Identifying Cost Relationships High-Low Method © Dale R Geiger 2011 How can we determine which costs are fixed and which are variable? © Dale R Geiger 2011 Terminal Learning Objective • Task: Determine the fixed and variable components of a mixed cost using the High-Low method • Condition: You are a cost advisor technician with access to all regulations/course handouts, and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors • Standard: with at least 80% accuracy • Calculate fixed and variable cost components from mixed cost data Describe High-low method â Dale R Geiger 2011 Need for High-Low Method • Fixed and variable components of cost are not always identifiable • This is especially true in service activities • Sometimes costs aren’t strictly fixed and variable but mixed or semi-variable • The High-Low Method permits further analysis by finding an approximate value for variable and fixed costs © Dale R Geiger 2011 High-Low Assumptions • The relationship between the cost at the highest level of output and the cost at the lowest level of output is linear • This linear relationship reasonably represents the relationship between costs at other levels of output • The change in cost from the highest level to the lowest level is due to the change in units from the highest level to the lowest: • Change in cost / change in units = VC/unit © Dale R Geiger 2011 High-Low Calculation • Step 1: Calculate Variable Cost $/unit: • Change in cost / change in units or: $ at high output – $ at low output # Units at high output – # Units at low output • Step Calculate Fixed Cost : • Total Cost – Variable Cost or: $ high output – VC $/unit * # Units high output © Dale R Geiger 2011 High-Low Calculation • Step 1: Calculate Variable Cost $/unit: • Change in cost / change in units or: $ at high output – $ at low output # Units at high output – # Units at low output • Step Calculate Fixed Cost : • Total Cost – Variable Cost or: $ high output – VC $/unit * # Units high output © Dale R Geiger 2011 High-Low Calculation • Step 1: Calculate Variable Cost $/unit: • Change in cost / change in units or: $ at high output – $ at low output # Units at high output – # Units at low output • Step Calculate Fixed Cost : • Total Cost – Variable Cost or: Total $ high output – (VC $/unit * # Units high output) © Dale R Geiger 2011 High-Low Calculation • Step 3: Develop the cost expression for total cost: Total cost = VC $/unit * # units + Fixed cost • This equation can be used for: •Planning for various levels of output •Break even analysis (Day 9) © Dale R Geiger 2011 Check on Learning • In the High-Low method, the change in cost from the high level of output to the low level of output is assumed to be caused by…? • How is fixed cost calculated using the High-Low method? © Dale R Geiger 2011 10 Calculate Fixed Cost © Dale R Geiger 2011 21 Calculate Fixed Cost © Dale R Geiger 2011 22 Express the Mixed Cost Relationship • Total Cost = VC $/Unit * # Units + Fixed Cost • Total Cost = $20/Unit * # Units + $600 © Dale R Geiger 2011 23 Express the Mixed Cost Relationship • Total Cost = VC $/Unit * # Units + Fixed Cost • Total Cost = $20/Unit * # Units + $600 © Dale R Geiger 2011 24 Using the Cost Expression • For planning: • If planned output in May is 60 purchase orders, what is our expected cost? $20/PO * 60 POs + $600 = $1800 • If planned output in June is 130 purchase orders? $20/PO * 130 POs + $600 = $3200 © Dale R Geiger 2011 25 Using the Cost Expression • For planning: • If planned output in May is 60 purchase orders, what is our expected cost? $20/PO * 60 POs + $600 = $1800 • If planned output in June is 130 purchase orders? $20/PO * 130 POs + $600 = $3200 © Dale R Geiger 2011 26 Using the Cost Expression • For planning: • If planned output in May is 60 purchase orders, what is our expected cost? $20/PO * 60 POs + $600 = $1800 • If planned output in June is 130 purchase orders? $20/PO * 130 POs + $600 = $3200 © Dale R Geiger 2011 27 Using the Cost Expression • For comparison and learning • April’s cost of $2750 for 105 POs was higher than expected Why? Expected cost = $20/PO * 105 POs + $600 = $2700 • January’s cost of $2500 for 100 POs was lower than expected Why? Expected cost = $20/PO * 100 POs + $600 = $2600 • What did we differently? What can we learn? © Dale R Geiger 2011 28 Using the Cost Expression • For comparison and learning • April’s cost of $2750 for 105 POs was higher than expected Why? Expected cost = $20/PO * 105 POs + $600 = $2700 • January’s cost of $2500 for 100 POs was lower than expected Why? Expected cost = $20/PO * 100 POs + $600 = $2600 • What did we differently? What can we learn? © Dale R Geiger 2011 29 Using the Cost Expression • For comparison and learning • April’s cost of $2750 for 105 POs was higher than expected Why? Expected cost = $20/PO * 105 POs + $600 = $2700 • January’s cost of $2500 for 100 POs was lower than expected Why? Expected cost = $20/PO * 100 POs + $600 = $2600 • What did we differently? What can we learn? © Dale R Geiger 2011 30 Using the Cost Expression • For comparison and learning • April’s cost of $2750 for 105 POs was higher than expected Why? Expected cost = $20/PO * 105 POs + $600 = $2700 • January’s cost of $2500 for 100 POs was lower than expected Why? Expected cost = $20/PO * 100 POs + $600 = $2600 • What did we differently? What can we learn? © Dale R Geiger 2011 31 Check on Learning • What might cause a difference between the expected cost using High-Low and the actual cost? © Dale R Geiger 2011 32 Practical Exercise © Dale R Geiger 2011 33 Enter and Filter Data to identify if relationship is reasonably linear The spreadsheet calculates the Variable and Fixed portions of the cost © Dale R Geiger 2011 34 Practical Exercise © Dale R Geiger 2011 35 ... can we determine which costs are fixed and which are variable? © Dale R Geiger 2011 Terminal Learning Objective • Task: Determine the fixed and variable components of a mixed cost using the High-Low... Sometimes costs aren’t strictly fixed and variable but mixed or semi -variable • The High-Low Method permits further analysis by finding an approximate value for variable and fixed costs © Dale R Geiger... regulations/course handouts, and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors • Standard: with at least 80% accuracy • Calculate fixed and variable