Example of High - Low Method of Cost Estimation
Based on the performance, such you have been provided along with the given information regarding ABC Ltd for the year ended on date 31 December 2004:
Labour hours Service cost (Shs)
Highest activity level 800 200,000
Lowest activity level 300 150,000
Required
Develop a net cost function based upon the above data utilizing the high-low method as:
Solution
Unit Variable cost = Variable cost/ Output Units
= (Cost at high level activity - cost at low level activity)/ (Units at high activity level - units at low activity level)
Variable Cost Per Unit = (Shs.200,000 - shs.150,000)/(800 hrs - 300 hrs)
= Shs.50,000/500 hrs
= shs.100/hr
Hence b = 100
To obtain the fixed cost a, substitute 'b' into the straight line equation as givens:
While labour hours (x) = 800, service cost (total cost, y) = shs.200,000
Hence from the Straight Line equation, y = a + b x
200,000 = a + (100) 800
200,000 = a + 80,000
a = 200,000 - 80,000
a = 120,000
Thus fixed costs = shs.120,000
NB: Even if we utilized the 2^{nd} set of labour hours and service costs, so we were would now get the similar answer that is:
While labour hours (x) = 300,
Service cost (total cost, y) = Shs.150, 000.
Thus 150,000 = a + 100(300)
a =150,000 - 30,000
= Shs.120,000
Consequently the cost equation is as:
y = 120,000 + 100x
This equation can be utilized to estimate the total costs: as like an example, while the activity level is as at 1000 labour hours, after that the total cost would be as:
Y= 120,000 + 1000(100)
=120,000 + 100,000
= Shs.220,000.