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. 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. The fixed cost is determined by calculating the variable costs using the rate calculated above and the number of units, and deducting this from the total cost. This calculation can be done using either the high or low values, but both are shown below for comparison.
As with any metric, it comes with its downsides of not being entirely accurate. But anything that uses extreme examples should always be used to give you a rough idea and the results must be taken with a grain of salt. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation. Someone on our team will connect you with a financial professional in our network holding the correct designation and expertise. Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs. Our goal is to deliver the most understandable and comprehensive explanations of financial topics using simple writing complemented by helpful graphics and animation videos.
In other words, the variable long term notes payable cost rate was $0.10 per machine hour ($2,000/20,000 MHs). A cost that contains both fixed and variable costs is considered a mixed cost. The high-low method is a simple technique for determining the variable cost rate and the amount of fixed costs that are part of what’s referred to as a mixed cost or semivariable cost.
Great! The Financial Professional Will Get Back To You Soon.
In our previous dog groomer example we could clearly see through our scattergram that maintenance costs were related to the number of dogs groomed. Remember that that was our initial diagnostic step before we moved on to more detailed analysis of our costs. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content. The articles and research support materials available on this site are educational and are not intended to use account numbers in your chart of accounts in quickbooks online be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.
Step 4: Calculate the Total Variable Cost for the New Activity
Due to its unreliability, high low method should be carefully used, usually in cases where the data is simple and not too scattered. For complex scenarios, alternate methods should be considered such as scatter-graph method and least-squares regression method. The high-low method only requires the high and low points of the data and can be worked through with a calculator. For example, the table below depicts the activity for a cake bakery for each of the 12 months of a given year. As an example of how to calculate high low method, suppose a business had the following information relating to its costs.
Accounting Ratios
- The cost of electricity was $18,000 in the month when its highest activity was 120,000 machine hours (MHs).
- 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.
- 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.
- This team of experts helps Finance Strategists maintain the highest level of accuracy and professionalism possible.
- The high-low method is a simple technique for determining the variable cost rate and the amount of fixed costs that are part of what’s referred to as a mixed cost or semivariable cost.
Because it relies on two extreme values from only one data set, it can distort costs. Because of the preceding issues, the high-low method does not yield overly precise results. Thus, you should first attempt to discern the fixed and variable components of a cost from more reliable source documents, such as supplier invoices, before resorting to the high-low method.
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. 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. The high low method accounting formula states that the variable cost per unit is equal to the change in cost between the high and low cost values divided by the change in units between the same values.
How much are you saving for retirement each month?
This team of experts helps Finance Strategists maintain the highest level of accuracy and professionalism possible. 11 Financial is a registered investment adviser located in Lufkin, Texas. 11 Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. 11 Financial’s website is limited to the dissemination of general information pertaining to its advisory services, together with access to additional investment-related information, publications, and links. 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.
If we use the lowest level of activity, the total cost of $16,000 would include $10,000 of variable cost (100,000 MHs times $0.10) with the remainder of $6,000 being the fixed cost for the month. 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.
