1. Identifying Cost Relationships High-Low Method © Dale R. Geiger 20111

2. How can we determine which costs are fixed and which are variable? © Dale R. Geiger 20112

3. Terminal 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 20113

4. 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 © Dale R. Geiger 20114

5. 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 © Dale R. Geiger 20115

6. 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: $ high output – VC $/unit * # Units high output © Dale R. Geiger 20116

7. 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: $ high output – VC $/unit * # Units high output © Dale R. Geiger 20117

8. 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) © Dale R. Geiger 20118

9. 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) © Dale R. Geiger 20119

10. Check 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 201110

11. High-Low Example The purchasing department shows the following activity for the last four months: MonthPOs ProcessedTotal Costs Jan100 $2500 Feb802200 Mar1203000 April1052750 © Dale R. Geiger 201111

12. 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 © Dale R. Geiger 201112

13. Graph of Actual Costs Cost at 120 POs = $3000 Cost at 120 POs = $3000 Cost at 80 POs = $2200 Cost at 80 POs = $2200 X-Axis represents number of Purchase Orders © Dale R. Geiger 2011 13

14. Multiple 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 14

15. 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 © Dale R. Geiger 2011 15

16. 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 © Dale R. Geiger 201116

17. 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 © Dale R. Geiger 201117

18. 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 © Dale R. Geiger 201118

19. 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 © Dale R. Geiger 201119

20. 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 © Dale R. Geiger 201120

21. 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 © Dale R. Geiger 201121

22. 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 © Dale R. Geiger 201122

23. Express the Mixed Cost Relationship Total Cost = VC $/Unit * # Units + Fixed Cost Total Cost = $20/Unit * # Units + $600 © Dale R. Geiger 201123

24. Express the Mixed Cost Relationship Total Cost = VC $/Unit * # Units + Fixed Cost Total Cost = $20/Unit * # Units + $600 © Dale R. Geiger 201124

25. 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 © Dale R. Geiger 201125

26. 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 © Dale R. Geiger 201126

27. 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 © Dale R. Geiger 201127

28. Using 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 201128

29. Using 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 201129

30. Using 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 201130

31. Using 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 201131

32. Check on Learning What might cause a difference between the expected cost using High-Low and the actual cost? © Dale R. Geiger 201132

33. Practical Exercise © Dale R. Geiger 201133

34. © Dale R. Geiger 201134 Enter and Filter Data to identify if relationship is reasonably linear The spreadsheet calculates the Variable and Fixed portions of the cost

35. Practical Exercise © Dale R. Geiger 201135