what the high low method tells you
the costs associated with a product product line equipment store geographic sales region or subsidiary consist of both variable costs and fixed costs to determine both cost components of the total cost an analyst or accountant can use a technique known as the high low method the high low method is used to calculate the variable and fixed costs of a product or entity with mixed costs it takes two factors into consideration 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 example of how to use the high low methodfor example the table below depicts the activity for a cake bakery for each of the 12 months of a given year below is an example of the high low method of cost accounting the highest activity for the bakery occurred in october when it baked the highest number of cakes while august had the lowest activity level with only 70 cakes baked at a cost of 3 750 the cost amounts adjacent to these activity levels will be used in the high low method even though these cost amounts are not necessarily the highest and lowest costs for the year we calculate the fixed and variable costs using the following steps variable cost tcha total cost of low activityhau lowest activity unitvariable cost 5 550 3 750125 70variable cost 1 80055 32 72 per cakewhere tcha total cost of high activityhau highest activity unit begin aligned text variable cost frac text tcha text total cost of low activity text hau text lowest activity unit text variable cost frac 5 550 3 750 125 70 text variable cost frac 1 800 55 32 72 text per cake textbf where text tcha text total cost of high activity text hau text highest activity unit end aligned variable cost hau lowest activity unittcha total cost of low activity variable cost 125 70 5 550 3 750 variable cost 55 1 800 32 72 per cakewhere tcha total cost of high activityhau highest activity unit to calculate the total fixed costs plug either the high or low cost and the variable cost into the total cost formula total cost vc units produced total fixed cost 5 550 32 72 125 total fixed cost 5 550 4 090 total fixed costtotal fixed cost 5 550 4 090 1 460where vc variable cost per unit begin aligned text total cost text vc times text units produced text total fixed cost 5 550 32 72 times 125 text total fixed cost 5 550 4 090 text total fixed cost text total fixed cost 5 550 4 090 1 460 textbf where text vc text variable cost per unit end aligned total cost vc units produced total fixed cost 5 550 32 72 125 total fixed cost 5 550 4 090 total fixed costtotal fixed cost 5 550 4 090 1 460where vc variable cost per unit using all of the information above the total cost equation is as follows total cost total fixed cost vc units produced total cost 1 460 32 72 125 5 550 begin aligned text total cost text total fixed cost text vc times text units produced text total cost 1 460 32 72 times 125 5 550 end aligned total cost total fixed cost vc units produced total cost 1 460 32 72 125 5 550 this can be used to calculate the total cost of various units for the bakery the difference between the high low method and regression analysisthe high low method is a simple analysis that takes less calculation work it only requires the high and low points of the data and can be worked through with a simple calculator it also gives analysts a way to estimate future unit costs 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 regression analysis helps forecast costs as well by comparing the influence of one predictive variable upon another value or criteria 1 it also considers outlying values that help refine the results however regression analysis is only as good as the set of data points used and the results suffer when the data set is incomplete 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 limitations of the high low methodthe high low method is relatively unreliable because it only takes two extreme activity levels into consideration 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 in this case the high low method will produce inaccurate results the high low method is generally not preferred as it can yield an incorrect understanding of the data if there are changes in variable or fixed cost rates over time or if a tiered pricing system is employed in most real world cases it should be possible to obtain more information so the variable and fixed costs can be determined directly thus the high low method should only be used when it is not possible to obtain actual billing data 