High-Low Method: Learn How to Estimate Fixed & Variable Costs

The high-low method is generally not preferred, as it can yield an incorrect understanding of the data if there are changes in variable- or fixed-cost rates over time or if a tiered pricing system is employed. 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. The highest activity for the bakery occurred in October, when it baked the highest number of cakes, while August had the lowest activity level, with only 70 cakes baked at a cost of $3,750. The cost amounts adjacent to these activity levels will be used in the high-low method, even though these cost amounts are not necessarily the highest and lowest costs for the year.

It is a very simple and easy way to divide the costs of the entity in a methodical manner, financial risk analytics even if the information available is very less. 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. Let’s say that you are running a business producing high end technology products.

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Help the company accountant calculate the expected factory overhead cost in March 2019 using the high-low method. Such a cost function may be used in budgeting to estimate the total cost at any given level of activity, assuming that past performance can reasonably be projected into future. This technique provides a simple and straightforward way to split fixed and variable components of combined costs. When analyzing costs as to behavior, costs are classified into fixed and variable costs. Before costs can be effectively used in analysis, they should be segregated into purely fixed and purely variable costs. Regression analysis helps forecast costs as well, by comparing the influence of one predictive variable upon another value or criteria.

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The high-low method is used to calculate the variable and fixed costs of a product or entity with mixed costs. It considers the total dollars of the mixed costs at the highest volume of activity and the total dollars of the mixed costs at the lowest volume of activity. The total amount of fixed costs is assumed to be the same at both points of activity. The change in the total costs is thus the variable cost rate times the change in the number of units of activity. In cost accounting, the high-low method is a technique used to split mixed costs into fixed and variable costs.

1. It is a nominal difference, and choosing either fixed cost for our cost model will suffice.
2. 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.
3. If the same truck is driven for only 35,000 miles in a month, its averageoperating cost increases to 53.6 cents per mile.
4. The high-low method is a straightforward, if not slightly lengthy, way to figure out your total costs.
5. The change in the total costs is thus the variable cost rate times the change in the number of units of activity.

You need to know what the expected amount of overheads that your production line will incur in the next month. The Western Company presents the production and cost data for the first six months of the 2015. The calculation follows simple process and step, which is better than the other complex methods like least-square regression. Therefore, the overhead cost is expected to be $65,000 for March 2019. 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.

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We may earn a commission when you click on a link or make a purchase through the links on our site. All of our content is based on objective analysis, and the opinions are our own. As with any metric, it comes with its downsides of not being entirely accurate. But anything that uses classified balance sheet template extreme examples should always be used to give you a rough idea and the results must be taken with a grain of salt.

However, regression analysis is only as good as the set of data points used, and the results suffer when the data set is incomplete. Calculating the outcome for the high-low method requires a few formula steps. First, you must calculate the variable-cost component and then the fixed-cost component, and then plug the results into the cost model formula.

Using either the high or low activity cost should yield approximately the same fixed cost value. Note that our fixed cost differs by $6.35 depending on whether we use the high or low activity cost. It is a nominal difference, and choosing either fixed cost for our cost model will suffice. The high-low method is a straightforward, if not slightly lengthy, way to figure out your total costs. The high-low method can be done graphically by plotting and connecting the lowest point of activity and the highest point of activity. The y-intercept (value of y when x is zero) would be equal to the fixed cost.

Moreover, these highest and lowest points often do not represent the usual activity levels of a business entity. The high-low point formula may, therefore, misrepresent the firm’s true cost behavior when it operates at normal activity level. The high-low method is an easy way to segregate fixed and variable costs. By only requiring two data values and some algebra, cost accountants can quickly and easily determine information about cost behavior. Also, the high-low method does not use or require any complex tools or programs.

High-low point method is a technique used to divide a mixed cost into its variable and fixed components. Given the variable cost per number of guests, we can now determine our fixed costs. While the high-low method is an easy one to use, it also has its disadvantages. Because it relies on two extreme values from only one data set, it can distort costs.

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Another drawback of the high-low method is the ready availability of better cost estimation tools. For example, the least-squares regression is a method that takes into consideration all data points and creates an optimized cost estimate. It can be easily and quickly used to yield significantly better estimates than the high-low method. He anticipates that the number of guests in September will be 3,000. Given the dataset below, develop a cost model and predict the costs that will be incurred in September. This can be used to calculate the total cost of various units for the bakery.

The high-low method is a simple analysis that takes less calculation work. It only requires the high and low points of the data and can be worked through with a simple calculator. Its drawback, however, is that not all data points are considered in the analysis. Other methods such as the scatter-graph method and linear regression address this flaw. Nevertheless, it has limitations, such as the high-low method assumes a linear relationship between cost and activity, which may be an oversimplification of cost behavior. Further, the process may be easy to understand, but the high-low method is not considered reliable because it ignores all the data except the two extreme ones.

As compared to scatter graph and least squares regression method, working with high-low point method is simple and easy. However, this method has some serious limitations which the managers must be fully aware of before using it to separate variable and fixed portions of a mixed cost. From all the above examples, we get a lot of clarity regarding the concept and how to calculate the same from data that we get in the financial statements. It is possible for the analysts and accountants to use this method effectively for determining both the fixed and variable cost component. The formula for high low method is quite simple and easy to understand.