'''Estimating Costs Using the High-Low Method'''

 

                      

                '''Estimating Costs Using the High-Low Method'''

hello and welcome to another TLC tutoring accounting lesson um if you haven't subscribed already please be sure to subscribe as we do try to release new tutoring videos weekly today we're going to be going over then high-low method and this is a way of estimating costs based on some type of activity level I'm in our case we're going to be doing it for XYZ manufacturing company based on production volume so essentially volume in units produced now typically when you're doing one of these high-low method problems you're going to be provided with a series of activity levels over a certain period could be quarterly could be monthly could be annually and also the related costs now the main thing to keep in mind is when they're saying high -low they are referring to the designated activity so in our case the designated activity is production volume so don't get confused and accidentally focus on the high-low of the costs so our first step as we're doing this is to begin with the basic high-low method formula which is going to be our cost at high activity level minus our cost at low activity level and this is going to be divided by our highest activity level and our lowest activity level now that kind of begs the question what are we referring to when we're talking about highest and lowest this is what I was referring to in the beginning as it related to the production volumes so the highest activity level would be the month in which we had the highest volume of production so in this case this would be June that we would be focusing on for the highest level now when it comes to the lowest activity level our focus is going to be on the lowest production here now this is where a lot of students might make a mistake they might go through and start focusing on high-low based on costs luckily our costs do match up with the volume but there could be a scenario where for example February's costs were lower than January so you would be trying to grab this one please make sure that you're focusing on high-low as it relates to whatever the activity is in this case production volume so let's go ahead and plug in what we would see in our formula so according to our formula our costs at the high activity level are 900 our one million two hundred and twenty five thousand dollars and our costs at the low activity level are nine hundred and fifty thousand dollars so essentially what we're doing in this formula is we're finding when we go from four thousand units to nine thousand units what's the increase in costs so we find that during that period or that difference from four thousand to nine thousand units we actually have an additional two hundred and seventy five thousand dollars in costs now start to think about what costs increase as volume increases variable are fixed variable what they're saying there is that 275,000 that we just found that is going to all be attributed to variable costs so now what we do is we find okay well if that's all of our variable costs then let's find out the variable cost per unit which is the first thing that this problem is asking us to find so in order to do that we need to know well if we know the increase in cost what are the increase in units and this is where our denominator comes into play our highest activity level was 9,000 units our lowest activity levels 4,000 units so we see that our denominator is 5,000 now what this means is that we have two hundred and seventy-five thousand dollars and five thousand units so if we divide those two figures that's going to tell us exactly what our variable cost per unit is two hundred and seventy five thousand divided by five thousand so our variable cost per unit is fifty five dollars so any increase in cost should be attributed to variable cost so that's why we're taking the that change in cost and dividing it by the change in production so now that we have exactly what our variable cost per unit is we're going to move on to our total fixed costs in order to do this we could use a basic cost function which is simply that our total cost will equal the variable cost per unit times the number of units plus total fixed costs and then basically our total fixed cost would be our unknown and we would be solving for x which would be total fixed costs but I do kind of just want to talk about this in a in a basic function anyway we know our total costs at the high point and the low point and we also know or we could figure out what our total variable costs would be at the high point or the low point so when you're doing the high-low method you're going to choose either the low point or the high point whichever one you use you still end up with the same answer so really no stress

here I'm going to go ahead and just use the low point though so I know that my total costs at the low point are nine hundred fifty thousand dollars and I know that my total variable costs at the low point are fifty five dollars per unit times the number of units that were actually produced so two hundred and twenty thousand dollars in variable costs while have two hundred and twenty thousand of that nine hundred fifty thousand is variable costs that means that the remainder must be my final answer of total fixed costs so nine hundred and fifty thousand - the two hundred and twenty thousand variable costs that means that my total fixed costs are seven hundred and thirty thousand now just to kind of bring this one step further let's go ahead and take a look at it if we were using our high point so total costs at the high point are 1 million two hundred twenty-five thousand very cost would be $55 per unit times the 9000 units so that means if we take away our variable costs from our total costs total fixed costs 730,000 so whether or not we use the low point or the high point we should still end up getting the same fixed cost now one thing to keep in mind is that you literally can only use the high point or the low point please make sure you're not using any other points that were in the data that was given to you all right so that answers our high-low method question please be sure to practice this a few times and try to understand it rather than just memorize the formulas it's going to help you a lot more in the long run that'll be all for me today if you have anything that you would like to contribute to the conversation please be sure to leave it in the comments below and if you haven't done already please subscribe and if you haven't visited our website yet keep in mind that we're trying to release additional practice and problems regularly so we are in the process of building that as well so that will be in the description below so until next time happy studyingSo to be effective as estimators, we need to be able to accurately identify the scope of the project and apply that most reasonable cost for the materials, labor, and other resources, that are specific to those project conditions. So it's very obvious then that our estimating process itself relies on data. And so this data-driven future is only going to be able to enhance our estimating capabilities. We also need to keep in mind the purpose though, of a cost estimate. The purpose of an estimate is to support effective decision-making that may significantly impact our organization's bottom line. That's the same, whether we are on our contractor, our organization's side of things, or our owner's side of things. So estimating supports decision-making to maximize the returns on our investment in capital projects. So our process then is creating information used for decisions. This is a flow chart from the AACE international total cost management framework that illustrates a process map for the steps involved in the estimating process. We always have a planning step and total cost management is built around what's known as the PDCA cycle - Plan, Do, Check, Assess, and Act upon the changes that we see. In our planning steps, we're establishing the class of estimate that's going to be correlated with the stage of project development. We'll be establishing project breakdown, and structures, identifying key cost driver attributes and relationships, collecting the information, pricing our estimate in terms of the current market conditions, and establishing the overall estimating methodologies that will use in our estimate. Then we lead into the quantification step which is really translating the technical scope documents prepared by the engineers and designers into those appropriate quantities of materials and labor activities that we're going to apply pricing to on our estimates. We need to cost our estimates, which is applying the base, our default costs to the scope. And then we go through the pricing step, which is really adjusting those default costs for the unique site, commercial, or other project conditions. We have some iterative steps to try to optimize costs within our estimate. Again, trying to support that decision-making. And eventually, we need to be able to translate the estimate into budgets, to support project controls and specific contracting requirements. Finally, we have that need to review and validate our estimates in consideration of risk and uncertainty. So I just want to provide that background so we can keep that in mind as we move through today's presentation