# high-low method

Problem 5-23 High-Low Method; Predicting Cost [LO1, LO3]

Echeverria SA is an Argentinian manufacturing company whose total factory overhead costs fluctuate somewhat from year to year according to the number of machine-hours worked in its production facility. These costs (in Argentinian pesos) at high and low levels of activity over recent years are given below:

Level of Activity

Low
High

Machine-hours
51,300

68,400

222,690
pesos
244,920
pesos

--------------------------------------------------------------------------------

The factory overhead costs above consist of indirect materials, rent, and maintenance. The company has analyzed these costs at the 51,300 machine-hours level of activity as follows:

Indirect materials (variable)
56,430
pesos

Rent (fixed)
129,000

Maintenance (mixed)
37,260

222,690
pesos

--------------------------------------------------------------------------------

For planning purposes, the company wants to break down the maintenance cost into its variable and fixed cost elements.

Requirement1:

Estimate how much of the factory overhead cost of 244,920 pesos at the high level of activity consists of maintenance cost. (Hint: To do this, it may be helpful to first determine how much of the 244,920 pesos cost consists of indirect materials and rent. Think about the behavior of variable and fixed costs.) (Omit the "pesos" sign in your response.)

Maintenance cost

pesos

Requirement2:

Using the high-low method, estimate a cost formula for maintenance where X represents the per machine-hour. (Omit the "pesos" sign in your response. Round the variable portion of the formula to 2 decimal places.)

Y
=

pesos
+

peso
X

Requirement3:

What total overhead costs would you expect the company to incur at an operating level of 56,430 machine-hours? (Omit the "pesos" sign in your response.)

pesos

--------------------------------------------------------------------------------

 tsmithers Posts: 6, Reputation: 1 New Member #2 Apr 23, 2009, 06:59 PM
I have the following answers; but I was having difficulty with the 3rd question.

I am showing #1: 54360

#2: 129000 + 5130
 morgaine300 Posts: 6,564, Reputation: 1474 Uber Member #3 Apr 24, 2009, 01:03 AM

Incorrect. Can you please show where you've gotten #1 from so we can see what has gone wrong.

#2 you're on the right track, but you've used the fixed for rent, instead of maintenance. I'm not sure where the 5130 came from, but keep in mind that an "equation" must have a variable. Make x equal the number of machine hours. It has to be the fixed costs for maintenance plus the variable times hours. i.e. this format:

fixed + variable per hour(x)

Leave the x in there so that it can be used for any level of machine hours. Otherwise it's an answer for one level, not an equation.
 tsmithers Posts: 6, Reputation: 1 New Member #4 Apr 24, 2009, 09:50 PM

I am going back over question this is what I show:

(244920-22269)/(68400-51300)
22230/17100 = 1.3
1.3X244920=318396
244920-318396

 morgaine300 Posts: 6,564, Reputation: 1474 Uber Member #5 Apr 25, 2009, 12:00 AM
[quote]
Quote:
 Originally Posted by tsmithers 22230/17100 = 1.3
That's correct, but that's also all variable costs per unit and doesn't divide down into the different costs. It always worries me when someone writes an answer like that as 1.3. It's money. This means you either aren't paying attention or you don't know that the 1.3 represents money, and you should. You should always know what your answers represent. It's 1.30 per unit variable.

Quote:
 1.3X244920=318396
That's where you're starting to go wrong. 244,920 is already the total costs for the high level. 1.30 is the cost per unit for variable costs. It's already part of the 244,920. In a way it's like saying your total grocery bill was \$134.16 and the milk was \$3.69 of that. And then doing 3.69 * 134.16, when the 3.69 was part of the total. As you see, there's no logic in that.

The 244,920 consists of both fixed and variable costs. The increase in costs from low to high of 22,230 can only be caused by a change in something variable. Because fixed costs are fixed and won't change no matter what you do to volume. The change in volume (machine hours that overhead was based on) is 17,100. That change is what caused the 22,230 change in cost. So by dividing, you're figuring out the rate per machine hour that is variable. 1.30 per machine hour.

Your next step is to go back and figure out for each level how much is variable and how much is fixed. Now that you know it's 1.30 per machine hour, take both the low and the high and figure out (at 1.30/hour) what the total variable costs would be for each level. I'm kind of thinking you may have been attempting to do this, but it's not 1.30 per dollar of cost, it's 1.30 per machine hour. Once you know the total variable for each level, you can figure out what's left over for the fixed costs.

While you are doing all this, be neat and label everything. There's a lot of numbers and pieces here and it's easy to get lost. You have to keep track of your numbers yourself - I can't do that for you.

Keep in mind that you have 3 overhead costs: indirect materials, rent and maintenance. Some of that is variable and some of that is fixed. If you have gotten the above part done, then you now know what fixed is (will be the same for all levels because it's fixed) and what the total variable is for each level. You can then figure out how much of the variable is indirect materials and how much of the fixed is rent. Pull those out and what you have left is maintenance.

See if you can work that far and see what you come up with. Long problem with lots of parts. I can't guide someone through the whole thing until you get more of it done.
 tsmithers Posts: 6, Reputation: 1 New Member #6 Apr 25, 2009, 06:52 AM

Machine hours:

High 68400/1.30 = 52,615.38
Low 51300/1.30 = 39,461.54
 tsmithers Posts: 6, Reputation: 1 New Member #7 Apr 25, 2009, 07:01 AM
Low High
Total 222,690 244,920
Rent (129,000) (129,000)
Indirect (39461.54) (52615.38)

Maint 54,228.46 63,304.62
 tsmithers Posts: 6, Reputation: 1 New Member #8 Apr 25, 2009, 09:35 PM

Question 1: Maint. 156000 - 129000 = 27000
Question 2: Y=156000 + 1.30 X(hours)
Question 3: 222,359 =156000+1.30*56430

 Kosovarja22 Posts: 1, Reputation: 10 Junior Member #9 Sep 7, 2011, 02:25 PM
For requirement 1, do you even have to use the linear function?

If at low activity, the indirect materials equals 56,430 pesos, then the variable cost per hour would be

--> 56,430 pesos/51,300 machine hours= 1.10 pesos per machine hour.

So at a high level of activity, would the indirect materials be:
--> Indirect materials =68,400 machine hours x 1.10 pesos per hour = 72,240

Since Fixed costs don't change, the fixed cost would remain at 129,000. So out of the total M.O.H, (244,920m.o.h-129,000rent-72,240indirect materials)= 43,680 maintenance mixed costs.

Please tell me if this is correct.

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