Question

Mears Production Company makes several products and sells them for an average price of $75. Mears' accountant is considering two different approaches to estimating the firm's total monthly cost function, account analysis and high-low. In both cases, she used units of production as the independent variable. For the account analysis approach, she developed the cost function by analyzing each cost item in June, when production was 1,950 units. The following are the results of that analysis:

COST ITEM	TOTAL COST	VARIABLE COST	FIXED COST
DIRECT MATERIALS	$8,775	$8,775	$0
DIRECT LABOR	$9,945	$9,945	$0
FACTORY OVERHEAD	$8,375	$5,265	$3,110
SELLING EXPENSES	$7,325	$3,705	$3,620
ADMINISTRATIVE EXPENSES	$4,450	$0	$4,450
TOTAL EXPENSES	$38,870	$27,690	$11,180

REQUIRED [ROUND UNIT COSTS TO THE NEAREST CENT AND TOTAL COSTS TO THE NEAREST DOLLAR.]

For the high-low method, she developed the cost function using the same data from June and data from August, when production was 2,500 units and total costs were $47,969.

After developing the two cost functions, the accountant used them to make predictions for the month of October, when production was expected to be 2,125 units.

Part B
1. Using the high-low method, what was the accountant's estimate of total fixed costs for October?  

2. Using the high-low method, what was the accountant's estimate of variable costs per unit for October?

Answer 1

Solution 1:

Variable cost per unit using high low method = (Total cost at high level - Total cost at low level) / (High level activity - Low level activity)

= ($47,969 - $38,870) / (2500 - 1950) = $16.54 per unit (Rounded off to two decimal places)

Fixed cost = $47,969 - 2500*$16.54 = $6,619

Cost function using high low method = $6,619 +$16.54X

Total fixed cost of october using high low method = $6,619

Solution 2:

Estimated variable costs per unit for october using high low method = $16.54 per unit