High-Low Method to Separate Mixed Cost into Fixed Cost & Variable Cost

This is Accounting

2 Feb 202006:24

Summary

TLDRThe video script outlines the high-low method for cost estimation, focusing on separating mixed costs into fixed and variable components. It details a four-step process: identifying high and low activity points, calculating the variable rate, determining fixed costs, and verifying calculations. Using a utilities cost example, the script demonstrates how to apply the method, resulting in accurate cost estimations.

Takeaways

🔍 The high-low method is a technique used by managers to estimate cost behavior by separating mixed costs into fixed and variable costs.
📈 The method involves four steps: identifying high and low activity points, calculating the variable rate, determining the fixed cost, and verifying the calculations.
📊 To start, select the highest and lowest activity levels from the data set, using machine hours as the activity measure in this example.
📝 The variable rate is calculated using the formula: (High point cost - Low point cost) / (High point activity - Low point activity).
💡 The variable cost is found by multiplying the variable rate by the number of machine hours, which represents the activity level.
🧮 Fixed cost is calculated by subtracting the variable cost (variable rate times activity) from the total cost at the high point.
🔄 Verification is crucial: ensure that the sum of fixed cost and variable cost equals the total cost at the high point to confirm accuracy.
📋 The script provides a practical example using data from April to August, with August being the high point and June the low point for machine hours.
💼 Understanding the high-low method is essential for cost estimation and financial analysis in business management.
🔎 The script emphasizes the importance of checking calculations to ensure they align with the original data, ensuring the accuracy of cost estimations.

Q & A

What is the high-low method used for in cost estimation?
-The high-low method is used to estimate the cost behavior by determining the components of mixed costs, separating them into fixed and variable costs.
How many steps are involved in the high-low method?
-There are four steps involved in the high-low method.
What is the first step in the high-low method?
-The first step is to look at the given set of data and choose the high point activity and the low point activity.
What does the high point activity represent in the high-low method?
-The high point activity represents the month with the highest machine hours in the given data set.
What is the significance of choosing the high and low points in the high-low method?
-Choosing the high and low points helps in selecting the data associated with the highest and lowest activities to calculate the variable rate.
What is the formula used to calculate the variable rate in the high-low method?
-The variable rate is calculated using the formula: (High point cost - Low point cost) / (High point output - Low point output).
How is the variable cost calculated in the high-low method?
-The variable cost is calculated by multiplying the variable rate by the number of machine hours.
What is the formula for calculating the fixed cost in the high-low method?
-The fixed cost is calculated using the formula: Total cost at the high point - (Variable rate * Output at the high point).
Why is it important to verify the calculated fixed and variable costs?
-Verifying the calculated fixed and variable costs ensures the accuracy of the high-low method by confirming that the total cost matches the data from the chart.
How can the accuracy of the high-low method be checked?
-The accuracy can be checked by ensuring that the total cost calculated (fixed cost + variable cost) matches the total cost from the data set at the high point.