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High-Low Method ER PDF

This document discusses the high-low method for separating mixed costs into variable and fixed components. It provides an overview of the key steps in the high-low method, including using the highest and lowest activity levels to determine the variable cost per unit and calculate fixed costs. It then presents three practice problems applying the high-low method to sample cost and activity data.

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566 views8 pages

High-Low Method ER PDF

This document discusses the high-low method for separating mixed costs into variable and fixed components. It provides an overview of the key steps in the high-low method, including using the highest and lowest activity levels to determine the variable cost per unit and calculate fixed costs. It then presents three practice problems applying the high-low method to sample cost and activity data.

Uploaded by

afreenessani
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 8

Revised Summer 2016 Exam Review

HIGH-LOW METHOD

Key Topics to Know


• One of several methods of separating mixed costs into their variable and fixed
components.
• Uses only the data points with the highest and lowest activity levels and the costs
associated with those two activity levels.
• Relies on the assumption that these two data points are representative of the
population of data points. May be an unreliable assumption.
• Result is a regression line passing through these two data points in the form:
Y= a + bX
Where Y is total cost, a is fixed cost, b is variable cost per unit and X is the
number of units
• The regression line will predict total costs (Y) at for any given level of activity (X).

Page 1 of 8
Revised Summer 2016 Exam Review

Problems
Problem #1

B Company is a manufacturer of a single product. B Company's income statements for


the last two years are given below:
This Year Last Year
Units sold 300,000 240,000
Sales revenue $1,500,000 $1,200,000
Less: Cost of goods sold 800,000 740,000
Gross margin 700,000 460,000
Less: Operating expenses 450,000 420,000
Net Income 250,000 40,000

Required: a) Using the high-low method, separate the cost of goods sold and
operating expenses into their variable and fixed elements.
b) Determine the cost formula for each type of cost.

Problem #2

Electrical costs at one of R Company's factories are listed below:

Machine-Hours Electrical Cost


March 413 $7,371
April 506 $7,740
May 435 $7,447
June 486 $7,660
July 499 $7,704
August 461 $7,563
September 467 $7,571
October 458 $7,522
November 425 $7,403

Required: Using the high-low method, the estimate of the fixed and variable
components of electrical costs.

Page 2 of 8
Revised Summer 2016 Exam Review

Problem #3

M Company produces and sells souvenir products. Monthly income statements for two
activity levels are provided below:

Product 1 Product 2
Number of units 20,000 30,000

Revenue $150,000 $225,000


Cost of goods sold 60,000 90,000
Gross margin $90,000 $135,000

Salaries and commissions 20,000 25,000


Advertising expenses 30,000 30,000
Administrative expenses 12,500 12,500
Total operating expenses 62,500 67,500
Operating Income $27,500 $67,500

Required: a) Identify the mixed expense(s).


b) Use the high-low method to separate the mixed costs into variable
and fixed components.
c) Prepare a contribution margin income statement at the 20,000-
unit level.

Page 3 of 8
Revised Summer 2016 Exam Review

Multiple Choice Questions


The next 2 questions refer to the following information.
Ajax uses the high-low method of estimating costs. Ajax had total costs of
$50,000 at its lowest level of activity, when 5,000 units were sold. When, at its
highest level of activity, sales equaled 12,000 units, total costs were $78,000.

1. Ajax would estimate variable cost per unit as


a) $10.00
b) $6.50
c) $4.00
d) $7.53

2. Ajax would estimate fixed costs as


a) $28,000
b) $30,000
c) $64,000
d) $128,000

3. F Company, which uses the high-low method, reported total costs of $24 per
unit at its lowest activity level, when production equaled 10,000 units. When
production doubled, at its highest activity level, the total cost per unit dropped
to $15. Foster would estimate variable cost per unit as
a) $9
b) $6
c) negative $9
d) negative $0.0009

4. J Company uses the high-low method of estimating costs. Ajax had total costs
of $50,000 at its lowest level of activity, when 5,000 units were sold. When, at
its highest level of activity, sales equaled 12,000 units, total costs were
$78,000. What would Ajax estimate its total cost to be if sales equaled 8,000
units?
a) $32,000
b) $52,000
c) $62,000
d) $80,000

Page 4 of 8
Revised Summer 2016 Exam Review

The next 3 questions refer to the following information.


Supply costs at C Company's chain of gyms are listed below:
Client-Visits Supply Cost
January 12,183 $26,642
February 12,408 $26,853
March 12,232 $26,675
April 12,597 $27,854
May 12,527 $26,988
June 12,608 $27,064
July 12,143 $26,585
August 12,005 $26,354
September 11,944 $26,393

Management believes that supply cost is a mixed cost that depends on client-
visits. Use the high-low method to estimate the variable and fixed components
of this cost.

5. Compute the variable component, rounding off to the nearest whole cent.
a) $2.18
b) $1.01
c) $1.04
d) $0.99

6. Compute the fixed component, rounding off to the nearest whole cent.
a) $14,607
b) $13,949
c) $14,330
d) $26,745

7. At an activity level of 8,300 machine-hours in a month, B Company’s total


variable maintenance cost is $220,448 and its total fixed maintenance cost is
$556,764. What would be the total variable maintenance cost at an activity
level of 8,600 machine-hours in a month? Assume that this level of activity is
within the relevant range.
a) $777,212
b) $220,448
c) $576,888
d) $228,416

Page 5 of 8
Revised Summer 2016 Exam Review

Solutions to Problems
Problem #1

Cost of goods sold: Cost Activity


High level of activity $800,000 300,000
Low level of activity 740,000 240,000
Change $ 60,000 60,000
Variable cost per unit = $60,000 / 60,000 units = $1.00 per unit
Fixed costs = $800,000 - $1.00 x 300,000 = $500,000
OR
Fixed costs = $740,000 - $1.00 x 240,000 = $500,000

Equation: Y = 500,000 + 1X

Operating expenses: Cost Activity


High level of activity $450,000 300,000
Low level of activity 420,000 240,000
Change $ 30,000 60,000
Variable cost per unit = $30,000 / 60,000 units = $.50 per unit

Fixed costs = $450,000 - $.50 x 300,000 = $300,000


OR
Fixed costs = $420,000 - $.50 x 240,000 = $300,000

Equation: Y = 300,000 + .5X

Problem #2

Electrical costs: High Point Low Point Change Variable Cost


per Unit
Cost $7,740 $7,371 $369
$3.97
Activity 506 413 93

Fixed costs = $7,740 - $3.97 x 506 = $5,731

Page 6 of 8
Revised Summer 2016 Exam Review

Problem #3

a)
The salaries and commissions cost is mixed.

b)
High Low Change
Cost $25,000 $20,000 $5,000
$.50 per unit
Units 30,000 20,000 10,000

Total cost Variable cost Fixed cost


Fixed cost $25,000 30,000 x $.50 $10,000

c)
Number of units 20,000

Revenue $150,000
Cost of goods sold 60,000
Salaries and commissions 10,000
Contribution margin 80,000

Salaries and commissions 10,000


Advertising expenses 30,000
Administrative expenses 12,500
Total operating expenses 52,500
Operating Income $27,500

Page 7 of 8
Revised Summer 2016 Exam Review

Solutions to Multiple Choice Questions


1. C
2. B
3. B
4. C
5. B
6. C
7. D

Page 8 of 8

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