CIMA BA2 Syllabus B. COSTING - High low Analysis - Notes ^{3 / 8}

High-low method

This method analyses semi-variable costs into their fixed and variable elements.

Always select the period with the highest activity level and the period with the lowest activity level.

1. Step 1: Find the variable cost per unit (VC/unit)

   Total cost at high activity level - Total cost at low activity level
   -----------------------------------------------------------------------
    Units at high activity level - Units at low activity level

2. Step 2: Find the fixed cost (FC)

   TC at high activity level – (Units at high activity level × VC/unit)

3. Step 3: Find the Total cost (TC)

   TC = FC + VC/unit x Activity level

Illustration 1

Solution:

1. Step 1: Variable cost per unit

   VC per unit = ($31,400 - $26,810) / (6,400 - 4,360) = $2.25

2. Step 2: Fixed cost

   TC = FC + VC
   $26,810 = FC + ($2.25/unit x 4,360 units)
   FC = $17,000

3. Step 3: Total cost of 3,000 units

   TC = $17,000 + (3,000 units x $2.25/unit)
   TC = 23,750

High-low method with Step up

1. Step 1: Remove the step up from the Total Cost (TC)

2. Step 2: Find the variable cost per unit (VC/unit)

   Total cost at high activity level - Total cost at low activity level
   --------------------------------------------------------------------
   Total units at high activity level - Total units at low activity level

3. Step 3: Find the fixed cost (FC)

   Total cost at high activity level – (Total units at high activity level × Variable cost per unit)

4. Step 4: Find the Total cost (TC)

   TC = FC + VC/unit x Activity level

Illustration 2

Note: If there is a step up of fixed cost between the activity levels given, first remove the step up and then find the variable and fixed costs with the high low method.

There is a step up of $5,000 in fixed costs when activity crosses 35,000 units.

What is the Production cost of 37,500 units?

Solution:

1. Step 1: Remove the step up from the TC

   $340,000 - $5,000 = $335,000

2. Step 2: Variable cost per unit

   VC per unit = ($335,000 - $270,000) / (44,000 - 32,000) = 5.42

3. Step 3: Fixed cost (Use the activity with the step up because our desired activity level also includes the step up)

   TC = FC + VC
   $340,000 = FC + ($5.42/unit x 44,000 units)
   FC = $101,520

4. Step 4: Total cost of 37,500 units

   TC = $101,520 + ($5.42/unit x 37,500 units)
   TC = $304,770

Advantages of the High-Low Method

1. Easy to use

2. Easy to understand

Limitations of the High-Low Method

1. It relies on historical cost data – predictions of future costs may not be reliable

2. It assumes that the activity level is the only factor affecting costs

3. It uses only two values to predict costs

4. Bulk discounts may be available at large quantities