High-Low Method

High-Low method is one of the several techniques used to split a mixed cost into its fixed and variable components (see cost classifications). Although easy to understand, high low method is relatively unreliable. This is because it only takes two extreme activity levels (i.e. labor hours, machine hours, etc.) from a set of actual data of various activity levels and their corresponding total cost figures. These figures are then used to calculate the approximate variable cost per unit (b) and total fixed cost (a) to obtain a cost volume formula:

 y = a + bx

High-Low Method Formulas

Variable Cost per Unit

Variable cost per unit (b) is calculated using the following formula:

 Variable Cost per Unit = y2 − y1 x2 − x1

Where,
y2 is the total cost at highest level of activity;
y1 is the total cost at lowest level of activity;
x2 are the number of units/labor hours etc. at highest level of activity; and
x1 are the number of units/labor hours etc. at lowest level of activity

The variable cost per unit is equal to the slope of the cost volume line (i.e. change in total cost ÷ change in number of units produced).

Total Fixed Cost

Total fixed cost (a) is calculated by subtracting total variable cost from total cost, thus:

 Total Fixed Cost = y2 − bx2 = y1 − bx1

Example

Company α wants to determine the cost-volume relation between its factory overhead cost and number of units produced. Use the high-low method to split its factory overhead (FOH) costs into fixed and variable components and create a cost volume formula. The volume and the corresponding total cost information of the factory for past eight months are given below:

MonthUnitsFOH
11,520$36,375 21,25038,000 31,75041,750 41,60042,360 52,35055,080 62,10048,100 73,00059,000 82,75056,800 Solution: We have, at highest activity: x2 = 3,000; y2 =$59,000
at lowest activity: x1 = 1,250; y1 = $38,000 Variable Cost per Unit = ($59,000 − $38,000) ÷ (3,000 − 1,250) =$12 per unit
Total Fixed Cost = $59,000 − ($12 × 3,000) = $38,000 − ($12 × 1,250) = $23,000 Cost Volume Formula: y =$23,000 + 12x

Due to its unreliability, high low method is rarely used. The other techniques of variable and fixed cost estimation are scatter-graph method and least-squares regression method.

Written by Irfanullah Jan