High-Low Method Accounting: Formula & Examples

High-Low Method Accounting: Formula & Examples
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Lesson Transcript
Instructor: Anthony Aparicio

Tony taught Business and Aeronautics courses for eight years; he holds a Master's degree in Management and is completing a PhD in Organizational Psychology

The high-low method is one type of cost-volume analysis used in accounting. This lesson describes how it is used and explains the formula for quickly computing an estimated cost per unit.

High-Low Method in Cost Accounting

Lets say that you started a business producing waterproof cell phone cases for retail sales. Two things that you would need to know are the amount of your fixed costs and variable costs to operate your business. Specifically, you should also be able to estimate your costs at different levels (quantities) of production.

There are three main ways of determining the amount of costs per item that you have for sale: scatter diagrams, the high-low method, and least-squares regression analysis. This lesson will focus on the high-low method, including its formulas and some examples.

Fixed costs are those expenses that remain unchanged regardless of the quantity of items you produce for sale. For example, the rent you pay on the production facility will be the same whether you produce one cell phone case or one million cases. Based on that logic, you would rather get the most of your money by producing the highest number of cases and reducing the average fixed cost per unit.

Variable costs will change depending on the number of units you're producing. Unlike fixed costs, variable costs will increase when producing more units and decrease when you produce fewer. Some examples of expenses that will be included in your variable costs are the materials (i.e., plastic, rubber, glue, etc.) needed to produce your cell phone cases, shipping costs, and possibly direct labor to assemble the products.

In order to use the high-low method, you will have to combine the fixed and variable costs of production within your company to come up with a total cost. You will notice that the high-low method will only give you an estimate of what total costs would be at any given amount of production. These estimates are helpful to management when preparing budgets for upcoming months.

Formulas and Examples

The high-low method is actually a two-step process where the first step will help us to determine the estimated total cost per unit. The second step of the process is where we take the cost per unit that we established from the first step and figure out the fixed costs for that level of production. Once we have those two pieces of information, we can use them to figure out the approximate cost for any level of production.

When reviewing your company's production and cost data, you will first have to find the highest and lowest quantity of items produced. Once you have that information, then you will be able to apply them to the formula.

Let's look at an example. As you can see, the highest number of units produced in a month was 72,500 at a total cost of $34,000; the lowest producing month generated only 18,750 units at a cost of $22,175. Taking the difference between the high and low of each shows that there is an estimated variable cost of $0.22 per unit produced.

High-low Formula

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