The scattergraph method is a visual representation of the cost and activity data associated with an expense, which is used to identify and separate the fixed and variable components of a cost. A cost that has both fixed and variable components is considered a mixed cost. 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 a 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.
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 ast $1,000 fixed cost + ($3.00/unit x 500 units)).
The scattergraph method is most useful for gaining insight into the nature of mixed costs, which can then be used to project costs in a company forecast, based on expected activity levels.
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.
The scattergraph method is also not useful in situations where there is little correlation between the cost incurred and the related activity level, since this makes it difficult to project costs into the future. Actual costs incurred in future periods might vary substantially from what the scattergraph method projects will happen.