These lectures contains practice CPA question covering high-low method on how to estimate variable cost as well as normal spoilage and abnormal spoilage.
High-Low method and Normal/Abnormal Spoilage
Managers can use a variety of methods to estimate the fixed and variable components of a mixed cost such as account analysis, the engineering approach, the high-low method, and least-squares regression analysis. In account analysis, an account is classified as either variable or fixed based on the analyst’s prior knowledge of how the cost in the account behaves. For example, direct materials would be classified as variable and a building lease cost would be classified as fixed because of the nature of those costs. The engineering approach to cost analysis involves a detailed analysis of what cost behavior should be, based on an industrial engineer’s evaluation of the production methods to be used, the materials specifications, labor requirements, equipment usage, production efficiency, power consumption, and so on.
The high-low and least-squares regression methods estimate the fixed and variable elements of a mixed cost by analyzing past records of cost and activity data.
The two types of spoilage are normal and abnormal. Normal spoilage occurs under normal operating conditions; it is uncontrollable in the short term and is considered a normal part of production and product cost. That is, the cost of spoiled unit costs is absorbed by the cost of good units produced. Abnormal spoilage is an excess over the amount of normal spoilage expected under normal operating conditions; it is charged as a loss to operations in the period detected. Normal spoilage is of two types: (1) specific normal spoilage, which is particular to a given job and is not due to factors related to other jobs, and (2) common normal spoilage, which is due to factors that affect two or more jobs, such as a machine malfunction that affected parts used in several jobs. Normal spoilage that is specific to a job is treated as a cost of that job, so that in effect the cost of spoilage is spread over the cost of the good units in the job. Normal spoilage that is common to two or more jobs is charged to factory over- head and, in this way, affects the costs of all jobs. Abnormal spoilage is charged to a special account, such as Loss from Abnormal Spoilage, so that management attention can be given to spoilage of this type, and because product cost should not include abnormal elements such as abnormal spoilage.