable and fixed costs of a product or entity with mixed costs. It considers the total dollars of the mixed costs at the highest volume of activity and the total dollars of the 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 number of units of activity. 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 total costs at each level.

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 be used in the high-low method, even though these cost amounts are not necessarily the highest and lowest costs for the year. Simply adding the fixed cost (Step 3) and variable cost (Step 4) gives us the total cost of factory overheads in April. 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. Although easy to understand, high low method may be unreliable because it ignores all the data except for the two extremes. It can be argued that activity-cost pairs (i.e. activity level and the corresponding total cost) which are not representative of the set of data should be excluded before using high-low method.

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The high-low method is relatively unreliable because it only takes two extreme activity levels into consideration. The high enterprise accounting services or low points used for the calculation may not be representative of the costs normally incurred at those volume levels due to outlier costs that are higher or lower than would normally be incurred. Fixed costs can be found be deducting the total variable cost for a given activity level (i.e. 6000 or 4000) from the total cost of that activity level.

First, you must calculate the variable-cost component and then the fixed-cost component, and then plug the results into the cost model formula. The company plans to produce 7,000 units in March 2019 on the back of buoyant market demand. Help the company accountant calculate the expected factory overhead cost in March 2019 using the high-low method.