As a result, Regent finds that its maintenance costs vary from month to month with the number of flight hours, as depicted in Figure 2.29.įigure 2.31 Scatter Graph of Snow Removal Costs for Regent Airlines. The Federal Aviation Administration establishes guidelines for routine aircraft maintenance based upon the number of flight hours. To demonstrate how a company would use a scatter graph, let’s turn to the data for Regent Airlines, which operates a fleet of regional jets serving the northeast United States. After using a scatter graph to determine whether cost and activity have a linear relationship, managers often move on to more precise processes for cost estimation, such as the high-low method or least-squares regression analysis. No one person’s line and cost estimates would necessarily be right or wrong compared to another they would just be different. When interpreting a scatter graph, it is important to remember that different people would likely draw different lines, which would lead to different estimations of fixed and variable costs. Because the trend line is somewhat subjective, the scatter graph is often used as a preliminary tool to explore the possibility that the relationship between cost and activity is generally a linear relationship. Once the scatter graph is constructed, we draw a line (often referred to as a trend line) that appears to best fit the pattern of dots. A diagnostic tool that is used to verify this assumption is a scatter graph.Ī scatter graph shows plots of points that represent actual costs incurred for various levels of activity.
In other words, costs rise in direct proportion to activity. One of the assumptions that managers must make in order to use the cost equation is that the relationship between activity and costs is linear. Demonstration of the Scatter Graph Method to Calculate Future Costs at Varying Activity Levels Total Variable Cost per Unit = $75 + $22 + $5 = $102 per unit. Direct Labor per Hour = $11.00 x 2 hours per unit (2,000 hrs/1,000 units) = $22 per unit. Direct Materials per Unit = $75,000 / 1,000 Units = $75 per unit. Let’s take a more in-depth look at the cost equation by examining the costs incurred by Eagle Electronics in the manufacture of home security systems, as shown in Table 2.9. Where Y is the total mixed cost, a is the fixed cost, b is the variable cost per unit, and x is the level of activity. Cost equations can use past data to determine patterns of past costs that can then project future costs, or they can use estimated or expected future data to estimate future costs.
The cost equation is a linear equation that takes into consideration total fixed costs, the fixed component of mixed costs, and variable cost per unit. Here we will demonstrate the scatter graph and the high-low methods (you will learn the regression analysis technique in advanced managerial accounting courses. Three estimation techniques that can be used include the scatter graph, the high-low method, and regression analysis. Estimation is also useful for using current data to predict the effects of future changes in production on total costs. Sometimes, a business will need to use cost estimation techniques, particularly in the case of mixed costs, so that they can separate the fixed and variable components, since only the variable components change in the short run.
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