To properly budget or manage your business activities, you must know the fixed and variable costs required for its operation. In cost accounting, the high-low method is a technique used to split mixed costs into fixed and variable costs. Although the what is the difference between the current ratio and working capital high-low method is easy to apply, it is seldom used because it can distort costs, due to its reliance on two extreme values from a given data set. The business has fixed and variable costs but wants an easy way to do cost planning for future budgets.

• But this is only if the variable cost is a fixed charge per unit of product and the fixed costs remain the same.
• As a result, Regent finds that its maintenance costs vary from month to month with the number of flight hours, as depicted in Figure 2.29.
• Three estimation techniques that can be used include the scatter graph, the high-low method, and regression analysis.
• This is the case for the managers at the Beach Inn, a small hotel on the coast of South Carolina.
• When using this approach, Eagle Electronics must be certain that it is only predicting costs for its relevant range.

In cost accounting, the high-low method is a way of attempting to separate out fixed and variable costs given a limited amount of data. The high-low method involves taking the highest level of activity and the lowest level of activity and comparing the total costs at each level. The biggest advantage of the High-Low method is that uses a simple mathematical equation to find out the variable cost per unit. Once a company calculates the variable cost, it can then assign the fixed cost for any activity level during that period. The same variable cost per unit can also provide a forecast analysis. As the company can use it to predict the portion of fixed costs with fluctuating activity levels.

Step 1: Find Out the Highest and Lowest Activity Level

Using a scatter graph to determine if this linear relationship exists is an essential first step in cost behavior analysis. If the scatter graph reveals a linear cost behavior, then managers can proceed with a more sophisticated analyses to separate mixed costs into their fixed and variable components. However, if this linear relationship is not present, then other methods of analysis are not appropriate. Let’s examine the cost data from Regent Airline using the high-low method.

• In contrast to the High Low Method, Regression analysis refers to a technique for estimating the relationship between variables.
• In that case, the high-low method calculator applies the high-low method formula to evaluate the total costs at any given amount of production.
• Also, the high-low method does not use or require any complex tools or programs.
• What if, instead, the cost of snow removal for the runways is plotted against flight hours?

What this means is that if we have a cost of 1,000 at a unit volume of 200 and a cost of 980 at 210 units, our High data point should be at 210 units, even if the value at 200 exceeds that. So the highest activity happened in the month of Jun, and the lowest was in the month of March. So the highest activity happened in the month of April, and the lowest was in the month of October. Highest activity level is 21,000 hours in Q4.Lowest activity level is 15,000 hours in Q1. The high-low method involves three main steps to calculate the cost for any level of production.

How to use the high-low method? – High-low method formula

Because it uses only two data values in its calculation, variations in costs are not captured in the estimate. The first step in analyzing mixed costs with the high-low method is to identify the periods with the highest and lowest levels of activity. In this case, it would be February and May, as shown in Figure 2.33. We always choose the highest and lowest activity and the costs that correspond with those levels of activity, even if they are not the highest and lowest costs.

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To separate the fixed cost element from the variable cost element the high low method can be used. Always select the period with the highest activity level and the period with the lowest activity level. Regression analysis helps forecast costs as well, by comparing the influence of one predictive variable upon another value or criteria. However, regression analysis is only as good as the set of data points used, and the results suffer when the data set is incomplete.

How to Use the High Low Method to Estimate Fixed and Variable Costs?

As a result, Regent finds that its maintenance costs vary from month to month with the number of flight hours, as depicted in Figure 2.29. One of the assumptions that managers must make in order to use the cost equation is that the relationship between activity and costs is linear. A diagnostic tool that is used to verify this assumption is a scatter graph.

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. It involves taking the highest level of activity and the lowest level of activity and comparing the total costs at each level.

That also means that the variable cost of 750 oil changes is $1,725. Using this equation, the Beach Inn can now predict its total costs (Y) for the month of July, when they anticipate an occupancy of 93 nights. J&L wants to predict their total costs if they complete 25 corporate tax returns in the month of February. Once you have the variable cost per unit, you can calculate the fixed cost. Hi-low is linked to the idea of cost behaviour and is one method for splitting semi-variable costs into their fixed and variable elements. (-) The High-Low method does not consider costs that don’t change proportionally with unit volume changes, but rather at discrete points, also known as Step Costs.

The negative amount of fixed costs is not realistic and leads me to believe that either the total costs at either the high point or at the low point are not representative. This brings to light the importance of plotting or graphing all of the points of activity and their related costs before using the high-low method. You may decide to use the second highest level of activity, if the related costs are more representative.

Fixed costs are expenses that remain the same irrespective of the quantity or number of units of goods produced for sale or services rendered. They include rent, the interest rate on loans, insurance charges, etc. There are a number of ways to calculate the cost formula for a mixed cost. This method is not the most precise method but it is the easiest to calculate. Let’s take a more in-depth look at the cost equation by examining the costs incurred by Eagle Electronics in the manufacture of home security systems, as shown in Table 2.9.