Question

Please describe the high-low method and explain how it is used to break off into the variable and fixed portions

Answer 1

High-low method is used to isolate fixed cost and variable cost of a product or organization with a given data series of mixed cost. This method based on the fact that fixed cost is constant over the entire periods. High-low method observes the highest and lowest cost of the series and assuming fixed cost to be equal in both cases, segregates the variable cost with given activity levels as per the below equation:

Variable cost = (Total cost of high activity – Total cost low activity) / (Highest activity unit – Lowest activity unit)

After computing variable cost, fixed cost can be easily calculated by putting it in any level of total cost as:

Total cost = (Variable cost per unit x Units produced) + Total fixed cost

Variable cost per unit = (Total cost - Total fixed cost)/ Units produced

Example:

Suppose total monthly costs and activity levels are given as:

Month	Expenses	No. of units
January	$                 13,000	500
February	$                 11,000	300
March	$                 14,500	650
April	$                 13,200	520
May	$                 14,100	610
June	$                 12,800	480
July	$                 15,000	700
August	$                 13,300	530
September	$                 14,400	640
October	$                 13,500	550
November	$                 12,600	460
December	$                 13,100	510
January	$                 14,000	600
February	$                 12,900	490

Fixed and variable cost can be segregate as follows:

Variable cost = (Total cost of high activity – Total cost low activity) / (Highest activity unit – Lowest activity unit)

                        = ($ 15,000 - $ 11,000)/ (700-300) = $ 4,000/400 = $ 10

Putting this variable cost in highest activity level, we get fixed cost as:

Total cost = (Variable cost per unit x Units produced) + Total fixed cost

$ 15,000 = ($ 10 x 700) + Total fixed cost

Total fixed cost = $ 15,000 - $ 7,000 = $ 8,000