EXHIBIT 4-9 Overhead Costs for KenCor Pizza

$11,000 10,000 9,000 8,000 7,000 6,000

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"Don't Change That Light Bulb!"

One thing is true about flying an airplanethe gas tank has to be full whether there are 15 passengers or 75 passengers. This is the brutal reality of operating an airlinethere are many fixed costs. Few airlines have faced this reality like American Airlines, which has lost more than $6.6 billion since late 2001. The company is now taking steps to curb its losses and is finding that questioning long-held beliefs about the industry can pay dividends. For example, the company has decided to spread out its schedule, rather than bunch flights close together, which required employees to staff gates and aircraft at the same time. Also, for firstclass passengers, the company now purchases less expensive blankets from China rather than Italy, and li ghtbulbs over seats are changed less frequently than they once were. Other cost savings efforts include replacing passenger windows less frequentlyeach window costs $1,000and polishing the exterior of airplanes every two years rather than every year as done in the past. These and other cost savings efforts have allowed American Airlines to slash its annual costs by an astounding $2.2 billion! However, if schedules are less convenient, layovers are longer, passengers are left sitting in the dark, or passengers become concerned about safety, short-term savings may result in long-term costs.

Regression Analysis
A statistical technique used to estimate the fixed and variable components of a mixed cost is called least squares regression. Regression analysis uses statistical methods to fit a cost line (called a regression line) through a number of data points. Note that although the data points in our example do not lie along a straight
96

Cost Behavior and Relevant Costs

line, regression analysis statistically finds the line that minimizes the sum of the squared distances from each data point to the line (hence the name least squares regression).

Using a Spreadsheet Program to Perform Regression Analysis

Using a spreadsheet program to estimate regression models is a relatively simple process. We are going to use Microsoft Excel in this example, but all spreadsheet programs are very similar. The first step is to enter the actual values for our mixed cost (called the dependent variable in regression analysis because the amount of cost is dependent on production) and the related volume of production (called the independent variable because it drives the cost of the dependent variable) into a spreadsheet using one column for each variable. Using data from KenCor Pizza Emporium for overhead costs incurred and pizzas produced for the first 12 months of operations, we see the results shown in the Excel spreadsheet in Exhibit 4-10.

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The next step in Excel (see Exhibit 4-11) is to click on the tools option from the toolbar and choose data analysis from the pull-down menu. From the data analysis screen, scroll down, highlight regression, and either double-click or choose OK. The regression screen will prompt you to choose a number of options. The first step is to input the y range. The y range will be used to identify the dependent variable (overhead costs) found in column C of your spreadsheet. You can either type in the range of cells or simply highlight the cells in the spreadsheet (be sure not to include the column heading), and click on the icon in the y-range box. The next step is to select the x range for the independent variable (volume of pizzas). Once again, you can entel the cells directly or highlight the cells in the second column of your spreadsheet.
Regression Analysis 97

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After inputting the appropriate y and x ranges, your Excel spreadsheet should look like the example shown in Exhibit 4-12. Click OK, and the regression model summary output appears as shown in Exhibit 4-13.

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98

Cost Behavior and Relevant Costs

EXHIBIT 4-13 Regression AnalysisSummary Output

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How is the summary output interpreted? First, note toward the bottom of Exhibit 4-13 that the estimated coefficient (value) of the intercept (the y intercept) is 3,998.25 and the estimated coefficient (value) of the x variable (the slope) is 2.09. This means that the fixed-cost component of our mixed overhead cost is estimated to be $3,998.25, and the variable-cost component is estimated to be $2.09 per pizza. Using the least squares regression results, we can compute the regression line for overhead costs at KenCor Pizza Emporium: Total overhead cost = Fixed cost + (Variable cost per unit x Volume) Total overhead cost = $3,998r25 +($2.09 x Volume) Graphically, the line for the total overhead costs can be expressed as shown in the following illustration.

Total Overhead Cost Slope

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Volume of Pizzas

We can use this equation to help predict the total amount of overhead costs that will be incurred for any number of pizzas within the relevant range. The
Regression Analysis
99

line, regression analysis statistically finds the line that minimizes the sum of the squared distances from each data point to the line (hence the name least squares regression).

Using a Spreadsheet Program to Perform Regression Analysis

Using a spreadsheet program to estimate regression models is a relatively simple process. We are going to use Microsoft Excel in this example, but all spreadsheet programs are very similar. The first step is to enter the actual values for our mixed cost (called the dependent variable in regression analysis because the amount of cost is dependent on production) and the related volume of production (called the independent variable because it drives the cost of the dependent variable) into a spreadsheet using one column for each variable. Using data from KenCor Pizza Emporium for overhead costs incurred and pizzas produced for the first 12 months of operations, we see the results shown in the Excel spreadsheet in Exhibit 4-10.

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The next step in Excel (see Exhibit 4-11) is to click on the tools option from the toolbar and choose data analysis from the pull-down menu. From the data analysis screen, scroll down, highlight regression, and either double-click or choose OK. The regression screen will prompt you to choose a number of options. The first step is to input the y range. The y range will be used to identify the dependent variable (overhead costs) found in column C of your spreadsheet. You can either type in the range of cells or simply highlight the cells in the spreadsheet (be sure not to include the column heading), and click on the icon in the y-range box. The next step is to select the x range for the independent variable (volume of pizzas). Once again, you can enter the cells directly or highlight the cells in the second column of your spreadsheet.
Regression Analysis 97