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

Exercise 42

High-Low Method, Scattergraph

Academy Products manufactures a variety of custom components for use in aircraft navigation and communications systems. The controller has asked for your help in estimating fixed and variable overhead costs for Academy’s Rio Puerco plant. The controller tells you that the best cost driver for estimating overhead is machine-hours.

Monthly data on machine-hours and overhead costs for the last year have been collected and are shown below:

Month	Machine-Hours	Overhead Costs
1	630,000	$ 660,000
2	900,000	2,170,000
3	765,000	1,220,000
4	665,000	780,000
5	1,035,000	3,700,000
6	800,000	1,400,000
7	750,000	1,100,000
8	815,000	1,500,000
9	935,000	2,500,000
10	680,000	840,000
11	715,000	980,000
12	700,000	910,000

Required

a. Estimate the monthly fixed costs and the unit variable cost per machine-hour using the high - low estimation method.

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b. Draw a scattergraph relating overhead costs to the number of machine-hours.

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c. Considering your scattergraph, how much confidence do you have in your estimate from requirement (a)?

Step 1 of 4

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.

Scatter graph

This graph indicates the relationship between cost and volume which based on past knowledge. Scatter graph considers all data points and develops a pattern of data points and provide rough estimation of cost. This graph also indicates fixed and variable of costs with activity level. It also shows the activity level where the relationship between cost activity level changes.