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High-Low Method of Separating Costs

 

For purposes of cost planning and control, semivariable and mixed costs must be divided into their respective variable and fixed cost components. This allows us to group them with other variable and fixed costs for analysis. When there is doubt about the behavior pattern of a particular cost, especially a semivariable cost, it helps to plot past costs and related measures of volumes in a scatter diagram. If the diagram suggests that a linear relationship exists, a cost line can be imposed on the data by either visual means or statistical analysis.

 

Here is an example:

 

Monthly Machine Hours and Electricity Costs
Month Machine Hours Electricity Costs
January 6,250 $24,000
February 6,300 24,200
March 6,350 24,350
April 6,400 24,600
May 6,300 24,400
June 6,200 24,300
July 6,100 23,900
August 6,050 23,600
September 6,150 23,950
October 6,250 24,100
November 6,350 24,400
December 6,450 24,700
Totals 75,150 $290,500

 

First you would identify the highest and lowest levels and then find the difference between them.

 

Volume Month Activity Level Cost
High December 6,450 machine hours $24,700
Low August 6,050 machine hours 23,600
Difference   400 machine hours $ 1,100

 

To determine the variable cost per machine hour, we divide the cost difference by the machine-hour difference: 

Variable cost per machine hour = $1,100 ÷ 400 machine hours 
                               = $2.75 per machine hour

Then we compute the fixed cost for any month (remember that fixed costs stay the same each month) by multiplying the machine hours times the variable rate and subtracting the amount from the total cost: 

Fixed cost for December = $24,700 - (6,400 x $2.75) 
                        = $6,962.50 


Fixed cost for August = $23,600 - (6,050 x $2.75) 
                      = $6,962.50

Here's the breakdown of total costs for the year:

Variable costs (75,150 x $2.75)            $206,662.50
Fixed costs [$290,500 - (75,150 x $2.75)     83,837.50 
                                           $290,500.00

This is the linear relationship of the data for the Winter Park Division: 

Total cost per month = $6,962.50 + $2.75 per machine hour.

 

scatter diagram plotting the machine hours and electricity costs