Being a new hire at the company, the manager assigns you the task of anticipating the costs that would be incurred in the following month (September). From all the above examples, we get a lot of clarity regarding the concept and how to calculate the same from data that what advantage does scenario analysis have over sensitivity analysis we get in the financial statements. It is possible for the analysts and accountants to use this method effectively for determining both the fixed and variable cost component. The high-low method is relatively unreliable because it only takes two extreme activity levels into consideration.

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- The company hasfound that if a delivery truck is driven for 52,500 miles in a month, its average operating cost comes to45.6 cents per mile.
- The high-low method is an accounting technique that is used to separate out your fixed and variable costs within a limited set of data.
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- Because it relies on two extreme values from only one data set, it can distort costs.
- However, this method has some serious limitations which the managers must be fully aware of before using it to separate variable and fixed portions of a mixed cost.

Calculating the outcome for the high-low method requires a few formula steps. First, you must calculate the variable-cost component and then the fixed-cost component, and then plug the results into the cost model formula. 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. Due to the simplicity of using the high-low method to gain insight into the cost-activity relationship, it does not consider small details such as variation in costs. The high-low method assumes that fixed and unit variable costs are constant, which is not the case in real life.

## Step 1: Find Out the Highest and Lowest Activity Level

Thus, you should first attempt to discern the fixed and variable components of a cost from more reliable source documents, such as supplier invoices, before resorting to the high-low method. Calculate the expected factory overhead cost in April using the High-Low method. High Low Method is a mathematical technique used to determine the fixed and variable elements of a historical cost that is partially fixed and partially variable. It is a very simple and easy way to divide the costs of the entity in a methodical manner, even if the information available is very less.

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. As compared to scatter graph and least squares regression method, working with high-low point method is simple and easy. However, this method has some serious limitations which the managers must be fully aware of before using it to separate variable and fixed portions of a mixed cost. The high-low method is a simple way in cost accounting to segregate costs with minimal information.

If the variable cost is a fixed charge per unit and fixed costs remain the same, it is possible to determine the fixed and variable costs by solving the system of equations. It is worth being cautious when using the high-low method, however, as it can yield more or less accurate results depending on the distribution of values between the highest and lowest dollar amounts or quantities. Understanding the concept of the high-low method is imperative because it is usually used in preparing the corporate budget.

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We’ll take a closer look at how you can utilise this technique and learn how to estimate your fixed and variable costs. High-low point method is a technique used to divide a mixed cost into its variable and fixed components. While the high-low method is an easy one to use, it also has its disadvantages. Because it relies on two extreme values from only one data set, it can distort costs. Using either the high 4 popular free and open source accounting software or low activity cost should yield approximately the same fixed cost value.

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You need to know what the expected amount of overheads that your production line will incur in the next month. There are a number of accounting techniques used throughout the business world. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation. Our goal is to deliver the most understandable and comprehensive explanations of financial topics using simple writing complemented by helpful graphics and animation videos.

Finance Strategists is a leading financial education organization that connects people with financial professionals, priding itself on providing accurate and reliable financial information to millions of readers each year. It’s also possible to draw incorrect conclusions by assuming that just because two sets of data correlate with each other, one must cause changes in the other. Regression analysis is also best performed using a spreadsheet program or statistics program. However, the formula does not take inflation into consideration and provides a very rough estimation because it only considers the extreme high and low values, and excludes the influence of any outliers.