Method 2: High-low Method
The
high-low method
fixes much of the uncertainty in the scatter diagram
approach by only using two data points – the high and low cost data points –
and the associated production quantity measurements on the vertical axis -
and drawing the “best fit” line through those 2 points. At the point where
the line crosses the Total Cost (or vertical) axis, an estimate of the fixed cost

is given. The benefit of this method is that there is no uncertainty as to the
high and low level of costs in the data table.
The following are the steps for the High-Low method:
Step 1
Arrange the information from the high and low periods as below:
High-Low
Month
Cost
Production
Step 2
Select the month with the high level of
activity (and its related total cost),
and the low level of activity (and its related total cost). From our data in the
example, the high level of activity (production of units) is found in December
and the low level of activity is found in January.
High level of activity:
December 20x1
Total cost:
$58,000
Production:
135,000 units***
*** must use high level of production (activity) on
horizontal axis and NOT high level of cost on vertical
axis
Low level of activity:
January 20x1
Total cost:
$41,000
Production:
35,000 units

Total cost difference:
$17,000
Production difference:
100,000 units
Step 3
Divide the difference in cost by the difference in activity (units produced) to
get the variable cost per unit of activity (units produced here).
Variable Cost per unit produced
$17,000/100,000 units =$.17/unit
or conversely
Change in cost/change in activity = $0.17
Step 4
Since there are two data points connected by a straight line extending to the
vertical axis, use the following equation here:
Total Cost =Variable Cost/unit x units produced) + Fixed Cost
Substitute in TC and VC/unit just computed at either the High or Low level of
activity, then solve for the Fixed Cost:
TC = $.17/unit (VC)+FC
$58,000 = ($.17/unit * 135,000 units) + FC
$58,000 = $22,950 + Fixed Costs
Fixed Costs = $58,000-22,950 = $35,050
(note: same Fixed Cost estimate occurs at low level of activity)

Step 5
Write the estimated cost equation based on the above computations:
TC = (VC/unit *units) + $FC
TC = ($.17/unit*#of units) + $35,050
The drawback to this high-low method is that there are only two data points
used out of the historical information available. If either of these data points
is not representative of the others, (a so called outlier), then we may not
have a valid model to estimate the costs based on changes in activity levels.
To overcome this possible shortfall, the regression method is sometimes
used.
Method 3: Least-squares Regression Method
The
least-squares regression method
has the advantage of estimated cost
behavior using all of the given data points. It is a statistical method that has
many repetitive calculations to “fit” the data to get a fairly accurate estimate
of cost behavior.

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- Spring '11
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- Managerial Accounting, Net Present Value