# High Low Method

## Definition

High Low Method is a mathematical technique used to determine the fixed and variable elements of a historical cost that is partially fixed and partially variable.

Topic Contents:

## Explanation

High Low Method provides an easy way to split fixed and variable components of combined costs using the following formula.

Variable Cost Per Unit | = | Highest Activity Cost - Lowest Activity Cost |

Highest Activity Units - Lowest Activity Units |

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.

**Fixed Cost** = Highest Activity Cost - (Variable Cost Per Units x Highest Activity Units)

Or

**Fixed Cost** = Lowest Activity Cost - (Variable Cost Per Units x Lowest Activity Units)

## Example

A company needs to know the expected amount of factory overheads cost it will incur in the following month.

Factory overheads cost in the previous three months was as follows:

Cost | Units | |

Jan | $30,000 | 6,000 |

Feb | $20,000 | 5,000 |

Mar | $25,000 | 4,000 |

Company expects to produce 7000 units in April.

**Calculate the expected factory overhead cost in April using the High-Low method.**

**Solution:**

**Step 1: Identify the highest and lowest activities**

** Highest activity level is 6000 units in Jan. Lowest activity level is 4000 units in March.**

It is important to remember here that it is the highest and lowest activity levels that need to be identified first rather than the highest/lowest cost.

**Step 2: Calculate variable cost per unit**

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.

Variable Cost Per Unit | = | 30,0000 - 25,000 | = | $2.5 Per Unit |

6000 - 4000 |

**Step 3: Calculate fixed cost**

Fixed costs can be found be deducting the total variable cost for a given activity level (i.e. 6000 or 4000) from the total cost of that activity level.

**Fixed cost = 30,000 - (2.5 x 6000) = $15,000**

**Step 4: Calculate total variable cost for new activity**

Simply multiplying the variable cost per unit *(Step 2)* by the number of units expected to be produced in April gives us the total variable cost for that month.

**Total variable cost = $2.5 x 7000 = $17,500**

**Step 5: Calculate total cost**

Simply adding the fixed cost *(Step 3)* and variable cost *(Step 4)* gives us the total cost of factory overheads in April.

**Total cost = $15,000 + $17,500 = $32,500**

## Limitations

- High Low Method assumes a linear relationship between cost and activity which is an over simplified analysis of cost behavior. Activity based costing can provide a more useful analysis of the behavior of cost in relation to distinct activities.
- High Low Method is not representative of entire data as it is based on just 2 activity levels. Linear regression analysis overcomes the limitation of this method by incorporating data of all activity levels and is therefore more statistically reliable.