Scattergraph method
/What is the Scattergraph Method?
The scattergraph method is a visual representation of the cost and activity data associated with an expense. The resulting chart is used to identify and separate the fixed and variable components of a cost. The method is most useful for gaining insight into the nature of mixed costs, which can then be used to project costs based on expected activity levels. A cost that has both fixed and variable components is considered a mixed cost. A scattergraph analysis can lead to the formulation of more accurate budgets. Generally, the scattergraph method is a useful tool within the field of management accounting.
Formulation of a Scattergraph
Use the following steps to create a scattergraph and glean costing information from it:
Plot a collection of data points on a chart, showing the amount of cost incurred for a given level of activity. The horizontal x axis shows the activity level, while the vertical y axis shows the amount of cost incurred.
Plot on the scattergraph a regression line that represents the relationship between the various data points. A typical regression line has an upward slant, indicating that costs increase with unit volume. The regression line may also intercept the y axis above the zero cost level, indicating the presence of fixed costs that must be incurred even in the absence of any unit activity.
Determine from the scattergraph that component of the cost data that indicates the presence of a fixed cost. This is the point at which the regression line intercepts the y axis.
After subtracting the impact of fixed costs from the scattergraph, determine the remaining cost per unit of activity, which is the variable cost per unit.
Apply these separated fixed and variable costs to the projection of costs to be incurred in the future.
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Example of the Scattergraph Method
Ideally, the result of a scattergraph analysis should be a formula that states the total amount of fixed cost and the variable cost per unit of activity. Thus, if an analyst finds that the fixed cost associated with a mixed cost is $1,000 per month and the variable cost component is $3.00 per unit, then it is easy to project that an activity level of 500 units in an accounting period will result in a total mixed cost of $2,500 (calculated as $1,000 fixed cost + ($3.00/unit x 500 units)).
Problems with the Scattergraph Method
There are several issues with the scattergraph method, which are as follows:
Does not account for step costing points. The scattergraph method is not an overly precise method for determining cost levels, since it does not factor in the impact of step costing points, where costs change dramatically at certain activity levels. For example, reaching a certain number of units produced might require outsourcing some work or opening a new production shift, either of which will alter the variable cost incurred per unit and/or the fixed cost level.
Sensitivity to outliers. Outliers in the data can significantly influence the placement of the line, leading to inaccurate cost estimates.
Limited precision in cost breakdowns. The scattergraph method often provides only a rough approximation of fixed and variable costs. This imprecision can lead to unreliable budgeting and decision-making.
Assumption of a linear relationship. It assumes a linear relationship between costs and activity levels, which may not hold true for all situations.
Ineffectiveness with sparse data. With limited data points, the scattergraph method becomes even less reliable, as a meaningful trend might not emerge.
Inability to handle complex cost structures. Costs that involve step functions, mixed costs, or curvilinear behaviors cannot be effectively analyzed using this method.
These drawbacks make the scattergraph method less reliable compared to more robust techniques for estimating cost behavior.