High Low Method
It is a technique for determining both variable cost per unit and total fixed cost separately from the total cost. The main assumption under this method is that the variable cost per unit and fixed cost for all the levels is the same. It only considers the highest and lowest levels of activity for calculating variable and fixed costs. High low method calculator is based on the same assumption.
Under this method, first of all, we calculate variable costs per unit. And the next step is to calculate the fixed cost with the help of the variable cost per unit calculated in the first step.
This method will help in determining the total cost at different levels using a linear equation:
y = a + (b*x)
Where y = total cost for x number of units
a = fixed cost
b = variable cost per unit
x = number of units under calculation
The formula to calculate variable cost per unit and fixed cost using the high-low method is as follows:
Variable Cost Per Unit
(y2 – y1)/(x2 – x1)
Where y2 = cost at the highest production level
y1 = cost at the lowest production level
x2 = total units at the highest production level
x1 = total units at the lowest production level
This will provide the result of variable cost per unit. Let us denote this variable cost per unit by ‘b.’
After calculating variable cost per unit, put this value in the formula of fixed cost to obtain fixed cost.
Fixed Cost = y2 – (b*x2)
How to Calculate using High Low Method Calculator?
Simply insert the following data into the high-low method calculator for an instant calculation.
Cost at Highest Production Level
Insert the total cost of the highest level into the calculator. Note this is the total cost, variable, and all fixed costs.
Cost at Lowest Production Level
Insert the total cost of the lowest level into the calculator.
Total Units at Highest Production Level
Input the total number of units manufactured at the highest level.
Total Units at Lowest Production Level
Input the total number of units manufactured at the lowest level.
For more clarity, let us take an example. Consider the following details of Company X.
|Quarter||Number of Units||Total Cost ($)|
The highest level of production is in the quarter 1 and lowest is in quarter 3. Therefore, x2 is 1,500 units and x1 is 625 units. And, y2 is $29,500 and y1 is $19,000
Variable Cost per Unit = (29,500 – 19,000)/(1,500-625) = $12 per unit
Now, b = $12. Let us calculate the fixed cost using this
Fixed Cost at higher level (x2) = 29,500 – (12 * 1,500) = 11,500
Fixed Cost at lower level (x1) = 19,000 – (12 * 625) = 11,500
Now, let us calculate the total cost of next quarter when 2000 units will be manufactured:
Simply put the values calculated in: y = a + bx
y = 11,500 + (12 * 2000) = 35,500
Despite the fact that the high-low method helps in calculating variable cost per unit and total fixed cost at different levels of production, it is not relevant for most cases. Because it has certain limitations, it assumes that per unit variable cost and total fixed cost remain the same for all the levels of production. And this assumption is very impractical. Also, it considers only the highest and lowest levels for calculation.