Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 26

Methods of Estimating Costs: High-Low

Adriana Corporation manufactures football equipment. In planning for next year, the managers want to understand the relation between activity and overhead costs. Discussions with the plant supervisor suggest that overhead seems to vary with labor-hours, machine-hours, or both. The following data were collected from last year’s operations:

Month	Labor-Hours	Machine-Hours	Overhead Costs
1	3,625	6,775	$513,435
2	3,575	7,035	518,960
3	3,400	7,600	549,575
4	3,700	7,265	541,400
5	3,900	7,955	581,145
6	3,775	7,895	572,320
7	3,700	6,950	535,110
8	3,625	6,530	510,470
9	3,550	7,270	532,195
10	3,975	7,725	565,335
11	3,375	6,490	503,775
12	3,550	8,020	564,210

Required

a. Use the high-low method to estimate the fixed and variable portions of overhead costs based on machine-hours.

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b. Managers expect the plant to operate at a monthly average of 7,500 machine-hours next year. What are the estimated monthly overhead costs, assuming no inflation?

Step 1 of 3

Cost estimation

Cost estimation is an important exercise because it helps managers in decision making. Correct cost estimates result in cost saving and making business successful. Cost estimates helps managers to evaluate and choose the best alternative. It is important for managers to capture the correct cost for each alternative.

There different methods used for cost estimation like engineering, accounting and statistical analysis.

High-low method of cost estimation

Under High-low method of cost estimation, variable cost is calculated by considering the total cost at highest and lowest level. The difference of total cost at highest and lowest activity level are divided by the difference of highest and lowest activity level to calculate variable cost per unit. This method compensates the price instability by considering the highest and lowest level of total cost and the activity level at those two points. Same way fixed cost is calculated by deducting variable cost at lowest activity level from total cost at lowest activity level.