Principles of Cost Analysis and Management Determine the Fixed and Variable Components of a Mixed Cost Using the High-Low Method Principles of Cost Analysis and Management

Terminal Learning Objective Action: Determine the Fixed and Variable Components of a Mixed Cost Using the High-Low Method Condition: FM Leaders in a classroom environment working individually and as a member of a small group, using doctrinal and administrative publications, self-study exercises, personal experiences, practical exercises, handouts, and discussion. Standard: With at least 80% accuracy (70% for International Learners): Identify High-Low Method Calculate Fixed and Variable Cost Components from Mixed Cost Data

How can we determine which costs are fixed and which are variable? Identify High-Low Method How can we determine which costs are fixed and which are variable?

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 costs

High-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

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) 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 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

Total cost = VC $/unit * # units + Fixed cost 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 Break even analysis (Day 9)

High-Low Example The purchasing department shows the following activity for the last four months: Month POs Processed Total Costs Jan 100 $2500 Feb 80 $2200 Mar 120 $3000 Apr 105 $2750

High-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

LSA #1 Check on Learning Q1. 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…? A1. Q2. How is fixed cost calculated using the High-Low method? Show Slide #10: LSA #1 Check on Learning Facilitator's Note: Ask check on learning question, facilitate discussion on answers given. Q1. 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…? A1. The change in number of units Q2. How is fixed cost calculated using the High-Low method? A2. Total cost at high level minus variable cost at high level.

LSA #1 Summary Identified need for High-Low Method and finding an approximate value for variable and fixed costs. High-Low Assumptions relationship between costs at other levels of output. Went over and conducted some High-Low Calculations and examples.

Graph of Actual Costs Cost at 120 POs = $3000 Cost at 80 POs = $2200 X-Axis represents number of Purchase Orders

Multiple Linear Relationships Exist Essentially any two points on the graph represent a linear relationship X-Axis represents number of Purchase Orders

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 $20/unit 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 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 Fixed Cost Total Cost – Variable Cost = Total $ high output – VC $/unit * # Units high output $3000 – ($20/unit * 120 units) $3000 – ($20 * 120 ) $3000 – $2400 = $600 Total Cost – Variable Cost = Total $ high output – VC $/unit * # Units high output $3000 – ($20/unit * 120 units) $3000 – ($20 * 120 ) $3000 – $2400 = $600 Total Cost – Variable Cost = Total $ high output – VC $/unit * # Units high output $3000 – ($20/unit * 120 units) $3000 – ($20 * 120 ) $3000 – $2400 = $600 Total Cost – Variable Cost = Total $ high output – VC $/unit * # Units high output $3000 – ($20/unit * 120 units) $3000 – ($20 * 120 ) $3000 – $2400 = $600

Express the Mixed Cost Relationship Total Cost = VC $/Unit * # Units + Fixed Cost Total Cost = $20/Unit * # Units + $600 Total Cost = VC $/Unit * # Units + Fixed Cost Total Cost = $20/Unit * # Units + $600

Using 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 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 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

Using the Cost Expression (Cont.) 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? 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? 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? 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?

LSA #2 Check on Learning Q1. What might cause a difference between the expected cost using High-Low and the actual cost? A1. Show Slide #22: LSA #2 Check on Learning Facilitator's Note: Ask check on learning question, facilitate discussion on answers given. Facilitator's Note: This is an animated slide, click on mouse or space bar for transition two part answer. Q1. What might cause a difference between the expected cost using High-Low and the actual cost? A1. High-Low is just an average, assuming the relationship between the highest output and the lowest are representative of the whole. NOTE: This may not be the case. Sometimes the differences are due to actual cost overruns or savings from efficiencies.

LSA #2 Summary During this lesson, we studied and talked about graphs for calculating fixed and variable cost components utilizing multiple linear relationships, calculating unit variables and fixed cost and cost expressions. Concluding with a PE for calculating the answers to the variable cost per mile, fixed cost, and develop of cost for its scenario.

Enter and Filter Data to identify if relationship is reasonably linear The spreadsheet calculates the Variable and Fixed portions of the cost

Practical Exercise

TLO Summary Action: Determine the Fixed and Variable Components of a Mixed Cost Using the High-Low Method Condition: FM Leaders in a classroom environment working individually and as a member of a small group, using doctrinal and administrative publications, self-study exercises, personal experiences, practical exercises, handouts, and discussion. Standard: With at least 80% accuracy (70% for International Learners): Identify High-Low Method Calculate Fixed and Variable Cost Components from Mixed Cost Data