The high-low method of accounting is a management accounting cost estimation tool used to determine the variable and fixed costs of a company’s product. To obtain the variable cost per unit, the high-low method involves dividing the difference between the total cost at the lowest and highest levels of production by the difference in the number of units between the highest and lowest level of production. To obtain the fixed cost, multiply the variable cost with the number of units at a particular production level and subtract the answer from the total cost at the same production level.
Even though the high-low method’s reliance on only two sets of values contributes to its simplicity, it also enhances its weakness as a cost estimation method. It ignores all data in between the extremes, capitalizing only on the highest and lowest. This effectively ignores all trends of costs in between the extreme values, thus making it impossible to obtain any additional information from figures derived from this method.
The high-low method operates under the assumption that no foreign factors affect the cost of products and fixed costs remain the same at all levels of production. Fixed costs, being semi-variable in nature, change when there is a large change in production, for example increased rental space due to additional machinery necessitated by increased production. Thus this method of cost estimation provides inaccurate estimates for such scenarios. This is because it does not differentiate between the change in the fixed cost and the variable cost.
The high-low method uses figures from periods of high and low production in a business. In the occurrence of exceptionally low and high production periods, outliers, the figures obtained from such periods may not be true representations of the scenario at normal levels of production. Formulas created on such bases produce incorrect estimates for the normal production periods.
High-low method calculates for cost estimates through the use of records of production levels from past periods in the business. This aspect limits the scope of applicability of this method to businesses with prior records and discriminates against newly formed businesses.