In addition the fixed cost is 1000 regardless of the gallons used The total in

In addition the fixed cost is 1000 regardless of the

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(=(A12/1000)*3). In addition, the “fixed” cost is $1,000, regardless of the gallons used. The total in column D is the summation of columns B and C. The cost components are mapped in the diagram at the right. Hopefully, the preceding illustration is clear enough. But, what if you were not given the “formula” by which the water bill is calculated? Instead, all you had was the information from a handful of past water bills. How hard would it be to to sort it out? Could you estimate how much the water bill should be for a particular level of usage? This type of problem is frequently encountered in business, as many expenses (individually and by category) contain both fixed and variable components. 7.2 High-Low Method One approach to sorting out mixed costs is the high-low method. It is perhaps the simplest technique for separating a mixed cost into fixed and variable portions. However, beware that it can return an imprecise answer if the data set under analysis has a number of rogue data points. But, it will work fine in other cases, as with the water bills for Butler’s Car Wash. Information from Butler’s actual water bills is shown at above right. Butler is curious to know how much the August water bill will be if 650,000 gallons are used. Assume that the only data available are from the aforementioned four water bills. With the high-low technique, the highest and lowest levels of activity are identified for a period of time. The highest water bill is $3,550, and the lowest is $2,020. The difference in cost between the highest and lowest level of activity represents the variable cost ($3,550 - $2,020 = $1,530) associated with the change in activity (850,000 gallons on the high end and 340,000 gallons on the low end yields a 510,000 gallon difference). The cost difference is divided by the activity difference to determine the variable cost for each additional unit of activity ($1,530/510 thousand gallons = $3 per thousand). The fixed cost can be calculated by subtracting variable cost (per-unit variable cost multiplied by the activity level) from total cost. The table at above right reveals the application of the high-low method. An electronic spreadsheet can be used to simplify the high-low calculations. The website includes a link to an illustrative spreadsheet for Butler. April 450,000 gallons $2,350 May 340,000 gallons $2,020 June 850,000 gallons $3,550 July 500,000 gallons $2,500 USAGE (in thousands of gallons) COST Highest level Lowest level Difference 850 340 510 $ 3,550 2,020 $ 1,530 Variable Cost per unit: ($1,530/510) $3 HIGH LOW Total cost Less: Variable cost ($3 per unit X usage) Fixed cost $ 3,550 2,550 $ 1,000 $ 2,020 1,020 $ 1,000
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Managerial and Cost Accounting 46 Cost-Volume-Profilt and Business Scalability 7.3 Method of Least Squares As cautioned, the high-low method can be quite misleading. The reason is that cost data are rarely as linear as presented in the preceding illustration, and inferences are based on only two observations (either of which could be a statistical anomaly or “outlier”). For most cases, a more precise analysis tool should be used. If you have studied statistical methods, recall “regression analysis” or the “method of least squares.” This tool is ideally suited to cost behavior analysis. This
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