Question

1.Nutt Industries electricity costs and machine hours over a six-month period follow:

	Machine	Electricity
	Hours	Cost
January	2000	$4,800
February	2500	5,200
March	3000	5,400
April	2400	5,000
May	2800	5,600
June	2200	5,000

Required:

a. Using the high-low method, what is the estimated electricity cost per machine hour?

b. Differentiate high-low method from other methods of inventory valuation.

Answer 1

Solution:

A) Computation of electricity cost per machine hour using high low point method

Particulars	Machine hours	Electricity cost
Highest activity level	3000 machine hours	$ 5,400
Lowest activity level	2000 machine hours	$ 4,800
Difference	1000 machine hours	$ 600

Variable electricity cost per machine hour = Difference in costs / Difference in machine hours

                                                                                   =   $ 600 / 1000 machine hours

                                                                                   =   $ 0.60 per machine hour

At 3000 machine hours

Particulars	Amount in $
Electricity cost	$ 5,400
Less : Variable electricity cost	($ 1,800) (3000 machine hours * $ 0.60)
Fixed electricity costs	$ 3,600

B) Differences that shall arise between high low method and other methods of inventory are enumerated below

· Its easy to calculate the fixed and variable costs in high low method and do not require much of complex nature for calculation where as in other methods it quite cumbersome to calculate.

· The accuracy can be provided only when the activity and cost are perfectly linear otherwise the above method fails to do so.

· High low method ignores inflation where as other methods consider the same in inventory valuation.

· High low method is oversimplified cost behavior whereas other methods do not follow the same and quite different .