Determining the cost of goods sold is an important part of analyzing profitability. In a manufacturing environment, there can be a lot of variables involved in producing the final product. There are fixed costs, variable costs and costs that can be both fixed and variable. This article looks at a particular job costing method called the high-low method, which is used when a particular cost has fixed and variable attributes.
Job Costing and Fixed Cost
Applying fixed costs to job costing is fairly simple since they remain somewhat constant. As production increases, the fixed cost assigned to each unit of production will decrease. As an example, if rent costs were $5,000 a month and the company produces 1,000 widgets, the fixed cost of rent allocated would be $5 per widget. If 2,000 widgets were produced the next month; the fixed cost of rent allocated would be $2.50 per widget.
Job Costing and Variable Cost
Variable costs on the other hand will increase and decrease along with production activity. As production increases, variable costs increase and vice versa. Using the above example for widgets, let’s assume it takes $1 in material handling costs per widget. In the month where 1,000 widgets were produced, material handing cost were $1,000. In a month were 2,000 widgets were produced, the cost incurred would be $2,000.
Job Costing and Mixed Cost
When a cost associated with production is fixed at a certain point and then become variable, the costs are mixed. Hourly wages may be an example of a mixed cost if overtime pay is generated with production increases. Hour wages associated with production could be an example of mixed cost if overtime is often used in order to keep up with production.
In an hourly wage scenario, a portion of the cost is fixed and a portion would be considered variable. Hence the costs are mixed. There are different methods for applying mixed costs. One of those methods is the high-low method.
Applying the High-Low Method to Job Costing
The high-low method is one technique used in manufacturing cost accounting to separate fixed and variable costs. This method assigns a dollar amount of the mixed expense to fixed and variable costs by units produced. It takes the highest and lowest cost in a time period then measures it against the highest and lowest activity within a time period. Using the wage example let’s look at a four-month period of wage activity associated with production.
- April – 1,600 widgets @ $30,000
- May – 1,500 widgets @ $29,000
- June – 1,400 widgets @ $27,000
- July – 1,200 widgets @ $26,000
- Highest Production 1,600 widgets
- Lowest Production 1,200 widgets
- Difference in Production 400 widgets
- Highest Wage Cost $30,000
- Lowest Wage Cost $26,000
- Difference in Cost $4,000
Variable Cost per Widget = $10 ($4,000 / 400 widgets)
The fixed cost assigned can then be calculated by subtracting variable cost from total cost. In May for example, the total cost was $29,000. Variable costs were $15,000 ($10 x 1,500 widgets.
May Fixed and Variable Wage Costs
- Total Wage Cost $29,000
- Variable Cost $15,000
- Fixed Cost $14,000
Using the high-low method can also help to figure what a given cost would be at a certain level of production. This method can also be used to calculate the cost of goods sold, depending on techniques used like absorption costing and variable costing methods.
James Clausen - Clausen received a Bachelors Degree in Business Administration in Automotive Management and Marketing at Northwood University, graduating ...
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