Lessons · Accounting · splitting a mixed cost with the high-low method
Splitting a mixed cost, with two months and no statistics
Take the highest-activity period and the lowest. The difference in cost divided by the difference in activity is the variable rate, because only the variable part moved. Put that rate back into either period and what is left over is the fixed part.
Hone is a place to practise a career, one idea a day. This is one of its lessons, written out in full and free to read without an account.
In beta. This lesson was written for Hone and has not yet been checked by a qualified accountant. Practice material, not professional advice. What that means.
What it is for
Mixed costs are everywhere -- power, maintenance, delivery, some wages -- and nothing else on this road works until they are split. The high-low method needs two data points and arithmetic, which means it can be done in a meeting.
How to think about it
Write the two periods with their activity and their cost. Subtract both. Divide the cost difference by the activity difference for the rate per unit of activity. Then take either period, multiply its activity by the rate, and subtract from its total cost.
Worked example
Busiest month: 1,200 units, cost 9,400. Quietest: 700 units, cost 6,900Two points, chosen by ACTIVITY and not by cost.
Variable rate = (9,400 − 6,900) / (1,200 − 700) = 2,500 / 500 = 5.00 a unitOnly the variable part could have caused the change.
Fixed = 9,400 − (1,200 × 5.00) = 9,400 − 6,000 = 3,400What is left when the variable part is taken out.
Check on the other month: 6,900 − (700 × 5.00) = 3,400The same fixed figure from either end, which is the check that it worked.
Your turn
Costs 9,400 at 1,200 units and 6,900 at 700 units. Write the line that gives the variable rate.
Variable rate = (9,400 − 6,900) / (1,200 − ) = 5.00
Solve one, graded on the server
The trap
Picking the most expensive and least expensive months instead of the busiest and quietest. The method assumes the only reason cost moved was activity, so the two points have to be chosen by activity. Choose by cost and you have measured something else entirely.