What Is the High-Low Method in Accounting?

For example, the table below depicts the activity for a cake bakery for each of the 12 months of a given year. The following are the given data for the calculation of the high-low method. As with any metric, it comes with its downsides of not being entirely accurate.

1. 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.
2. Unfortunately, the only available data is the level of activity (number of guests) in a given month and the total costs incurred in each month.
3. However, there are more advanced methods available in the current scenario, like regression analysis, that may be more complex and involve more calculations, but they provide better estimations with higher level of accuracy.
4. As compared to scatter graph and least squares regression method, working with high-low point method is simple and easy.

High-Low Method: Learn How to Estimate Fixed & Variable Costs

The high-low point method uses only two data points (i.e., the highest and the lowest activity levels) which are generally not enough to get the satisfactory results. Moreover, these highest and lowest points often do not represent the usual activity levels of a business entity. The high-low point formula may, therefore, misrepresent the firm’s true cost behavior when it operates at normal activity level. Difference between highest and lowest activity units and their corresponding costs are used to calculate the variable cost per unit using the formula given above. Once variable cost per unit is found, you can calculate the fixed cost by subtracting the total variable cost at a specific activity level from the total cost at that activity level.

The high-low method comprises the highest and the lowest level of activity and compares the total costs at each level. In cost accounting, the high-low method is a technique used to split mixed costs into fixed and variable costs. Although the high-low method is easy to apply, it is seldom used because it can distort costs, due to its reliance on two extreme values from a given data set. In cost accounting, the high-low method is a way of attempting to separate out fixed and variable costs given a limited amount of data. The high-low method involves taking the highest level of activity and the lowest level of activity and comparing the total costs at each level.

What Is the High-Low Method in Accounting?

The high-low method is used to calculate the variable and fixed costs of a product or entity with mixed costs. It considers the total dollars of the mixed costs at the highest volume of activity and the total dollars of the mixed costs at the lowest volume of activity. The total amount of fixed costs is assumed to be the same at both points of activity. The change in the total costs is thus the variable cost rate times the change in the number of units of activity.

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She has been assigned the task of budgeting payroll costs for the next quarter. A company gaap analysis needs to know the expected amount of factory overheads cost it will incur in the following month. The calculation follows simple process and step, which is better than the other complex methods like least-square regression. Whether it’s to figure out the profitability of a product, or getting an overview of the overall financial health of your business. The Western Company presents the production and cost data for the first six months of the 2015.

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. If the same truck is driven for only 35,000 miles in a month, its averageoperating cost increases to 53.6 cents per mile. High-low method is a method of estimating a cost function that uses only the highest and values of the cost driver within the relevant range.

The high or low points used for the calculation may not be representative of the costs normally incurred at those volume levels due to outlier costs that are higher or lower than would normally be incurred. The formula for high low method is quite simple and easy to understand. debt vs equity financing However, there are more advanced methods available in the current scenario, like regression analysis, that may be more complex and involve more calculations, but they provide better estimations with higher level of accuracy. They are suitable for more complex cost structures and larger databases.

Let us try to understand the concept of high-low method total cost formula with the help of some suitable examples. On account of these defects, high-low point method is considered less accurate when compared with least squares regression method which takes into account all data points and provides much more accurate results. To make the procedure simple and easy to understand, we can divide the calculations into the following three steps.

The high-low method involves comparing total costs at the highest level of activity and the lowest level of activity, after each level is determined. The high-low method used in analysis of costs that help in estimating the variable and fixed costs from a given data set of financial information. Using this formula, it is possible to estimate the costs individually but may not always provide actual estimate due to certain limitations. A cost that contains both fixed and variable costs is considered a mixed cost. The manager of a hotel would like to develop a cost model to predict the future costs of running the hotel. Unfortunately, the only available data is the level of activity (number of guests) in a given month and the total costs incurred in each month.

But anything that uses extreme examples should always be used to give you a rough idea and the results must be taken with a grain of salt. Someone on our team will connect you with a financial professional in our network holding the correct designation and expertise. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content. Finance Strategists has an advertising relationship with some of the companies included on this website. We may earn a commission when you click on a link or make a purchase through the links on our site.