Hi, Could you please explain me why the variable cost of each month is not calculated as Total cost – Fixed cost ? Because we calculated the fixed cost before using the High- Low method, and the fixed cost should be the same for every month. I am asking because for July you are calculating the total cost as Fixed cost 32.500 + units * 75= 55.000, but the exercise mentions that July total cost is 50.000. This is why I am not understanding and I would like you explain me why. Thank you.

In a perfect world the fixed cost would be the same each month and the variable cost per unit would also be constant. However in the real world this is unlikely to be true and that is why the high low method is not very good (but is quick and easy). That is why regression analysis (which you should remember from Paper MA or whatever exempted you) is a much better approach. However regression analysis is not examinable in Paper PM.

I fail to understand why we take the ‘highest’ value and ‘lowest’ value (I know this is the correct way, I just fail to understand why). If we subtract a greater value from a lesser value shouldn’t that eliminate the fixed cost and enable us to find the variable cost per unit?

If the relationship was perfectly linear then it would not matter which two values you took. However, given it might not be perfectly linear we use the highest and lowest to give hopefully the best estimate (even though in fact that might not be the case).

Sir, i have a question that is bothering me a lot: you have said that the extra costs in those 2 months for the high low method, the extra costs are extra variable costs incurred because of producing the extra amount of units.

my question is what if we produce 600 units then? if we produce 600 units, then surely we must have fixed and variable costs, should we not? but here we are concluding that for producing 600 units, the total costs incurred are all variable, this is what is confusing me.

———

in hindsight, i believe the above understanding is wrong, its the extra amount of units produced when we compare 2 original productions, both of which must have had fixed costs, so that is why, since by producing extra units, the extra costs is the total variable costs ( fixed costs remain constant).

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mbruno says

Hi,

Could you please explain me why the variable cost of each month is not calculated as Total cost – Fixed cost ? Because we calculated the fixed cost before using the High- Low method, and the fixed cost should be the same for every month.

I am asking because for July you are calculating the total cost as Fixed cost 32.500 + units * 75= 55.000, but the exercise mentions that July total cost is 50.000. This is why I am not understanding and I would like you explain me why.

Thank you.

John Moffat says

In a perfect world the fixed cost would be the same each month and the variable cost per unit would also be constant. However in the real world this is unlikely to be true and that is why the high low method is not very good (but is quick and easy).

That is why regression analysis (which you should remember from Paper MA or whatever exempted you) is a much better approach. However regression analysis is not examinable in Paper PM.

mbruno says

Thank you very much

John Moffat says

You are welcome 馃檪

visheshparyani says

Hey John,

I fail to understand why we take the ‘highest’ value and ‘lowest’ value (I know this is the correct way, I just fail to understand why). If we subtract a greater value from a lesser value shouldn’t that eliminate the fixed cost and enable us to find the variable cost per unit?

Thank you,

Vishesh Paryani

John Moffat says

Yes, and that is what we do 馃檪

visheshparyani says

My question is why do we have to take the highest and lowest value and not just a higher and lower value? Why does it have to be at the extremes?

John Moffat says

If the relationship was perfectly linear then it would not matter which two values you took. However, given it might not be perfectly linear we use the highest and lowest to give hopefully the best estimate (even though in fact that might not be the case).

visheshparyani says

Oh, I understand.

Thank you for the fast reply John, really appreciate it 馃檪

perkeqimarjeta says

Sir, are these lessons still relevant for the exam of paper F5 in March 2020?

Thank you!

John Moffat says

Of course 馃檪

Our lectures are always kept up-to-date for the current syllabuses.

perkeqimarjeta says

Many thanks 馃檪

John Moffat says

You are welcome 馃檪

alie2018 says

Thanks John. This approach is simple and straightforward

jareerabedin says

Sir, i have a question that is bothering me a lot:

you have said that the extra costs in those 2 months for the high low method, the extra costs are extra variable costs incurred because of producing the extra amount of units.

my question is

what if we produce 600 units then?

if we produce 600 units, then surely we must have fixed and variable costs, should we not?

but here we are concluding that for producing 600 units, the total costs incurred are all variable, this is what is confusing me.

———

in hindsight, i believe the above understanding is wrong, its the extra amount of units produced when we compare 2 original productions, both of which must have had fixed costs, so that is why, since by producing extra units, the extra costs is the total variable costs ( fixed costs remain constant).

John Moffat says

Yes – what you have written is correct. The fixed costs stay the same and so there is just the extra variable cost.