Figure 3-5 Longberry Corporation manufactures and sells party items. The following representative direct labor hours and production costs are provided for a four-month period:
Refer to Figure 3-5. Using the high-low method, what is the cost formula for estimating costs?
A) Total cost = $20,000 + $2.08X
B) Total cost = $7,500 + $2.08X
C) Total cost = $5,000 + 2.08X
D) Total cost = $2.08X

Question

Figure 3-5 Longberry Corporation manufactures and sells party items. The following representative direct labor hours and production costs are provided for a four-month period:
  Refer to Figure 3-5. Using the high-low method, what is the cost formula for estimating costs?
A) Total cost = $20,000 + $2.08X 
B) Total cost = $7,500 + $2.08X 
C) Total cost = $5,000 + 2.08X 
D) Total cost = $2.08X

Quizplus · Accepted Answer

Using the high-low method, we need to identify the highest and lowest level of activity and determine the variable cost per unit of activity.

From the data provided, the highest level of direct labor hours is 900 in Month 3, and the lowest is 500 in Month 1. The corresponding total production costs are $7,500 and $5,000, respectively.

Variable cost per direct labor hour = (Total cost at highest level - Total cost at lowest level) / (Highest level of activity - Lowest level of activity)
Variable cost per direct labor hour = ($7,500 - $5,000) / (900 - 500)
Variable cost per direct labor hour = $2.08

The fixed cost can be calculated by using the formula: 
Total cost = Fixed cost + (Variable cost per unit x Level of activity)
Substituting one set of values from the data, we get: 
$5,000 = Fixed cost + ($2.08 x 500)
Fixed cost = $7,500 - $1,040
Fixed cost = $6,460

Therefore, the cost formula for estimating costs using the high-low method is: 
Total cost = $6,460 + $2.08 x Direct labor hours. 
The correct choice based on this calculation is B.

Figure 3-5 Longberry Corporation Manufactures and Sells Party Items