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As discussed earlier in this chapter, accountants assume that costs are linear rather
than curvilinear. Because of this assumption, the general formula for a straight line

can be used to describe any type of cost within a relevant range of activity. The
straight-line formula is

If a cost is entirely variable, the a value in the formula will be zero. If the cost is
entirely fixed, the b value in the formula will be zero. If a cost is mixed, it is necessary
to determine formula values for both a and b.
HIGH-LOW METHOD
The high-low method analyzes a mixed cost by first selecting two observation
points in a data set: the highest and lowest levels of activity, if these points are
within the relevant range. Activity levels are used because activities cause costs to
change and not the reverse. Occasionally, operations may occur at a level outside
the relevant range (a rush special order may be taken that requires excess labor
or machine time) or distortions might occur in a normal cost within the relevant
range (a leak in a water pipe goes unnoticed for a period of time). Such nonrepresentative
or abnormal observations are called outliers and should be disregarded

when analyzing a mixed cost.
Next changes in activity and cost are determined by subtracting low values
from high values. These changes are used to calculate the b (variable unit cost)

The b value is the unit variable cost per measure of activity. This value is multiplied
by the activity level to determine the amount of total variable cost contained
in total cost at either (high or low) level of activity. The fixed portion of a mixed
cost is then found by subtracting total variable cost from total cost.
Total mixed cost changes with changes in activity. The change in the total
mixed cost is equal to the change in activity times the unit variable cost; the fixed
cost element does not fluctuate with changes in activity.
Exhibit 3–7 illustrates the high-low method using machine hours and utility
cost information for the Cutting and Mounting Department of the Indianapolis Division
of Alexander Polymers International. Information was gathered for the eight
months prior to setting the predetermined overhead rate for 2001. During 2000,
the department’s normal operating range of activity was between 4,500 and 9,000
machine hours per month. For the Cutting and Mounting Department, the March
observation is an outlier (substantially in excess of normal activity levels) and should
not be used in the analysis of utility cost.
One potential weakness of the high-low method is that outliers may be inadvertently
used in the calculation. Estimates of future costs calculated from a line
drawn using such points will not be indicative of actual costs and probably are not
good predictions. A second weakness is that this method considers only two data