accounting

High-low method
It is the simplest form of quantitative analysis.

It uses only the highest and lowest observed values of the cost
driver within the relevant range and their respective costs.

Under high-low method

Δy
(slope coefficient) b = Δ x

change∈costs
(or) = change∈activity∨cost driver

Change (∆) =highest observation−lowest observation

Example:
The following observation are available for Verina,an
accounting services firm,for its printing costs for the past 4 methods.

Month Pages Printing cost

July 8,000 $2,500
August 10,000 3,100
September 8,500 2,800
October 9,000 2,950

If Verina uses the high-low method

1-Which month is considered the high month,and which month is

considered the low month?

2-What is the slope coefficient for each page?

3-What is the constant for the month for printing?

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4-What are printing costs expected to be in November if 8,800 pages are
expected to be printed?

5-What are printing costs expected to be in November if 12,000 pages are

expected to be printed?

Solution:
1-August is considered the highest month and July is considered
the lowest month.

2-∆x=10000-8000=2000

∆y=3100-500=600
Δy 600
Slope coefficient(b)= Δ x = 2,000 =,3

3- 3100=a+,3(10,000) so, constant a=3,100-3,000=100

Estimated cost function is

4- Y=100+,3(8,800)=2,740

5- 12,000 pages are outside the relevant range of estimation (higher

than highest point)so the estimated cost function will not be valid if it used
to estimate the costs outside the relevant range.

Example:
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As part his job as cost analyst,pullitgn collected the following
information concerning the operations of the machining department:

Observation Machine Total operating costs

January 4,000 $45,000
Februry 4,600 49,500
March 3,800 45,750
April 4,400 48,000
May 4,500 49,800
Required:
1-Use the high-low method to determine the estimating cost function with
machine – hours as the cost driver.

2-If june’s estimated machine – hours total 4,200 , what are the total
estimated costs of machining department?

Solution:
Observation Machine-hours(x) Total operating
costs(y)
Highest observation 4600 49,500
Lowest observation 3800 45,750

1- ∆x=4,600-3,800=800

∆y=49,500-45,750=3,750
Δy 3,750
B= Δ x = 800 = 4.6875 per machine hour

49,500=a+4.6875(4600)

49,500=a+21562.5
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a=49,500-21562.5

a=27937.5

Estimated cost function

Y=27937.5+4.6875x (mixed cost function)

2- Y=27937.5+4.6875x

Y=27937.5+4.6875(4200) = 47,625

Example:
The president of beta company,has asked for information
about the cost behavior of manufacturing overhead costs. Specifically,he
wants to know how much overhead costs is fixed and how much is
variable. The following data are the only records available:

Observation Machine-hours Total overhead costs

February 1,700 20,500
March 2,800 22,250
April 1,000 19,950
May 2,500 21,500
June 3,500 23,950
Required:
Using the high-low method,determine the overhead cost
equation.use machine-hours as your cost driver.

Solution:
X Y
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High:June 3500 23950

Low:April 1000 19950

Difference 2500 4000

4000
Variable cost per MH (b) = 2500 = 1.60 per MH

Fixed cost (a) =19950=a+1.60(10000)

A=$18,350

Estimated cost equation:

Y=18,350+1.60x (mixed cost function)

Example:
Given the following information about maintenance hours
and costs for six periods:

Period Maintenance hours Maintenance costs

1 300 900
2 200 850
3 400 1000
4 350 910
5 250 880
6 150 800

Required:
1-use the high low method to estimate the cost function

2-what is the maintenance cost if the expected maintenance

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hours is 380?

3-what is the maintenance cost if the expected maintenance

hours is 450?

Solution:
Δy 1000−800
1- Slope coffiecient (b) = Δ x = 400−150 = ,8

Y=a+,8x

1000=a+.8(400)

A=1000-320=680

Estimated cost function is y=680+.8x

2-Y=680+,8(380)=984

3- 450 are outside the relevant range of estimation (higher than

highest point)so the estimated cost function will not be valid if it is
used to estimate the costs outside the relevant range.

2-Regression analysis method(least squares method)

Statistical method that measure the average amount of changes in the
dependent variable associated with a unit change in one or more
independent variable .
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Types of regression
1-simple regression:analysis estimates the relationship between
dependent variable and one independent variable.

2-multiple regressions:analysis estimates the relationship between the

dependent variable and two or more independent variables.

Note.regression analysis is more accurate than high low method because

regression method estimates costs using information from all observations
while the high low method uses information from only two observation

Under regression method

( ∑ y ) ( ∑ x 2 ) −( ∑ x ) (∑ xy )
A= n ( ∑ x ) −( ∑ x ) (∑ x)
2

n ( ∑ xy )−( ∑ x ) (∑ y)
B= n ( ∑ x ) −( ∑ x ) (∑ x )
2

Example:
Presented below is the production data for the six months of the year for
the mixed costs incurred by paris company

Month Machine hours Total operating cost

Jan 185 90
Feb 220 110
Mar 200 100
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Apr 240 120
may 170 85
June 215 105

If paris company uses the regression method to analyze mixed

costs.estimate cost function.

Sol:
2
X Y Xy x
90 185 16,650 8,100
110 220 24,200 12,100
100 200 20,000 10,000
120 240 28,800 14,400
85 170 14,450 7225
105 215 22,575 11025
∑x=610 ∑y=1,230 ∑xy=126,675 ∑ x 2=62,850

( ∑ y ) ( ∑ x 2 ) −( ∑ x ) (∑ xy )
A=
n ( ∑ x ) −( ∑ x ) (∑ x)
2

( 1230 )( 62850 )−( 610 ) (126675)

A= 6 ( 62850 )−( 610 ) (610)

A=6.75
n ( ∑ xy )−( ∑ x ) (∑ y)
b= n ( ∑ x 2 ) −( ∑ x ) (∑ x )

6 ( 126675 )−( 610 ) (1230)

b= 6 ( 62850 )−( 610 ) (610)

b=1.95

y=6.75+1.95x
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Cost function:

It is a mathematical description of how a cost changes in the level of an

activity relating to that cost.

Total cost =fixed cost+variable cost

Tc= fc + vc

(or) y=a + bx

Y:total cost

A:constant or intercept or fixed cost

B:slope coefficient or rate of activity or variable cost per unit

Note

Cost function may be expressed as follows

1-fixed cost function:cost function in which all costs are fixed

Fixed cost function y=a

2-variable cost function:cost function in which all costs are variable

Variable cost function y=bx

3-mixed cost function:cost function that has both fixed and variable
elements

Mixed cost function y=a+bx

Example:
For the negotiation between cannon services and world wide
communication (wwh) for exculsive use of a telephone line between
NewYork and paris, wwh offers three altenative cost structure.
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Required

For each alternative compute total cost

Alternative 1: 5 per phone minute used

Sol:

Total cost changes with the number of phone minutes used

Y=bx

Y=5x (variable cost function)

Alternative 2: 10,000 per month

Total cost will be 10,000 per month ,regardless of the number of phone
minutes used,

So. Y=a

Y=10,000 (fixed cost function)

Alternative 3: 3,000 per month plus 2 per minute for phone use

Y=3000+2x (mixed costs function)

Example:
Refer to the previous example assume that cannon services expect to use
at least 4000 phone minutes per month.

What is the total cost under the three alternatives?

Solution:

Alternative 1: y=bx = 5x4000 = 20,000

Alternative 2 : y=a = 10,000

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Alternative 3 : y=a+bx = 3000+(2 X 4000) = 11000

Note

linear cost function : is a cost function for which the graph for total cost is
straight line within the relevant range.

Nonlinear cost function: is a cost function for which the graph for total
cost is not straight line within the relevant range.

Cost classification and estimation function

Classification of costs to variable and fixed costs depends on the following
criteria.

1-choice of cost object.

.different cost object may result to different classification of the same cost.

.if the cost object is number of taxis so the license fees will be variable
cost ,but if the cost object is miles driven so the license fees is fixed cost .

2-Time horizon

.whether a cost is variable or fixed with respect to a particular activity

depends on the time span.

.more costs are variable with longer time spans.

3-Relevant range

.variable and fixed cost behavior patterns are valid for linear cost functions
only within the given relevant range.

.costs may behave nonlinear outside the range.

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.cost estimation: is the attempt to measure a past cost relationship costs
and the level of an activity.

.past cost behavior functions can help managers make more accurate cost
predictions.

.better cost predictions help managers make more informed planning and
control decisions.

The cause and effect criterion in choosing cost drivers.

Without cause and effect relationship between cost and the level of activity
managers will be unable to estimate or predict costs.

Cause and effect relationship might arise as a result of:

a)physical relationship between the level of activity and costs

b)contractual arrangement

c)knowledge of operation

cost estimation method (approaches)

four methods of cost estimation:

1-the industrial engineering method(work measurement method)

.estimate cost function by analyzing the relationship between inputs and

outputs in physical terms.

.the industrial engineering method can be very time consuming

.many organization find it too costly to use for the entire cost structure.

2-Conference method
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Estimates cost functions on the basis of analysis and opinion about costs
and their drivers gathered from various department of an organization.

3-account analysis method

.Estimates cost function by classifying costs account into

variable ,fixed,mixed costs with respect to the identified level of activity.

.the cost analyst uses experience and judgment to separate total costs into
fixed and variable.

.it is easy to use and widely used method but its result is subjective.

4-The quantitative analysis method: uses formal mathematics models to fit

cost functions to past data observations . the most common quantitative
analysis methods are the high low method and regression analysis.