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One of the more important functions of Management Accounting is examining the principles of cost behavior. Whether you are a manager, business owner or business student knowing the way costs react to changes in activity levels are a key concept. This usually involves situations where costs are mixed. This means there are fixed AND variable costs that need to be separated first before measuring. One of the easiest methods to do this is using the high low method. |
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Step 1  FC vs. VC Know the difference between "Fixed" and "Variable" costs. Fixed costs are those that do not change regardless of the level of change in activity (activity can be a number of cost drivers, or measures of output, such as labor or machine hours or whichever "activity" your specific situation uses). Variable costs are those that do move in relation to fluctuations in activity. For example, the total variable costs move in relation to the units produced or sold. (see the "Tips" section below for one more note on variable costs) Step 2  Type of To use the high-low (hi-lo) method you will use data on a month to month schedule using two parts of information. First is the total number of units (let's assume it's Gallons of paint for your large painting company). Second is the total cost of the gallons of paint each month. Step 3 Pick a range of consecutive months and make three columns. From left to right the columns should be; MONTH-UNITS-TOTAL COST. Let's say you pick June to December, so your first column will be June, July, August....to December. Step 4 The UNITS column will have a varying amount of gallons of paint per month for the designated period (in our case 7 months). The TOTAL COST column will simply be the amount of that months' gallons of paint used or sold. Step 5  Pick Highest & Lowest Units The high low cost behavior process now requests you to identify the highest and lowest UNITS, not cost, for the time period. After you have those also note the costs associated with those two months. Step 6  Use a calculator to easily find VC per unit What we are actually measuring is the change in the level of costs by the change in activity (this case "gallons of paint). Let's assume the costs for the highest and lowest activity months were July and September respectively. Step 7  Change in Costs / Change in Activity Because the high-low method dictates we choose the corresponding figures from the Units column we ignore the costs column regardless if it seems it should be higher or lower based on the units. Now we take the difference in costs and divide by the difference in units to find our variable cost per unit. Start with the highest figure July (3,000 units or "gallons") and its cost $9,750 less than September (1,550 units or "gallons")cost, $3,100. So: |
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