identifying cost relationships high-low method © dale r. geiger 20111
TRANSCRIPT
Identifying Cost RelationshipsIdentifying Cost RelationshipsHigh-Low MethodHigh-Low Method
© Dale R. Geiger 2011 1
How can we determine which costs How can we determine which costs are fixed and which are variable?are fixed and which are variable?
© Dale R. Geiger 2011 2
Terminal Learning ObjectiveTerminal 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• Calculate fixed and variable cost components
from mixed cost data• Describe High-low method
© Dale R. Geiger 2011 3
Need for High-Low MethodNeed 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 costs
© Dale R. Geiger 2011 4
High-Low AssumptionsHigh-Low Assumptions
• The relationship between the cost at the highest level of output and the cost at the lowest level of output is linear
• This linear relationship reasonably represents the relationship between costs at other levels of output
• The change in cost from the highest level to the lowest level is due to the change in units from the highest level to the lowest:
• Change in cost / change in units = VC/unit
© Dale R. Geiger 2011 5
High-Low CalculationHigh-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
© Dale R. Geiger 2011 6
High-Low CalculationHigh-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
© Dale R. Geiger 2011 7
High-Low CalculationHigh-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)
© Dale R. Geiger 2011 8
High-Low CalculationHigh-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•Break even analysis (Day 9)
© Dale R. Geiger 2011 9
Check on LearningCheck 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?
© Dale R. Geiger 2011 10
High-Low ExampleHigh-Low Example
• The purchasing department shows the following activity for the last four months:
Month POs Processed Total CostsJan 100 $2500Feb 80 2200Mar 120 3000April 105 2750
© Dale R. Geiger 2011 11
High-Low ExampleHigh-Low Example
• The manager of the purchasing department sees that total costs increase as Purchase Orders increase
• However, he knows that the cost is not strictly variable
• He would like to segregate the variable component of the cost from the fixed cost
© Dale R. Geiger 2011 12
Graph of Actual CostsGraph of Actual Costs
Cost at 120 POs = $3000
Cost at 80 POs = $2200
X-Axis represents number of Purchase Orders© Dale R. Geiger 2011
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Multiple Linear Relationships ExistMultiple Linear Relationships Exist
Essentially any two points on the graph represent a linear
relationship
X-Axis represents number of Purchase Orders© Dale R. Geiger 2011
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High-Low RelationshipHigh-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© Dale R. Geiger 2011
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Calculate Unit Variable CostCalculate 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© Dale R. Geiger 2011 16
Calculate Unit Variable CostCalculate 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© Dale R. Geiger 2011 17
Calculate Unit Variable CostCalculate 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© Dale R. Geiger 2011 18
Calculate Fixed CostCalculate 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 )$3000 – $2400
= $600
© Dale R. Geiger 2011 19
Calculate Fixed CostCalculate 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 )$3000 – $2400
= $600
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Calculate Fixed CostCalculate Fixed Cost
© Dale R. Geiger 2011 21
Calculate Fixed CostCalculate Fixed Cost
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Express the Mixed Cost RelationshipExpress the Mixed Cost Relationship
• Total Cost = VC $/Unit * # Units + Fixed Cost• Total Cost = $20/Unit * # Units + $600
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Express the Mixed Cost RelationshipExpress the Mixed Cost Relationship
• Total Cost = VC $/Unit * # Units + Fixed Cost• Total Cost = $20/Unit * # Units + $600
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Using the Cost ExpressionUsing the Cost Expression
• For planning:• If planned output in May is 60 purchase orders,
what is our expected cost?$20/PO * 60 POs + $600 = $1800
• If planned output in June is 130 purchase orders?$20/PO * 130 POs + $600 = $3200
© Dale R. Geiger 2011 25
Using the Cost ExpressionUsing the Cost Expression
• For planning:• If planned output in May is 60 purchase orders,
what is our expected cost?$20/PO * 60 POs + $600 = $1800
• If planned output in June is 130 purchase orders?$20/PO * 130 POs + $600 = $3200
© Dale R. Geiger 2011 26
Using the Cost ExpressionUsing the Cost Expression
• For planning:• If planned output in May is 60 purchase orders,
what is our expected cost?$20/PO * 60 POs + $600 = $1800
• If planned output in June is 130 purchase orders?$20/PO * 130 POs + $600 = $3200
© Dale R. Geiger 2011 27
Using the Cost ExpressionUsing the Cost Expression
• For comparison and learning• April’s cost of $2750 for 105 POs was higher than
expected. Why?Expected cost = $20/PO * 105 POs + $600 = $2700• January’s cost of $2500 for 100 POs was lower
than expected. Why?Expected cost = $20/PO * 100 POs + $600 = $2600
• What did we do differently? What can we learn?
© Dale R. Geiger 2011 28
Using the Cost ExpressionUsing the Cost Expression
• For comparison and learning• April’s cost of $2750 for 105 POs was higher than
expected. Why?Expected cost = $20/PO * 105 POs + $600 = $2700• January’s cost of $2500 for 100 POs was lower
than expected. Why?Expected cost = $20/PO * 100 POs + $600 = $2600
• What did we do differently? What can we learn?
© Dale R. Geiger 2011 29
Using the Cost ExpressionUsing the Cost Expression
• For comparison and learning• April’s cost of $2750 for 105 POs was higher than
expected. Why?Expected cost = $20/PO * 105 POs + $600 = $2700• January’s cost of $2500 for 100 POs was lower
than expected. Why?Expected cost = $20/PO * 100 POs + $600 = $2600
• What did we do differently? What can we learn?
© Dale R. Geiger 2011 30
Using the Cost ExpressionUsing the Cost Expression
• For comparison and learning• April’s cost of $2750 for 105 POs was higher than
expected. Why?Expected cost = $20/PO * 105 POs + $600 = $2700• January’s cost of $2500 for 100 POs was lower
than expected. Why?Expected cost = $20/PO * 100 POs + $600 = $2600
• What did we do differently? What can we learn?
© Dale R. Geiger 2011 31
Check on LearningCheck on Learning
• What might cause a difference between the expected cost using High-Low and the actual cost?
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Practical ExercisePractical Exercise
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Enter and Filter Data to identify if relationship is reasonably linear
The spreadsheet calculates the Variable and Fixed portions of the cost
Practical ExercisePractical Exercise
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