COST ESTIMATION
USING HIGH AND LOW ACC 221 (TOPIC 3)
METHOD
OBJECTIVES
Participants should be able:
Define cost estimation
Identify various methods of cost estimation
Separate semi-variable costs into fixed and variable components
(using high and low method)
Estimate total cost from a linear cost function
COST ESTIMATION
Measurement / analysis of historical cost
objective of predicting future costs
Provides estimates
Aids decision making
TECHNIQUES OF COST
ESTIMATION
Account classification method
High and low method (range method)
Scattered graph
Regression analysis (least square method)
ACCOUNT CLASSIFICATION
METHOD
Examines items of expenses
Classifies based on the subjective judgement of the accountant
Fast and inexpensive
Simple and easy to understand
Initial classification has considerable subjective elements
Separation of semi-variable cost into fixed and variable
components is arbitrary
HIGH AND LOW METHOD
Historical costs are measured and analysed
Selects costs in two particular periods for estimation
Period with lowest activity level
Period with highest activity level
Difference between the total cost of identified periods is variable
cost of the difference in activity level
Not a subjective method of estimation
Ignores information between two extremes of observation used
SCATTERED GRAPH
Visual technique
Plots the coordinates of the cost and activity level (of previous
periods) on a graph
Fixed cost is calculated at the point of interception with cost axis
Gradient of the line represents variable cost (rate of change of cost
with activity level)
REGRESSION ANALYSIS
Statistical technique
Uses the whole of historical data available
Uses computers and electronic devices which are not prone to
errors
Requires a large number of observations
ILLUSTRATION (HIGH AND
LOW METHOD)
Recall that this method uses the highest and lowest periods of
sctivity level in cost estimation
ACTIVITY LEVEL (units TOTAL COST
produced/sold, hours
spent/
Highest A C
Lowest B D
Difference A-B C-D
Variable cost= C-D
A-B
ILLUSTRATION (HIGH AND
LOW METHOD)
Total cost function
y = a+bx
Where
a = fixed cost
b = variable cost
x = activity level
y = total cost
ILLUSTRATION (HIGH AND
LOW METHOD)
Where
Variable cost= C-D
A-B
y = a + (C-D) x
A-B
a = y - (C-D) x
A-B
EXAMPLE 1 (HIGH AND LOW
METHOD)
Tolulope Plc uses the high-low method of estimating costs.
The firm had total costs of ₦50,000 at its lowest level of activity,
when 5,000 units were sold.
At its highest level of activity when sales equaled 12,000 units, total
costs were
₦ 78,000.
i. What is the variable cost per unit sold for Tolulope Plc
ii. What is its fixed cost
iii. Determine the total cost if 20,000 units are sold
SOLUTION 1 (HIGH AND LOW
METHOD)
TOLULOPE PLC
ACTIVITY LEVEL (units Total cost (₦)
sold)
Highest 12000 78000
Lowest 5000 50000
Difference 7000 28000
Recall: (C-D) for computing the variable cost
A-B
i. Variable cost per unit sold
₦ (78000-50000) = ₦28000 = ₦4 per unit
(12000- 5000) units 7000 units
SOLUTION 1 (HIGH AND LOW
METHOD)
Recall: a = y - (C-D)x for computing the fixed cost
A-B
Using the lowest activity as basis for computing fixed cost,
a = ₦50000 – ₦4(5000units)
a = ₦50000 – ₦20000
a = ₦ 30000
ii. Fixed cost = ₦ 30000
Exercise: Calculate the fixed cost using the highest activity level as
the basis
SOLUTION 1 (HIGH AND LOW
METHOD)
Recall: y = a+bx
y = ₦ 30000 + ₦4(20000units)
y = ₦ 30000 + ₦ 80000
y = ₦ 110000
iii. Total cost if 20,000 units are sold = ₦ 110000
EXAMPLE 2 (HIGH AND LOW
METHOD)
At an activity level of 8,300 machine-hours in a month, Bolu
Company’s total variable maintenance cost is ₦220,448 and its total
fixed maintenance cost is ₦556,764. What would be the total
variable maintenance cost at an activity level of 6000 machine-
hours in a month?
Solution:
Variable cost per hour = ₦220448/8300 hours = ₦26.56/hour
Total variable cost @ 6000 machine hours = 6000 hours *
₦26.56/hour
= ₦159360
EXAMPLE 3 (HIGH AND LOW
METHOD)
Binta Ltd has computed its total factory overhead at high and low
levels of activity as follows.
Direct labour hours Total factory
overhead (₦)
Low 50000 142000
High 75000 176250
Assume that the factory overhead cost above consist of direct
materials, rent and maintenance expenses. The company has
analysed at the 50000 direct labour hours as follows:
₦
Indirect materials (variable) 50000
Rent (fixed) 60000
Maintenance (mixed) 32000
EXAMPLE 3 (HIGH AND LOW
METHOD)
The maintenance cost is to be separated into its variable and fixed
components for planning purposes.
Required:
i. Determine how much of the factory overhead cost at the high
activity level is the maintenance cost
ii. Using the high and low method of cost estimation, determine
the cost function of the maintenance cost
iii. Determine the total factory overhead cost at 100000 labour
hours
SOLUTION 3 (HIGH AND LOW
METHOD)
BINTA LTDLOW (50000 HIGH(75000
hours) hours)
₦ ₦
Indirect material (variable) @ ₦1 per hour 50000 75000
Rent (fixed) 60000 60000
Maintenance cost 32000 X(unknown)
Total 142000 176250
i. Maintenance cost @ 75000 hours (unknown)
= ₦ 176250- ₦(75000+60000)
= ₦ (176250-135000)
= ₦ 41250
SOLUTION 3 (HIGH AND LOW
METHOD)
Maintenance cost (₦) Machine hours
Low 32000 50000
High 41250 75000
Difference 9250 25000
Variable maintenance cost= ₦ 9250/25000 hours = ₦ 0.37 per hour
Maintenance cost function
y =a+bx
SOLUTION 3 (HIGH AND LOW
METHOD)
@ the lowest level of machine hours (50000 hours),
y = a + bx
₦ 32000 = a + ₦ 0.37(50000 hours)
₦ 32000 = a + ₦ 18500
a = ₦ 32000 – ₦ 18500
a = ₦ 13500
ii. Maintenance cost function=₦ 13500 + ₦ 0.37x
SOLUTION 3 (HIGH AND LOW
METHOD)
iii. Total maintenance cost @ 100000 labour hours
= ₦ 13500 + ₦ 0.37 (100000)
= ₦ 13500 + ₦ 37000 = ₦ 50500
100000 hours
₦
Indirect material (variable) @ ₦1 per hour 100000
Rent (fixed) 60000
Maintenance cost 50500
Total 210500
PRACTICE QUESTION 1 (HIGH
AND LOW METHOD)
Given the electrical costs at one of Rita factories below, using the high
and low method, calculate the estimate of the fixed and variable
components of the electrical costs
Months Machine- Electrical Cost
Hours (₦)
March 413 7,371
April 506 7,740
May 435 7,447
June 486 7,660
July 499 7,704
August 461 7,563
September 467 7,571
October 458 7,522
November 425 7,403
PRACTICE QUESTION 2
(HIGH AND LOW METHOD)
Muinat Company produces and sells souvenir products. Monthly income statements for two
activity levels are provided below:
Product 1 Product 2
Number of units 20000 30000
Salaries and commissions 20000 25000
Advertising expenses 30000 30000
Administrative expenses 12500 12500
Required:
a) Identify the mixed expense(s)
b) Use the high-low method to separate the mixed expenses into variable and fixed
components
c) Determine the expenses if 50000 units are sold
Thank you for
listening
