# Difference quotient method

The **difference quotient method** is one of several methods for cost resolution that is used in the context of cost and performance accounting.

## definition

The difference quotient method separates a company's total costs into fixed and variable costs by forming two differences (cost difference and output difference), which are then put in relation to each other.

## example

A company produces 10,000 output units in period 1 (e.g. January) and 15,000 output units in period 2 (e.g. February) . In period 1 the total cost of the company is € 100,000 and in period 2 the total cost is € 120,000.

The increase in the quantity produced by 5,000 product units has therefore increased the total costs by € 20,000. From this it is concluded that each individual output unit increases the costs by 20,000 / 5,000 = € 4. The variable unit costs must therefore be € 4.

If an output unit causes variable unit costs of € 4, then 10,000 output units cause variable costs totaling 4 * 10,000 = € 40,000. If the total costs for 10,000 output units are € 100,000 and of which € 40,000 are variable, then the remaining € 60,000 must be fixed costs.

The cost function of the production process can be derived from this:

K = 60,000 + 4x

With the help of this cost function, the total costs (K) can be determined for any output quantity x.

## formula

= variable unit costs

= Total costs for period 1

= Total costs for period 2

= Output quantity of period 1

= Output quantity of period 2

## Criticism of the difference quotient method

- The method assumes a linear cost function. It leads to incorrect results for non-linear cost functions.

- If step- fixed costs occur when increasing the output quantities , the method also leads to incorrect results

- If the output differences on which the calculations are based are too small, the process becomes very imprecise

- Coincidences in cost fluctuations affect the outcome of the procedure