What Is the High-Low Method in Accounting? (2024)

The highest activity for the bakery occurred in October, when it baked the highest number of cakes, while August had the lowest activity level, with only 70 cakes baked at a cost of $3,750. The cost amounts adjacent to these activity levels will be used in the high-low method, even though these cost amounts are not necessarily the highest and lowest costs for the year.

We calculate the fixed and variable costs using the following steps:

1. Calculate variable cost per unit using identified high and low activity levels

$\begin{aligned} &\text{Variable Cost} = \frac{ \text{TCHA} - \text{Total Cost of Low Activity} }{ \text{HAU} - \text{Lowest Activity Unit} } \\ &\text{Variable Cost} = \frac { \$5,550 - \$3,750 }{ 125 - 70 } \\ &\text{Variable Cost} = \frac { \$1,800 }{ 55 } = \$32.72 \text{ per Cake} \\ &\textbf{where:} \\ &\text{TCHA} = \text{Total cost of high activity} \\ &\text{HAU} = \text{Highest activity unit} \\ \end{aligned}$​VariableCost=HAU−LowestActivityUnitTCHA−TotalCostofLowActivity​VariableCost=125−70$5,550−$3,750​VariableCost=55$1,800​=$32.72perCakewhere:TCHA=TotalcostofhighactivityHAU=Highestactivityunit​

2. Solve for fixed costs

To calculate the total fixed costs, plug either the high or low cost and the variable cost into the total cost formula:

$\begin{aligned} &\text{Total Cost} = ( \text{VC} \times \text{Units Produced} ) + \text{Total Fixed Cost} \\ &\$5,550 = ( \$32.72 \times 125 ) + \text{Total Fixed Cost} \\ &\$5,550 = \$4,090 + \text{Total Fixed Cost} \\ &\text{Total Fixed Cost} = \$5,550 - \$4,090 = \$1,460 \\ &\textbf{where:} \\ &\text{VC} = \text{Variable cost per unit} \\ \end{aligned}$​TotalCost=(VC×UnitsProduced)+TotalFixedCost$5,550=($32.72×125)+TotalFixedCost$5,550=$4,090+TotalFixedCostTotalFixedCost=$5,550−$4,090=$1,460where:VC=Variablecostperunit​

3. Construct total cost equation based on high-low calculations above

Using all of the information above, the total cost equation is as follows:

$\begin{aligned} &\text{Total Cost} = \text{Total Fixed Cost} + ( \text{VC} \times \text{Units Produced} ) \\ &\text{Total Cost} = \$1,460 + ( \$32.72 \times 125 ) = \$5,550 \\ \end{aligned}$​TotalCost=TotalFixedCost+(VC×UnitsProduced)TotalCost=$1,460+($32.72×125)=$5,550​

This can be used to calculate the total cost of various units for the bakery.

The Difference Between the High-Low Method and Regression Analysis

The high-low method is a simple analysis that takes less calculation work. It only requires the high and low points of the data and can be worked through with a simple calculator. It also gives analysts a way to estimate future unit costs.

However, the formula does not take inflation into consideration and provides a very rough estimation because it only considers the extreme high and low values, and excludes the influence of any outliers.

Regression analysis helps forecast costs as well, by comparing the influence of one predictive variable upon another value or criteria. It also considers outlying values that help refine the results. However, regression analysis is only as good as the set of data points used, and the results suffer when the data set is incomplete.

It’s also possible to draw incorrect conclusions by assuming that just because two sets of data correlate with each other, one must cause changes in the other. Regression analysis is also best performed using a spreadsheet program or statistics program.

Limitations of the High-Low Method

The high-low method is relatively unreliable because it only takes two extreme activity levels into consideration. The high or low points used for the calculation may not be representative of the costs normally incurred at those volume levels due to outlier costs that are higher or lower than would normally be incurred. In this case, the high-low method will produce inaccurate results.

The high-low method is generally not preferred, as it can yield an incorrect understanding of the data if there are changes in variable- or fixed-cost rates over time or if a tiered pricing system is employed. In most real-world cases, it should be possible to obtain more information so the variable and fixed costs can be determined directly. Thus, the high-low method should only be used when it is not possible to obtain actual billing data.

The Bottom Line

The high-low method is a simple way in cost accounting to segregate costs with minimal information. The high-low method involves comparing total costs at the highest level of activity and the lowest level of activity, after each level is determined.