Slides determine the fixed and variable components

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 a

Identifying Cost Relationships

High-Low Method

How can we determine which costs are

fixed and which are variable?

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

mixed cost data

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

• Change in cost / change in units = VC/unit

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 2 Calculate Fixed Cost :

• Total Cost – Variable Cost or:

$ high output – VC $/unit * # Units high output

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 2 Calculate Fixed Cost :

• Total Cost – Variable Cost or:

$ high output – VC $/unit * # Units high output

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 2 Calculate Fixed Cost :

• Total Cost – Variable Cost or:

Total $ high output – (VC $/unit * # Units high output)

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

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?

High-Low Example

• The purchasing department shows the following

activity for the last four months:

Month POs Processed Total Costs

• He would like to segregate the variable component

of the cost from the fixed cost

Graph of Actual Costs

Multiple Linear Relationships Exist

Essentially any two points on the graph represent a linear relationship

High-Low Relationship

High-Low Method assumes the relationship between highest point and lowest point

is representative of the whole

X-Axis represents number of Purchase Orders

Calculate Unit Variable Cost

Change in Cost / Change in Units

= Total $ at high output – Total $ at low output

# Units at high output – # Units at low output

= ($3000 – $2200) / (120 units – 80 units)

=

$800/40 units

Calculate Unit Variable Cost

Change in Cost / Change in Units

= Total $ at high output – Total $ at low output

# Units at high output – # Units at low output

= ($3000 – $2200) / (120 units – 80 units)

=

$800/40 units

=

$20/unit

Calculate Unit Variable Cost

Change in Cost / Change in Units

= Total $ at high output – Total $ at low output

# Units at high output – # Units at low output

= ($3000 – $2200) / (120 units – 80 units)

=

$800/40 units

Calculate Fixed Cost

Total Cost – Variable Cost

=Total $ high output – VC $/unit * # Units high output

Calculate Fixed Cost

Total Cost – Variable Cost

=Total $ high output – VC $/unit * # Units high output

=

$3000 – ($20/unit * 120 units)

$3000 – ($20/unit * 120 units)

$3000 – ($20 * 120 )

Calculate Fixed Cost

Calculate Fixed Cost

Express the Mixed Cost Relationship

• Total Cost = VC $/Unit * # Units + Fixed Cost

• Total Cost = $20/Unit * # Units + $600

Express the Mixed Cost Relationship

• Total Cost = VC $/Unit * # Units + Fixed Cost

• Total Cost = $20/Unit * # Units + $600

Using the Cost Expression

• For planning:

what is our expected cost?

$20/PO * 60 POs + $600 = $1800

$20/PO * 130 POs + $600 = $3200

Using the Cost Expression

• For planning:

what is our expected cost?

$20/PO * 60 POs + $600 = $1800

$20/PO * 130 POs + $600 = $3200

Using the Cost Expression

• For planning:

what is our expected cost?

$20/PO * 60 POs + $600 = $1800

$20/PO * 130 POs + $600 = $3200

Using the Cost Expression

• For comparison and learning

expected Why?

Expected cost = $20/PO * 105 POs + $600 = $2700

than expected Why?

Expected cost = $20/PO * 100 POs + $600 = $2600

Using the Cost Expression

• For comparison and learning

expected Why?

Expected cost = $20/PO * 105 POs + $600 = $2700

than expected Why?

Expected cost = $20/PO * 100 POs + $600 = $2600

• What did we do differently? What can we learn?

Using the Cost Expression

• For comparison and learning

expected Why?

Expected cost = $20/PO * 105 POs + $600 = $2700

than expected Why?

Expected cost = $20/PO * 100 POs + $600 = $2600

Using the Cost Expression

• For comparison and learning

expected Why?

Expected cost = $20/PO * 105 POs + $600 = $2700

than expected Why?

Expected cost = $20/PO * 100 POs + $600 = $2600

• What did we do differently? What can we learn?

Check on Learning

• What might cause a difference between the expected cost using High-Low and the actual cost?

Practical Exercise

Enter and Filter Data to identify if relationship is reasonably linear

The spreadsheet

Practical Exercise