Question

What is the high-low method and what purpose does it serve in cost determination? exaplain in 350 or more words

Answer 1

High low method is a method used in accounting which helps in dividing and determining variable and fixed costs of a product with mixed costs. Fixed cost is that part of costs which will be incurred irrespective of the level of production, it may even occur even if production is NIL, Variable costs is that cost which depends on level of production and varies as the number of units produced increase or decrease. In mixed costs, both are combined and many a times for accounting purpose it is important to know both variable and fixed costs separately. High low method helps us in achieving that.
High Low method involves taking the highest and the lowest level of activity and then comparing the results. Basically what we see is that irrespective of the level of activity, the fixed cost is going to remain constant , so therefore difference between total cost in the highest and lowest level of activity after we consider fixed cost will give us variable cost as it changes depending on the number of units in an activity.
An example will help us understand High low method of costing better.
Suppose you work in a manufacturing company. You have data for production of last 4 months and need to analyze cost for the upcoming 5th month. The activities and total costs of last 4 months are as follows:

Month	Activity	Total cost
January	4000	$24000
February	4500	$26000
March	5500	$30000
April	3000	$20000
May	6000 (Expected Production)	????

From the above table, we see that March had the highest level of activity, whereas April month had the lowest. High low method needs two things. Total level of activity (highest and lowest) and their total cost.
By using the given formula, we can get the variable cost per unit
=> (Highest activity's total cost - Lowest activity's total cost) / (Highest activity - Lowest activity)
=> ($30000 - $20000) / (5500 units - 3000 units)
=> $10000 / 2500 units
=> $4 per unit (Variable cost per unit)

Since we have the variable cost per unit, by applying it in any month, we will get the Fixed cost
Fixed cost in March = Total cost - (Total activity X Variable cost per unit)
=> $30000 - (5500 units X $4)
=> $30000 - $22000
=> $8000 (Fixed cost)
Once variable cost per unit is established, same fixed cost will be derived from each month's activity.
So, in this way, we can estimate May month's total cost if 6000 units are expected to be produced.
May's total cost = Fixed cost + (Expected levelof activity X Variable cost per unit)
=> $8000 + (6000 units X $4)
=> $8000 + $24000
=> $32000

Highlow method is very helpful in segregating costs even when we have only limited information. By it's help we can determine indivvidual costs that have already incurred and also make assumptions about future costs that may be needed to be incurred for a given level of activity.

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