What is a High-low Method in Accounting?

In cost accounting, the high-low method refers to the mathematical technique used to separate fixed and variable components that are otherwise part of the historical cost that is mixed, i.e., partially fixed and partially variable. The high-low method comprises the highest and the lowest level of activity and compares the total costs at each level.

The formula for the High-Low Method

Under the high-low method, the variable cost per unit is calculated by initially deducting the lowest activity cost from the highest activity cost, then deducting the number of units at the lowest activity from that of the highest activity, and then dividing the former by the latter. Mathematically, it is represented as,

The fixed cost can be calculated once the variable cost per unitVariable Cost Per UnitVariable cost per unit refers to the cost of production of each unit produced, which changes when the output volume or the activity level changes. These are not committed costs as they occur only if there is production in the company.read more is determined. It is calculated by deducting the product of variable cost per unit and the highest activity units from the highest activity cost or by deducting the product of variable cost per unit and lowest activity units from the lowest activity cost.

Mathematically, it is represented as,

or

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: High-Low Method Formula (wallstreetmojo.com)

Calculation of the High-low Method in Accounting

Example

  • Firstly, determine the highest and lowest activity units from the available costing chart. Next, determine the corresponding cost of production at the level of the highest and level activity units. Next, deduct the lowest activity cost from the highest activity cost to take out the fixed cost component such that the remaining variable component corresponds to the incremental number of units. Variable cost component = Highest activity cost – Lowest activity cost Next, the total number of units is calculated by deducting the number of units at the lowest activity from that of the highest activity. The total number of units = Highest activity units – Lowest activity units. Next, the variable cost per unit is calculated by dividing the expression in step 3 by the expression in step 4, as shown above. Next, the fixed cost is calculated either by deducting the product of variable cost per unit and the highest activity units from the highest activity cost or by deducting the product of variable cost per unit and lowest activity units from the lowest activity cost, as shown above. The formula for the calculation of variable cost and fixed cost under the high-low method is derived by using the following steps: Firstly, determine the highest and lowest activity units from the available costing chart. Next, determine the corresponding cost of production at the level of the highest and level activity units. Next, deduct the lowest activity cost from the highest activity cost to take out the fixed cost component such that the remaining variable component corresponds to the incremental number of units. Variable cost component = Highest activity cost – Lowest activity cost Next, the total number of units is calculated by deducting the number of units at the lowest activity from that of the highest activity. The total number of units = Highest activity units – Lowest activity units. Next, the variable cost per unit is calculated by dividing the expression in step 3 by the expression in step 4, as shown above. Next, the fixed cost is calculated either by deducting the product of variable cost per unit and the highest activity units from the highest activity cost or by deducting the product of variable cost per unit and lowest activity units from the lowest activity cost, as shown above.

Variable cost component = Highest activity cost – Lowest activity cost

The total number of units = Highest activity units – Lowest activity units.

The formula for the calculation of variable cost and fixed cost under the high-low method is derived by using the following steps:

The company plans to produce 7,000 units in March 2019 on the back of buoyant market demand. Help the company accountant calculate the expected factory overhead cost in March 2019 using the high-low method.

Solution:

The following are the given data for the calculation of the high-low method.

Therefore, using the above information, variable cost per unit can be calculated as,

  • Variable cost per unit = ($60,000 – $50,000) / (6,000 – 4,000)

Variable cost per unit will be-

  • Variable cost per unit = $5 per unit

Now, the fixed cost can be calculated as,

  • Fixed cost = $60,000 – ($5 * 6,000)

Fixed Cost will be –

  • Fixed cost = $30,000

Therefore, the expected overhead costOverhead CostOverhead cost are those cost that is not related directly on the production activity and are therefore considered as indirect costs that have to be paid even if there is no production. Examples include rent payable, utilities payable, insurance payable, salaries payable to office staff, office supplies, etc.read more for March 2019 for 7,000 units can be calculated as,

  • Total cost = Fixed cost + Variable cost per unit * Number of units= $30,000 + $5 * 7,000

Expected Overhead Cost will be-

  • Total Cost = $65,000

Therefore, the overhead cost is expected to be $65,000 for March 2019.

Relevance and Uses

Understanding the concept of the high-low method is imperative because it is usually used in preparing the corporate budget. It is used in estimating the expected total cost at any given level of activity based on the assumption that past performance can be practically applied to project cost in the future. The underlying concept of the method is that the change in the total costs is the variable cost rate multiplied by the change in the number of units of activity.

Nevertheless, it has limitations, such as the high-low method assumes a linear relationshipLinear RelationshipA linear relationship describes the relation between two distinct variables - x and y - in the form of a straight line on a graph. When presenting a linear relationship through an equation, the value of y is derived through the value of x, reflecting their correlation.read more between cost and activity, which may be an oversimplification of cost behavior. Further, the process may be easy to understand, but the high-low method is not considered reliable because it ignores all the data except the two extreme ones.

This article has been a guide to the High-Low Method in Accounting and its Definition. Here we discuss the formula to create a high-low cost model and calculate the variable cost and fixed cost per unit, along with the practical examples and a downloadable excel sheet. You can learn more about financing from the following articles –

  • Semi Variable Cost FormulaSemi Variable Cost FormulaFixed and variable costs combine to form semi-variable costs. Because semi variable costs are influenced by both fixed and variable costs, they are also referred to as mixed costs.read moreVariable Costing CalculationVariable Costing CalculationThe variable costing formula evaluates the direct cost and other variable manufacturing expenses incurred on each product unit. It is computed as the sum of direct labor cost, direct raw material cost, and variable manufacturing overhead divided by the total number of units produced.read moreCost Recovery MethodCost Recovery MethodThe Cost Recovery Method is one of the revenue recognition methods in which the company does not record gross profit or income generated against goods sold to customers until the total cost element related to the respective sale has been fully received by the company from the customer. After the total cost amount has been received, the remaining amount is recorded as income.read moreSpecific Identification MethodSpecific Identification MethodThe specific identification method is one of the accounting methods for inventory valuation that keeps track of each and every item of inventory used in the company from the time it enters the business until it leaves the business, as well as assigning a cost to each item individually rather than grouping them together.read more