Question

The controller of Rather Production has collected the following monthly expense data for analyzing the cost behavior of electricity costs.

		Total Electricity Costs				Total Machine Hours
January			$2,500				300
February			3,000				350
March			3,600				500
April			4,500				690
May			3,200				400
June			4,900				700
July			4,100				650
August			3,800				520
September			5,100				680
October			4,200				630
November			3,300				350
December			5,860				720

a) Determine the fixed- and variable-cost components using the high-low method.

b) What electricity cost does the cost equation estimate for a level of activity of 500 machine hours? By what amount does this differ from March’s observed cost for 500 machine hours?

c) What electricity cost does the cost equation estimate for a level of activity of 700 machine hours? By what amount does this differ from June’s observed cost for 700 machine hours?

Answer 1

Answer:-a)- Variable Cost per machine hour = $8 per hour.

Total Fixed Cost =$100

Explanation:-

High-Low Method:-

Variable Cost per Unit

Variable cost per unit (b) is calculated using the following formula:

Variable cost per unit = (Y2-Y1)/(X2-X1)

Where,
y2 is the total cost at highest level of activity;
y1 is the total cost at lowest level of activity;
x2 are the number of units/miles/ labor ,machine hours etc. at highest level of activity; and
x1 are the number of units/miles/ labor, machine hours etc. at lowest level of activity

The variable cost per unit is equal to the slope of the cost volume line (i.e. change in total cost ÷ change in number of machine hours).

Total Fixed Cost

Total fixed cost (a) is calculated by subtracting total variable cost from total cost, thus:

Total Fixed Cost = (y2 – b)*x2 = (y1 – b*x1)

We have,
at highest activity: x₂ = 720 Machine hours; y₂ = $5860
at lowest activity: x₁ = 300 Machine hours; y₁ = $2500

Variable Cost per delivery = ($5860-$2500) /(720 hours −300 hours)  

= $3360/420 hours

= $8 per machine hour
Total Fixed Cost = $5860 − ($8 per hour*720 hours)

= $5860-$5760

=$100

b)- Electricity costs for a level of activity of 500 machine hours = ($8 per hour*500 hours)+$100

= $4000+$100

= $4100

The amount differ from March’s observed cost for 500 machine hours = $4100-$3600

= $500

c)- Electricity costs for a level of activity of 700 machine hours = ($8 per hour*700 hours)+$100

= $5600+$100

= $5700

The amount differ from March’s observed cost for 700 machine hours = $5700-$4900

= $800