High-low method. Ken Howard, financial analyst at KMW Corporation, is examining the behavior of

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High-low method. Ken Howard, financial analyst at KMW...

High-low method. Ken Howard, financial analyst at $\mathrm{KMW}$ Corporation, is examining the behavior of quarterly maintenance costs for budgeting purposes. Howard collects the following data on machinehours worked and maintenance costs for the past 12 quarters: 1. Estimate the cost function for the quarterly data using the high-low method. 2. Plot and comment on the estimated cost function. 3. Howard anticipates that KMW will operate machines for 100,000 hours in quarter $13 .$ Calculate the predicted maintenance costs in quarter 13 using the cost function estimated in requirement 1

High-low method. Ken Howard, financial analyst at $\mathrm{KMW}$ Corporation, is examining the behavior of quarterly maintenance costs for budgeting purposes. Howard collects the following data on machinehours worked and maintenance costs for the past 12 quarters:
1. Estimate the cost function for the quarterly data using the high-low method.
2. Plot and comment on the estimated cost function.
3. Howard anticipates that KMW will operate machines for 100,000 hours in quarter $13 .$ Calculate the predicted maintenance costs in quarter 13 using the cost function estimated in requirement 1

Key Concepts

Fixed Cost Component

The fixed cost component is the portion of total costs that remains constant regardless of the level of activity within the relevant range. Once the variable cost per unit is determined using the high-low method, the fixed cost can be estimated by subtracting the total variable cost (variable cost per unit multiplied by the level of activity) from the total cost at either the high or low activity point.

Variable Cost Component

The variable cost component represents the portion of total costs that change directly in proportion to changes in the level of activity. In the context of the high-low method, it is determined by dividing the change in cost between the periods with the highest and lowest activity levels by the corresponding change in activity, providing a per-unit cost measure.

Forecasting Using Cost Functions

Forecasting using cost functions involves applying the derived cost function to predict future costs based on anticipated levels of activity. This process helps in budgeting and planning, as it provides a method to estimate costs under different operational scenarios by using the fixed and variable cost components obtained from historical data.

High-Low Method

The high-low method is a simple cost estimation technique used in cost accounting to separate fixed and variable components of a cost. By selecting the periods with the highest and lowest activity levels, the method calculates the variable cost per unit based on the difference in total costs and activity, and subsequently determines the fixed cost component by subtracting the variable costs from the total cost at either level of activity.

Cost Function

A cost function is a mathematical model that represents the total cost as a function of a level of activity. In many cases, this function is expressed in a linear form, consisting of a fixed cost component and a variable cost component multiplied by the activity level, which makes it easier to predict future costs under varying conditions.

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