High-low: how to calculate fixed and variable costs
In the real world, even fixed costs can change during a year if a supplier puts up their prices. Likewise, the cost per unit of variable costs might also change. How do we account for this?
One of the main reasons for calculating costs is so we can use them to forecast what might happen in the future and set a budget accordingly. But calculating the costs you have already paid is pointless unless you can use them to accurately estimate costs that are upcoming.
The answer is the ‘high-low method’.
In this video, the Kaplan tutor expands on what you learned in Identifying fixed and variable costs, and explains how this method can be used when an organisation has many items of data available rather than just two. Basically put, the method involves looking at the data associated with the highest level and the lowest level of activity during a given period.
The video includes the following table:
| Month | Output (units) | Cost ($) |
|---|---|---|
| January | 1,800 | 35,000 |
| February | 2,450 | 41,150 |
| March | 2,300 | 41,750 |
| April | 2,000 | 38,000 |
| May | 1,750 | 36,250 |
| June | 1,950 | 37,650 |
The highest and lowest levels of output are the following:
| Month | Output (units) | Cost ($) |
|---|---|---|
| February | 2,450 | 41,150 |
| May | 1,750 | 36,250 |
On the graph, a straight line is drawn between these two points.
Budget Forecasting, Costing, and Variances
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