Companies use variable costs to evaluate business decisions, to create realistic budgets and to set selling prices. Some business decisions require the company to consider selling products at a reduced price. In these situations, the company needs to ensure that the reduced price still covers the variable costs. Realistic budgets need to account for variable costs, which change as production changes. Some costs, called mixed costs, include both fixed and variable characteristics. The high-low method provides a tool for determining the variable portion of a mixed cost. An example of a mixed cost is the electric bill. One portion of the electric bill, the access charge, remains fixed. The other portion of the electric bill, based on kilowatt hours, varies with the usage.
Instructions
1. Identify the mixed cost for which you need to determine the variable cost. Classify each cost on your expense report as fixed, mixed or variable. Choose one of the mixed costs for which to calculate the variable cost.
2. Choose several reference points. Review the actual expense and usage data for the mixed cost you are analyzing. Gather each month's expense report and pull the total expense amounts from these reports. Review monthly production reports and locate the total production volume for each month. Create a list and include the month, the total mixed cost and the total production volume.
3. Identify the high point. Review the list and locate the month with the highest production volume. Highlight the month, the expense and the volume for this point.
4. Identify the low point. Review the list and locate the month with the lowest production volume. Highlight the month, the expense and the volume for this point.
5. Calculate the difference between the high and low points. Using the highlighted numbers, subtract the lowest production volume from the highest production volume. Subtract the lowest expense from the highest expense.
6. Calculate the variable cost per unit. Divide the difference in the expenses by the difference in the production volumes. This provides the variable cost per unit for this mixed cost.
Tags: mixed cost, production volume, electric bill, month expense, variable costs, business decisions