Mixed cost behavior is displayed when activities use a mix of resources that are: (1) acquired in advance and (2) acquired as needed. Sometimes it is easy to identify the variable and fixed components of a mixed cost, as in the scenario in Step 2 for the Landry Security Systems sales representatives. Many times, however, the only information available is the total cost of an activity and a measure of output (the variables Y and X). Since accounting records typically show only the total cost and the associated output of a mixed cost item, it is necessary to separate an activity’s total cost into its fixed and variable components.
The high-low method is a widely used quantitative method that separates a mixed cost into its fixed and variable components. The high-low method assumes a linear cost relationship: Y – F + VX. Since the accounting records reveal only X and Y, those values must be used to estimate the component parameters F and V.
Basic geometry tells us that two points determine a line. F, the fixed cost component, is the intercept of the total cost line, and V, the variable cost per unit, is the slope of the line. Given two points, the slope and the intercept can be determined. The high-low method preselects the two points that are used to compute the parameters F and V. The high point is defined as the point with the highest output or driver level. The low point is defined as the point with the lowest output or driver level. Note that the high and low points are determined by the independent variable, not the dependent variable (typically cost). With the two points identified, the slope (variable cost) is estimated first by the following equation:
| V = (Y2 – Y1)/(X2 – X1) |
| V = (Cost of High Point – Cost of Low Point)/(High Activity Level – Low Activity Level) |
Once the variable cost is calculated, the fixed cost is then calculated using the following formula and the values associated with either the high or the low point (but only the values from the same point):
| F = Y – VX |
| F = Total Cost – (Variable rate × Level of activity) |
Apply the Concepts
Introduction:
McCourt Company had the following 10 months of data on materials handling cost and number of moves within its manufacturing plant:
| Month | Materials Handling Cost | Number of Moves |
|---|---|---|
| January | $5,600 | 475 |
| February | 3,090 | 125 |
| March | 2,780 | 175 |
| April | 8,000 | 600 |
| May | 1,990 | 200 |
| June | 5,300 | 300 |
| July | 4,300 | 250 |
| August | 6,300 | 400 |
| September | 2,000 | 100 |
| October | 6,240 | 425 |
Required:
| 1. | Based on the above data, determine the high point and the low point for McCourt Company (provide the month, total cost and activity level (number of moves in your response)): | ||||||||||||||||||
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| 2. | Calculate McCourt Company’s variable rate for materials handling based on the number of moves (round to the nearest cent): | ||||||||||||||||||
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Variable rate = $ |
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| 3. | Calculate McCourt Company’s fixed monthly cost of materials handling (round to the nearest dollar): | ||||||||||||||||||
| Fixed cost = $
per month |
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| 4. | Based on the variable rate and fixed monthly cost in Requirements 2 and 3, provide the following estimated materials handling costs for the coming year if the number of moves expected is 4,000 (round to the nearest dollar): | ||||||||||||||||||
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