DEFINITION of Scattergraph Method
The scattergraph method is a visual technique for separating the fixed and variable elements of a semi-variable expense (also called a mixed expense) in order to estimate and budget for future costs. A scattergraph has a horizontal x-axis that represents production activity, a vertical y-axis that represents cost, data that are plotted as points on the graph and a regression line that runs through the dots to represent the relationship between the variables.
BREAKING DOWN Scattergraph Method
Business managers use the scattergraph method when estimating costs to anticipate operating costs at different activity levels. 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)). A mixed cost is a cost with both fixed and variable components.
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.
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.