LIMITATIONS OF HIGH-LOW METHOD

A high-low method is a common tool employed to determine what portion of a cost is fixed and what portion of a cost is variable. Small-business owners can use this information to create budgets and to help understand how changes in volume affect the company's costs in total and on a per-unit basis. However, the high-low method comes with some disadvantages.

Two value:
Even though the high-low method's reliance on only two sets of values contributes to its simplicity, it also enhances its weakness as a cost estimation method. It ignores all data in between the extremes, capitalizing only on the highest and lowest. This effectively ignores all trends of costs in between the extreme values, thus making it impossible to obtain any additional information from figures derived from this method.

Assumption:
The high-low method operates under the assumption that no foreign factors affect the cost of products and fixed costs remain the same at all levels of production. Fixed costs, being semi-variable in nature, change when there is a large change in production, for example, increased rental space due to additional machinery necessitated by increased production. Thus this method of cost estimation provides inaccurate estimates for such scenarios. This is because it does not differentiate between the change in the fixed cost and the variable cost.

Misrepresentation:
The high-low method uses figures from periods of high and low production in a business. In the occurrence of exceptionally low and high production periods, outliers, the figures obtained from such periods may not be true representations of the scenario at normal levels of production. Formulas created on such bases produce incorrect estimates for the normal production periods.

Past data:
The high-low method calculates for cost estimates through the use of records of production levels from past periods in the business. This aspect limits the scope of applicability of this method to businesses with prior records and discriminates against newly formed businesses.

Multiple steps:

Another disadvantage of the high-low method is the number of steps necessary to perform this analysis. The accountant needs to gather monthly data regarding the expense being analyzed and the unit of activity. The accountant lists each set of data and identifies the high and low values. He calculates the difference between these sets of values. He divides the difference in Taka by the difference in activity to calculate the cost per unit of activity or the variable activity. He multiplies the variable cost per unit by the number of activities to calculate the total variable cost. He subtracts the total variable cost from the total cost to determine the fixed cost. Each additional step increases the potential for errors.

Estimate:
A disadvantage of the high-low method is that the results are estimates, not exact numbers. An accountant who needs to know the exact dollar amount of fixed expenses each month should contact a vendor directly.