Question

After reading Appendix 5A and reviewing the online videos, you should have a good understanding of the various tools management accountants might use to create a cost formula for a mixed cost (both variable and fixed components). The three methods outlined in Appendix 5A are the scattergraph method, the high-low method, and the method of least squares (regression).

For this discussion, I'd like you to tell me which method you think is most practical for use in "the real world" for purposes of estimating and budgeting for future costs. Is there a method that might be more objective but might end up being less reliable? Why might this be? Alternatively, is there or should there be room for subjectivity in estimating future mixed costs?

Answer 1

The more practical method to use in business for segregation of fixed and variable cost in mixed cost is regression method.

The High-Low method is more objective but it ends up being less reliable. The reasons for its lower reliability are due to following disadvantages listed:

· It considers only two months for determining the variable cost and fixed costs and ignores the other month’s overheads. Hence overheads segregation can change if other months’ data are considered.

· It cannot be used when overheads are having non-linear relationship with activity levels.

· It is not a reliable method of overhead estimation like mathematical models used for segregation example: regression analysis used for estimating overheads.

· It does not give exact overheads and hence may affect the decision making like Product costing, product pricing, decision regarding continue or discontinue of products etc

· This method is no useful when overheads are driven by multiple activity levels since high low method considers only one activity level for segregation

There might be some room for subjectivity needed in estimating future mixed costs. The reason being future mixed costs involves estimation and some amount of subjectivity in inevitable.