We can calculate the variable cost and fixed cost components by using the High-Low method. The first step is to determine the highest and lowest levels of activities and the units produced against each of these levels. The computations above show that the actual total costs and computed total costs using the equation don’t match. This scenario best shows that there will be instances where the cost equation won’t hold true. Therefore, even though we have zero client support calls, we still incur $1,500 client support costs because these are fixed costs.
The high low method determines the fixed and variable components of a cost. It can be applied in discerning the fixed and variable elements of the cost of a product, machine, store, geographic sales region, product line, etc. The third step is to find the fixed cost using the following formula. This can be used to calculate the total cost of various units for the bakery. Let’s say you are a hotel manager and are concerned about the cost of which the hotel is incurring, and you want to derive a model to predict future cost based on historical cost. You have collected data for the last 10 months and want to see the cost for the next 2 months.
High-Low Method Formula
For instance, if the number of client calls in December reaches 1,000 calls, such is considered an outlier since it’s too far from the other observations. The high-low method is relatively unreliable because it only takes two extreme activity levels into consideration. For the last 12 months, you have noted the monthly cost and the number of burgers sold in the corresponding month. Now you want to use a high-low method to segregate fixed and variable costs. The high-low accounting method estimates these costs for different production levels, mainly if you have limited data to inform your decisions.
Both of these costs have an impact on overall profitability and knowing each will help you make better decisions. Therefore, total fixed costs for client support calls is $1,500 per month. In the side-by-side computation above, we’ve proven our point that regardless of which reference point we use, we still arrive at $1,500.
Suppose a company Green Star provides the following production scenario for the 06 months of the production period. Highest activity level is 21,000 hours in Q4.Lowest activity level is 15,000 hours in Q1. If the data is inaccurate, either method will produce inaccurate results. Good bookkeeping is still essential flexible budget formula to ensure high-quality data for analysis. To learn more about bookkeeping, our guide on small business bookkeeping will teach you how to perform small business bookkeeping and how to organize accounting data appropriately. To substitute the rest except a, we pick either the high or low point as reference.
As the company can use it to predict the portion of fixed costs with fluctuating activity levels. The high-low method in accounting is the simplest and easiest way to separate mixed costs into their fixed and variable components. By using this method, we observe only the highest and lowest points in the data set with the assumption that all the data have a linear relationship. The high-low method is used to calculate the variable and fixed cost of a product or entity with mixed costs.
