 Hello and welcome to the session in which we will discuss the high-low method. Why do we use the high-low method? Well most costs are mixed and what does it mean it's mixed? It means it has a fixed portion, it means it doesn't change with the activity and the cost will have a variable portion, so it's a fixed plus variable. So we can express total cost with the following equation total cost equal to the fixed cost plus the variable cost. Now why is this important? Well cost behave differently. The way fixed cost behave is our fixed cost per unit goes down as our activity goes up. Variable cost increases in total with the number of units produced or the number of activities. So the business wants to know which portion of their total cost, this is total cost, is fixed and which portion is variable. Also this formula could be expressed as y which is total cost equal to b plus mx. B is the fixed component and m is the variable cost times the activity, whatever that activity is is x. So there's many ways to express this but basically it's based on that algebra formula where it says y equal mx plus b. So y equal maybe you learn it in algebra mx plus b. Okay so hopefully you are kind of familiar with this equation. So here's what we do. The first thing we do is when we have a bunch of data what we do is the company will have to basically first get an idea whether there's a relationship, some sort of a linear relationship between two factors. Here what we're looking at is the number of travelers for a particular airline you know southwest airline spirit or whatever and the cleaning department cost and the cleaning department is the crew that cleans the plane after you leave and the crew that cleans the terminal and this is important now for airline companies with COVID they want to make sure that they're cleaning their terminals and planes very well for the next batch of travelers. So the first thing they should do is to kind of eyeball the data by drawing a graph see if there's any relationship between the number of travelers and the cleaning department. So I'm going to be doing so use an excel but you can do you can do this manually. So I'm going to highlight the data go to chart and basically draw this chart and basically on the x-axis I have the number of travelers here's the x-axis number of travelers as the number of travelers increase and here's the cost it looks there is some sort of a relationship between the two. So yes it's worth looking at determining which component of our cost is fixed and which component of our cost is variable and the reason we want to know this is we might be able to switch the fixed cost into a variable or maybe the variable cost into a fixed maybe it's beneficial from a business perspective. So one way to do so there's more than one way one way to do so is to use the high low method now how does the high low method works well we're going to look at our activity which is here the number of travelers not the dollar amount remember it's based on the activity we're going to look at the highest level the highest month of activity in June we had 1900 travelers in the lowest month in November we had 1100 at this point we are going to basically compute the slope of the line and how do we compute the slope of the line hopefully you know how to do this from your math course otherwise I'm going to review this now. Before we review how to compute the slope of the line I would like to remind you whether you are an accounting student or a CPA candidate to take a look at my website farhatlectures.com I don't replace your CPA review course nor your accounting course I'm a useful addition to your CPA exam preparation and your accounting course how I provide you resources I provide you explanation from a different perspective for your accounting courses as well as your CPA examination and CMA this is a list a partial list of my accounting courses my CPA material is aligned with your Becker, Roger, Becker, Gleam or Wiley or even Miles or any other CPA review course and I also give you access to 1500 previously released AI CPA questions in their original format plus detailed solution if you have not connected with me on LinkedIn please do so take a look at my LinkedIn recommendation like this recording share it with other connect with me on Instagram, Facebook, Twitter and Reddit I'm trying to grow my Instagram followers please connect with me on Instagram so how do we compute the slope of the line we're going to take the difference in the dollar amount which is in in our case in this situation is the difference between 15 200 and 12 800 and that's going to be the difference in the dollar amount and we're going to divide this by the difference in the activity so the difference between 15 200 and 12 800 is 2400 and we're going to do the same thing for the activity the difference in the activity level which is 1900 minus 1100 now we'll take the difference but we divide y you know y is the 2400 and x is the activity we divide them and we find out that the slope of the line is three what do we conclude from this here's what we can say we can say it's costing us three dollars per traveler so this is the variable cost now what is the fixed cost we really don't know what our fixed cost is but we can find or approximate our fixed cost now remember this is a good approximation a good approximation why it's a good approximation because we're only going through two line to two data two points of data we're not going through the whole data so how do we do so so let's assume we select 1600 the point of 1600 okay we said if we have 1600 travelers our cleaning cost should be 14 000 well so 14 000 so this is what the formula looks like the total cost 14 000 should equal to the variable cost which is three dollars times three dollars times 1600 plus the fixed cost that we don't know so what is three dollars times 1600 so we're going to find out the variable cost three times 1600 1600 travelers so the variable cost the variable cost is 4800 well we still don't know what the fixed cost is we know our total cost is 14 000 if we take the total cost 14 000 which is it's giving from the data from our accounting department and we deduct the variable cost we find out that the fixed cost is 9200 so what is the total cost now let's let's see if we were how close are we to 14 000 4800 plus 9200 it's exactly 14 000 it's exactly 14 000 is this going to work in every point let's see if we choose for example the 1100 well if we chose the point 1100 our total cost should be 12 800 so i i i choose i'm choosing this point and you're going to see why i'm choosing another point to illustrate the concept so let me just highlight this so you see which one i am discussing so at this point our variable cost should be 1100 times three okay this is our variable cost our fixed cost then it should be if the total cost is 12 800 our fixed cost should be 9 500 and if we take this amount plus this amount it should uh it's 3000 oops let me go back let me do it one more time if we take 3300 plus 9 500 it will give us 12 800 okay so notice here that our fixed cost it was in this example 9200 in this example 9500 so it's approximately between 9 000 maybe it could be around 9200 to 9500 we can select another point and it's going to give us something in that ballpark so you know we know the variable cost is three approximately three now why is this not accurate 100 percent because we are going through only two points of data now luckily we could have regression we could have different type of things but let me show you what excel could give us if you click on those points and let's assume i want to do first of all i can do a trend line and i see my trend line is upward so it looks you know as we have as we have more travelers cost go up now we can let we can let excel display the equation this equation the total cost equation and this is what it looks like and if we look at excel that goes through all the points it looks like the variable cost y equal to $2.64 approximately $2.65 plus the fixed cost is approximately 9994 is this through all the time not necessary because we can let me go back here and use some use some use some statistics we can have an r square and based on the r square this relationship holds 71 of the time so it's not there is a linear relationship but it's not perfect perfect but it it's approximately it looks like it's you know $2.65 per traveler not $3 this is this I would say this is more accurate and the fixed cost always say it's approximately 9900 notice here when we did two points at some point the fixed cost was 9200 and another point was 9500 what what excel stillness it should be approximately 9900 once again those are estimate it's a good starting point in understanding your total cost which is part of your cost is fixed cost part of it is variable and why do we have to notice why do we have to know fixed and variable because fixed and variable behave in a different way under different circumstances as a total and as per unit so it's very important that you understand how cost behave and if you understand how cost behave then the company can change their cost structure for example they might benefit if they have more fixed costs or they might benefit more if they have more variable costs depending on their business depending on the resources depending on their strategy and this is basically in a nutshell the high low method what should you do now go to my website farhatlectures.com work multiple choice questions look at the additional resources download this powerpoint slide and this excel sheet and play with it good luck study hard and of course stay safe