High Low Method and Philosophy (15 points)

High Low Method and Philosophy (15 points)

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Please refer to page 6 from Syllabus which describes the format and content of this assignment. You are asked to compose a brief memorandum (executive summary) describing your conclusions.  You are asked to provide support for your memorandum in the form of numerical or other data.

Learning Objective Chapter 20: Describe and illustrate the role, purpose and financial rational for the High Low Method.

1. Describe the definition and behavior of a variable and fixed cost in a manufacturing business’s income statement.

As business activities levels changes, some costs undergo variations and others do not. This response of cost to fluctuations in business activity is defined as cost behavior. Understanding cost reaction to change in levels of activities eases budget derivation, determination of profit a product is expected to generate, forecast preparation, and determining alternatives to be undertaken. Costs are categorized in three; fixed, variable and’ mixed costs. Variable cost changes regarding the production volume of a manufacturing business, it may increase or decrease depending on production volume. This means that if the volume of production increases, variable costs will escalate. Variable costs can be calculated using this formula;

Total Variable Costs = Total quantity of output * variable costs per unit of output

Fixed costs, on the other hand, are not affected by the production volume. Fixed cost does not change whether goods or services are produced. In this case, if a company has more fixed costs, it will have to employ more revenue to break even. This means that the company will have to work extra harder to manufacture and sell it is products. The fixed cost can be calculated using this formula;

Fixed cost = Total cost of production – Variable Cost Per Unit* No. of Units Produced

2. Explain the definition of a mixed cost and provide two examples in a manufacturing business’s income statement.

Mixed cost refers to the total cost that involves a combination of two types of costs, the variable cost and the fixed cost which means that some part of it does not respond to change in production while others do. In my view, every company should understand the combination of these elements. This will help manufacturers predict changes in costs at different levels of production activities. The fixed cost can be calculated through the following formula;

Where,

y is a total mixed cost

a is the fixed cost

b variable rate

x unit number

3. Explain what the key elements/factors are required in the High Low Method formula.

High Low Method is a way to separate fixed costs and variable costs from the amount of data. It entails taking the highest activity level and comparing the total costs at each level which implies that it is possible to determine the variable and fixed costs in a particular set of data. When separating the two costs, the High-Low Method put into consideration two factors. Mixed costs total dollars at the highest production level and the mixed costs dollars at the lowest production level. However, at both points of activity, the amount of fixed costs is always assumed. The change in total cost can be achieved multiplying variable costs rate with the activity number units.

4. How does the High Low Method and Formula assist Business?

Apart from discerning fixed and variable costs in data portions, this method is also useful in price analysis and deriving budgets. It also could be used in determining variable and fixed costs components within a product, geographic sales region, a customer, subsidiary or a machine.