a =150,000 – 30,000 = Shs.120,000 Therefore the cost equation is:y = 120,000 + 100x This equation can be used to estimate or predict the total costs : for example, when the activity level is say at1000 labour hours, then the total cost would be Y= 120,000 + 1000(100)=120,000 + 100,000= Shs.220,000.
What are the advantages and disadvantages of the high low method?b)
Account Analysis (Inspection of Accounts)
Using account analysis, the accountant examines and classifies each ledger account as variable, fixed ormixed. Mixed accounts are broken down into their variable and fixed components. They base theseclassifications on experience, inspection of cost behaviour for several past periods or intuitive feelings of the manager.
Management has estimated Shs.1,090 variable costs, Shs.1,430 fixed costs to make 100 units using 500machine hours. Since machine hours drives variable costs in our example, the variable cost stated as Then we get the total cost equation as Y = ,1430 +2.18 xWhere y = total costx = number of machine hoursFor 550 machine hours Total cost = Shs.1,430 + Shs. 2.18 (550) = 1,430 + 1,999 = Shs.2,629 This analysis should determine whether any factors apart from output machine hours are influencing totalcost.A danger in using this method lies in the fact that many managers may assume a cost’s behaviour withoutfurther analysis. This is because the method is highly subjective.
This method is based on a detailed study of each operation where careful specification is made formaterials, labour and equipment necessary to produce a product. It involves identifying the level of inputrequired of an activity in form of raw material and labour while total cost is based on the cost of eachinput. This approach is applicable where no past data exists. The main setback of the approach is that itrequires a complex analysis of all the constituents of an activity and the requirements of an activity interms of costs detailed into materials, labour, overheads and time.d)
Visual fit (scatter graph method)
Cost estimation is based on past data regarding the dependent variable and the cost driver. The past dataon cost levels and the output levels) is plotted on a graph( called a scatter graph )and a line of best fit isdrawn as shown in the diagram . A line of best fit is a line drawn so as to cover the most points possibleon a scatter graph. Its intersection with the vertical axis indicates the fixed cost while the gradientindicates the variable cost per unit.