High Low Method With Examples

 

This is a cost function relevant to cost accounting. The high low method is applied when there is the need to split total costs into its fixed and variable components. The high low method is straightforward to apply, all you have to do is to factor in the extreme level of activities (the highest and lowest) and the corresponding total costs at each level.

In an examination question, instances, where the high low method may appear to be technical, is when inflation is factored to be in the costs.

In such situations:

All you have to do is eliminate the effect of inflation from the cost before applying the high low method. And while the high low method is quite easy to apply, you may get inaccurate results due to the extreme values of a data set.

 

What Is The Formula For High Low Method?

The high low method formula is given below;

First off, you have to calculate the variable cost per unit using this equation: 

Variable cost/unit = HAC – LAC

                                    HAUs – LAUs

Where HAC is Highest Activity Cost and LAC is Lowest Activity Cost,

HAUs is the Highest Activity Units and LAUs is the Lowest Activity Units.

 

Next is to plug the variable cost per unit into the fixed cost function to determine the fixed cost. Either of these formulas can be applied:

Fixed cost = LAC – (Variable cost per unit x LAUs)

OR Fixed Cost = HAC − (Variable Cost per unit × HAUs)

 

The final step is to calculate High Low Cost using:

Fixed cost + (Variable cost x Unit activity)

 

Now that you understand the procedure for using the high low method, let’s cover an illustration to further strengthen your understanding.

 

Worked Example On High Low Method

A food retail company in Abuja asks you, an intern in the company to estimate the future cost of producing Pasta and Turkey in November 20xx. The information provided is the estimated number of customers and the total cost. 1500 customers are expected to patronize the food outlet in November. Find below the information on the total cost and number of customers:

 

Month  Number of customers Total cost (Naira)
January 1000 80,000
February 1050 80,000
March 1100 70,000
April 1150 50,000
May 1200 120,000
June 1250 130,000
July 1300 145,000
August 1400 132,000
September  1100 122,000
October  1900 145,000
November  1500 xx

Using the formula earlier stated:

Step 1: Variable cost/unit = HAC – LAC

                                                    HAUs – LAUs

 

= 145,000 – 80,000 = 65,000

         1900 – 1000           900

=N 72.2/unit.

 

Step 2: Using either of Highest or Lowest Activity Costs.

Fixed Cost = HAC −(Variable Cost per unit × HAUs)

= 145,000 – (72.2 X 1900)

=N 7,820

OR

Fixed cost = LAC – (Variable cost per unit x LAUs)

= 80,000 – (72.2 x 1000)

= N7,800

 

Note:

The difference of 20 Naira between the Fixed Cost derived using both the Highest and Lowest Activity Cost is a nominal difference due to approximation. Using either of the two figures is correct.

The basis for choosing the highest or lowest cost should be based on the level of activity. The lowest activity level should determine the lowest cost ditto for the highest cost.

 

Step 3: High Low Cost = Fixed cost + (Variable cost x Unit activity)

= 7,800 + (72.2 x 1500) = 116,000.

The estimated total cost for feeding 1500 customers in November will be 116,000 Naira.

 

Advantages Of High Low Method.

  1. It is easy to calculate.
  2. It is equally to understand.
  3. It helps the management in budgeting.
  4. It is a useful model for estimating costs where there is limited information available.
  5. It does not entail complex computations.

What Are The Limitations?

  1. It does not take into consideration the effect of inflation. Assuming costs are constant is not possible in real life.
  2. Because of the minimal amount of data available, it may not give accurate results as it relies on the highest and lowest data set for computation.
  3. The regression analysis model is perceived to be better than the high low method.

 

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