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Dear Sir,
There is an illustration regarding the high/low method given in the new Kaplan F2 Study text which I am unable to understand. I am writing the question below if you could work it out and explain it to me that will be a great help.Question:
An organisation has the following total costs at three activity levels:
Activity levels (units) 4,000 6,000 7500
Total cost $40,800 $50,000 $54,800
Variable cost per unit is constant within this activity range and there is a step up of 10% in the total fixed costs when the activity level exceeds 5,500 units
What is the total cost at an activity level of 5,000 units
A $44,000
B $44,800
C $45,400
D $46,800Between 6,000 and 7,500 units, the fixed cost stays the same and so you can calculate the variable cost per unit in the normal way (4,800/1500)
At an activity level of 5,000, the fixed overheads will be the same as they are for 4,000. So the only reason the total costs will be higher is because of the extra variable overheads for the extra 1,000 units.
So the total cost will be 40,800 plus the extra variable cost (already calculated) of the extra 1000 units.
If you do the arithmetic you will get answer A
But sir, if so, the method is no longer High /Low method as it now accounts for non extreme levels.
It is also done in Émile Woolf that way, but I am always against it because the data do not necessarily follow thé trend 100%.
I always tackle it from first principles and preserve the use of High/Low method.
Total cost =Fixed cost +Variable cost
Then
54800=1.1F + 7500v
40800=F + 4000v
Solving, F=28000, v=3.2But F = Fixed cost for units not exceeding 5500. For units above 5500, we add 10%.
But our qn is at 5000.
So Total cost =28000+3.2*5000
=$44000Is it just fine to include levels that are neither high nor low ?
Your advice sir.
This is a pure high-low question and my answer above was completely correct!
By all means do it the way that you have done – nobody will look at your workings and all that is marked is the final answer which is indeed $44,000 (as results from my workings above).
However, given the time pressure in the exam, I think my way is rather quicker, and speed in the exam is just as important as knowledge!
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