Question

LO 2.3Explain how the high-low method is used for cost estimation. What, if any, are the limitations of this approach to cost estimation?

Answer 1

Answer:

The high and low method of cost estimation considers the difference between highest cost and lowest cost and the difference between highest activity and lowest activity in determining the variable cost and fixed cost. High and low method only considers two extreme values ie the highest points and lowest points. This method is subjective because it does not give the best estimate of cost.

Explanation:

In high and low method of cost estimation, lowest cost is deducted from highest cost. Lowest activity is also deducted on highest activity. The difference in cost is divided by the difference in activity level in order to obtain the variable cost per unit. Fixed cost is calculated by applying the linear equation Y = a + bx.

We will substitute the highest activity (x), highest cost (Y) and variable cost per unit(b) into the above formula and obtain the fixed cost (a). Fixed cost is the subject of the formula.                                                                                                                                                                                                                                                                                                                        

Answer 2

Answer:

Please see explanation

Explanation:

The following steps are used to estimate cost in high-low method:

Step 1: Take the activity level and cost for

the highest activity level

the lowest activity level

Step 2: The variable cost per unit can be calculated as:

Variable cost per unit=Difference in total cost at two levels/difference in number of units at two levels.

Step 3: Having calculated the variable cost per unit of activity, fixed cost can be calculated by substitution into one of the cost expressions.The difference between the total costs at this activity level and the total variable costs at this activity level is the fixed cost.

Limitations:

High- Low analysis uses just two sets of data i.e. highest value and lowest value for cost estimation. Due to this reason, this analysis can not be used for rough estimation.Since the other methods of cost estimation such as regression analysis calculates a line of best fit for all the available data, it is likely to provide a more reliable estimate than the high low analysis.