Abdul Karim Company manufactures a product A. The company estimates the cost function for the total costs. The cost driver is number of units. The following information were collected:
Month Units Total Costs
January 3,560 SAR 242,400
February 3,800 SAR 252,000
March 4,000 SAR 260,000
April 3,600 SAR 244,000
May 3,200 SAR 228,000
June 3,040 SAR 221,600
Compute a cost function using the high-low method.
Cost Function Calculation for Abdul Karim Company
To determine the cost function using the high-low method, we will identify the highest and lowest activity levels and their corresponding costs. By calculating the variable cost per unit, we can then derive the fixed cost component of the total costs.
Data Analysis:
- Highest Activity Level: March (4,000 units, SAR 260,000)
- Lowest Activity Level: June (3,040 units, SAR 221,600)
Formula for Variable Cost per Unit:
Variable Cost per Unit = (Cost at High Activity Level - Cost at Low Activity Level) / (Units at High Activity Level - Units at Low Activity Level)
Variable Cost per Unit = (260,000 - 221,600) / (4,000 - 3,040) = 38,400 / 960 = SAR 40
Calculating Fixed Costs:
Using the high activity level data:
Total Costs = Fixed Costs + (Variable Cost per Unit * Number of Units)
260,000 = Fixed Costs + (40 * 4,000)
260,000 = Fixed Costs + 160,000
Fixed Costs = 260,000 - 160,000
Fixed Costs = SAR 100,000
Cost Function:
Therefore, the cost function for Abdul Karim Company's product A is:
Total Costs = Fixed Costs + (Variable Cost per Unit * Number of Units)
Total Costs = SAR 100,000 + (40 * Number of Units)
This equation can now be used to estimate total costs based on the number of units produced.