Be the Professor

Intro: Hello my name is Professor Yas and I will be teaching how the linear function is used in accounting. The overarching responsibility of a managerial accountant is to contribute towards adding value to the firm to maximize shareholder’s value. They accomplish this by mitigating cost and increasing revenue. Today we are going to focus on how managerial accountants can evaluate cost by introducing the “High-Low” method, which uses the cost equation: y=a+bX (which is typically seen as y=mx+b). In the given equation y=a+bX----“y” is total cost, “a” is total fixed cost, and “b” is total variable cost per unit. The High-Low method involves finding the slope of the equation, the change in Y over the change in X ---ΔY/ΔX. (Note: Y is always in dollars and X is always in units/level of activity.) After finding the slope, we carefully identify our highest activity and our lowest activity. Moreover, we are finding the difference between our highest activity and our lowest activity, and dividing it into its corresponding cost.  In other words, we are comparing the number we produce against how much it cost. 

Example: Accountants typically gather historical data in order to appropriately approximate future trends. For example, Company ABC has provided you with data from the past couple of months, shown below.

Our first step in completing the High-Low method is to identify our highest and lowest activity (and then their corresponding cost).

High          68000   Low      46000

High  $1274000    Low  $889000

Then find the slope

$1274000 - $889000= $385000

68000-46000= 22000

$385000/$22000= 17.5

After we find the slope (which is our total variable cost per unit), we plug the slope back into the equation.

Y=a+bX

Y=a+17.5X

Then we plug in the highest data points we previously used in order to find the total fixed cost.

$1274000=a+17.5(68000)

a=$84000 or total fixed cost =$84000

Finally, we can complete the cost equation.---  “y=$84000+17.5X”

Summary: We can now use the cost equation to evaluate the increase or decrease in production. For example, if Company ABC decides to increase production for holiday season and the manager needs to budget correctly for the next following quarters, how much should she budget for if the company decides to produce 70000 units? 

Our cost equation

y=$84000+17.5X

(Plug in 70000 for X because it is our activity)

y=$84000+17.5(70000)

(Solve for Y)

y=$1309000

Conclusion: The manager should plan on budgeting for $1309000 to cover an increase in production for the holiday season.

That completes our lesson. (: