What Is the Scattergraph Method?
The scattergraph (or scatter graph) method is a visual technique used in accounting for separating the fixed and variable elements of a semi-variable expense (also called a mixed cost) in order to estimate and budget for future costs. A semi-variable expense is more complicated to analyze since it is made up of both fixed and variable factors.
A scattergraph uses a horizontal x-axis that represents a firm's production activity and a vertical y-axis that represents its cost. Data are plotted as points on the graph, and a regression line that runs through the dots represents the best fit of the relationship between the variables.
- The scattergraph method visually indicates how a semi-variable expense differs for various activity levels of a firm.
- The graph utilizes a linear regression to generate a line of best fit to plot the relationship between a firm's productivity and expenses.
- The method provides a mixed cost equation that allows managers and accountants to estimate the amount of the cost for future periods under a variety of circumstances.
Understanding the Scattergraph Method
Business managers use the scattergraph method when estimating costs to anticipate operating costs at different activity levels. This is known as a mixed or semi-variable cost. Also known as a semi-fixed cost, this refers to a cost composed of a mixture of both fixed and variable components. Costs are fixed for a set level of production or consumption, and become variable after this production level is exceeded. If no production occurs, a fixed cost is often still incurred.
The method derives its name from the overall image of the graph, which consists of many scattered dots. The method is simple, but it is also imprecise. Ideally, the result of a scattergraph analysis is a formula with the total amount of fixed cost and the variable cost per unit of activity.
If an analyst calculates 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 can be determined that an activity level of 500 units in an accounting period will equate to a total mixed cost of $2,500 (calculated as $1,000 fixed cost + ($3.00/unit x 500 units)).
The scattergraph method is not an overly precise approach for determining cost levels since it does not include the impact of step costing points, where costs change dramatically at certain activity levels. The method is also not useful when there is little correlation between the costs incurred and the related activity level because projecting costs into the future is difficult. Actual costs incurred in future periods might vary from the scattergraph method's projections.
But it's nonetheless a good formula to have an idea about the operating leverage of a company, which is the percentage of fixed cost versus variable cost. The desired company is one with a low level of fixed cost so that it can manage through crisis phases where demand and activity level are low.
Alternate methods of cost estimation include cost accounting's high-low method, a technique of attempting to separate out fixed and variable costs given a limited amount of data; account analysis, in cost accounting, a way for an accountant to analyze and measure the cost behavior of a firm; and least squares, a statistical method used to determine a line of best fit by minimizing the sum of squares created by a mathematical function.