What is the High-Low Method?
Last editedJan 20212 min read
The high-low method is an accounting technique used to separate out fixed and variable costs in a limited set of data.
It involves taking the highest level of activity and the lowest level of activity and comparing the total costs at each level. If the variable cost is a fixed charge per unit and fixed costs remain the same, it is possible to work out the fixed and variable costs by solving the equations.
However, users must be cautious of the high-low method. While it is easy to apply, it can distort costs and yield more or less accurate results because of its reliance on two extreme values from one data set.
High-low method formula
The high-low method provides a simple way to split fixed and variable components of combined costs using a few formula steps. First you calculate the variable cost component and fixed cost component, then plug the results into the cost model formula.
Variable cost per unit = (Highest activity cost − Lowest activity cost) ÷ (Highest activity units − Lowest activity units)
Once you have the variable cost per unit, you can calculate the fixed cost.
Fixed cost = Highest activity cost − (Variable cost per unit x Highest activity units)
or
Fixed cost − Lowest activity cost − (Variable cost per unit x Lowest activity units)
Then use all the results to calculate the high–low cost using this formula:
High-low cost = Fixed cost + (Variable cost + Unit activity)
High-low method example
Bonnie runs a small car factory in Detroit and needs to know the expected amount of overheads the factory will incur in the next month.
Factory overheads cost for the four months prior were as follows:
|
Cost |
Units |
|
|
January |
$60,000 |
10,000 |
|
February |
$40,000 |
7,500 |
|
March |
$50,000 |
6,000 |
|
April |
$55,000 |
5,500 |
Bonnie expects to produce 8,000 units in May.
Step 1: Identify the highest and lowest activity level
The highest activity level is 10,000 units in January (highest activity cost is $60,000)
The lowest activity level is 5,500 units in April (lowest activity cost is $55,000)
Step 2: Calculate the variable cost per unit
Use the formula shown above to work it out:
Variable cost per unit = ($60,000 − $55,000) ÷ (10,000 − 5,500)
Variable cost per unit = $5,000 ÷ 4,500 = $1.11 per unit
Step 3: Calculate the fixed cost
Use the formula shown above to work it out:
Fixed cost = $60,000 − ($1.11 x 10,00) = $48,900
Step 4: Calculate the total variable cost for the new activity
Multiply the variable cost per unit (step 2) by the number of units expected to be produced in May to work out the total variable cost for the month.
Total variable cost = $1.11 x 8,000 = $8,880
Step 5: Calculate the total cost
Now add the fixed cost (step 3) and variable cost for the new activity (step 4) together to get the total cost of overheads for May.
Total cost = $48,900 + $8,880 = $57,780
High-low method limitations
The high-low method does not consider small details such as variation in costs. It assumes that fixed and unit variable costs are constant, which is not always the case in real life.
There are also other cost estimation tools that can provide more accurate results. The least-squares regression method takes into consideration all data points and creates an optimized cost estimate. It can be easily and quickly used to yield significantly better estimates than the high-low method.
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