Managerial Accounting Notes
Managerial Accounting Notes
Managerial Accounting Notes
High-Low Method
High-Low method is one of the several techniques used to split a mixed cost into its fixed
and variable components (see cost classifications). Although easy to understand, high low
method is relatively unreliable. This is because it only takes two extreme activity levels (i.e.
labor hours, machine hours, etc.) from a set of actual data of various activity levels and
their corresponding total cost figures. These figures are then used to calculate the
approximate variable cost per unit (b) and total fixed cost (a) to obtain a cost volume
formula:
y = a + bx
Variable cost per unit (b) is calculated using the following formula:
y2 y1
Variable Cost per Unit =
x2 x1
Where,
y2 is the total cost at highest level of activity;
y1 is the total cost at lowest level of activity;
x2 are the number of units/labor hours etc. at highest level of activity; and
x1 are the number of units/labor hours etc. at lowest level of activity
The variable cost per unit is equal to the slope of the cost volume line (i.e. change in total
cost change in number of units produced).
Total fixed cost (a) is calculated by subtracting total variable cost from total cost, thus:
Total Fixed Cost = y2 bx2 = y1 bx1
Example
Company wants to determine the cost-volume relation between its factory overhead cost
and number of units produced. Use the high-low method to split its factory overhead (FOH)
costs into fixed and variable components and create a cost volume formula. The volume
and the corresponding total cost information of the factory for past eight months are given
below:
Sales mix is the proportion in which two or more products are sold. For the calculation of
break-even point for sales mix, following assumptions are made in addition to those
already made for CVP analysis:
1. The proportion of sales mix must be predetermined.
2. The sales mix must not change within the relevant time period.
The calculation method for the break-even point of sales mix is based on the contribution
approach method. Since we have multiple products in sales mix therefore it is most likely
that we will be dealing with products with different contribution margin per unit and
contribution margin ratios. This problem is overcome by calculating weighted average
contribution margin per unit and contribution margin ratio. These are then used to
calculate the break-even point for sales mix.
The calculation procedure and the formulas are discussed via following example:
Calculation
Step 1: Calculate the contribution margin per unit for each product:
Product A B C
Sales Price per Unit $15 $21 $36
Variable Cost per Unit $9 $14 $19
Contribution Margin per Unit $6 $7 $17
Step 2: Calculate the weighted-average contribution margin per unit for the sales mix using
the following formula:
Product A CM per Unit Product A Sales Mix Percentage
+ Product B CM per Unit Product B Sales Mix Percentage
+ Product C CM per Unit Product C Sales Mix Percentage
= Weighted Average Unit Contribution Margin
Product A B C
Sales Price per Unit $15 $21 $36
Variable Cost per Unit $9 $14 $19
Contribution Margin per Unit $6 $7 $17
Sales Mix Percentage 20% 20% 60%
$1.2 $1.4 $10.2
Sum: Weighted Average CM per Unit $12.80
Step 3: Calculate total units of sales mix required to break-even using the formula:
Break-even Point in Units of Sales Mix = Total Fixed Cost Weighted Average CM per Unit
Total Fixed Cost $40,000
Weighted Average CM per Unit $12.80
Break-even Point in Units of Sales Mix 3,125
Step 4: Calculate number units of product A, B and C at break-even point:
Product A B C
Sales Mix Ratio 20% 20% 60%
Total Break-even Units 3,125 3,125 3,125
Product Units at Break-even Point 625 625 1,875
Step 5: Calculate Break-even Point in dollars as follows:
Product A B C
Product Units at Break-even Point 625 625 1,875
Price per Unit $15 $21 $36
Product Sales in Dollars $9,375 $13,125 $67,500
Sum: Break-even Point in Dollars $90,000