Methods of segregation of Semi-variable costs: Scatter-graph Method

Cost Accounting

Prof: K. Viswanathan

What is Semi-variable Cost in a nutshell:

Semi-variable cost is an expense which contains both a fixed-cost component and a variable-cost component. The fixed cost element shall be a part of the cost that needs to be paid irrespective of the level of activity achieved by the entity. On the other hand the variable component of the cost is payable proportionate to the level of activity. Cost of energy, such as electricity, is a good example as it is integral to production of goods and services. It shows similarities to telephone bills. One must pay line rental and on top of that a price that depends on how heavy one is using the service. So it changes with output. Another example is satellite television. A price for the box must be paid monthly and to get additional movies, more money has to be given.

Cost Accounting

Prof. K. Viswanathan

General Formula for Semi-variable Cost:

The relationship between mixed cost and level of activity can be expressed by the following equation:

Y = a + bx
In this equation; Y = The total mixed cost a = The total fixed cost b = The variable cost per unit x = The level of activity
Graphical procedure used to separate a semi-variable expense (or mixed cost) into the fixed and the variable cost portion. In this method, a semi-variable expense is plotted on the vertical axis (or y -axis) and activity measure is plotted on the horizontal axis (or x -axis). Then a regression line is fitted by visual inspection of the plotted data, as shown in the following graph. The scatter graph method is relatively easy to use and simple to understand. However, it should be applied with extreme caution, because it does not provide an objective test for assuring that the regression line drawn is the most accurate fit for the underlying observations.

Cost Accounting

Prof. K. Viswanathan

Procedure
Step 1: Draw scatter graph Plot the data on scatter graph. Plot activity level (i.e. number of units, labor hours etc.) along x-axis and total mixed cost along y-axis.
Step 2: Draw regression line Draw a regression line over the scatter graph by visual inspection and try to minimize the total vertical distance between the line and all the points. Extend the line towards y-axis. Step 3: Find total fixed cost Total fixed is given by the y-intercept of the line (point were x axis is zero). Yintercept is the point at which the line cuts y-axis.

Step 4: Find variable cost per unit Variable cost per unit is equal to the slope of the line. Take two points (x1,y1) and (x2,y2) on the line and calculate variable cost using the following formula:

Variable Cost per Unit = Slope of Regression Line =

y2 y1 x2 x 1

# Above formula helps find b in the Y = a + bx

Cost Accounting Prof. K. Viswanathan

Example Company decides to use scatter graph method to split its factory overhead (FOH) into variable and fixed components. Following is the data which is provided for the analysis.

Month
1 2 3

Units
1,520 1,250 1,750

FOH
36,375 38,000 41,750

4
5 6 7

1,600
2,350 2,100 3,000

42,360
55,080 48,100 59,000

2,750

56,800

Cost Accounting

Prof. K. Viswanathan

Fixed Cost (a) = Point were line intercepts Y axis = 18,000 Variable Cost per Unit = Slope of Regression Line (b) To calculate slop we will take two points on line: (0,18000) and (3500,68000) Variable Cost per Unit = (68000 18000) (3500 0) = 14.286 (b)
Cost Accounting Prof. K. Viswanathan

Cost Accounting

Prof. K. Viswanathan

Pros & Cons:

Easy to use & Calculate Simple to understand and train on Graphical presentation

Complex to interpret in case of extensive data. Uncertain & unreliable incase of amplified & approximate data (assumptions). Scope is limited, does not use all information Different accountants may prefer different cost lines appealing to their eyes.

In conclusion, it is wise to prepare the scatter graph even if you use the
high-low method or regression analysis. The benefit of the scatter graph is that it allows you to see if some of the plotted points are simply out of line. These points are referred to as outliers and will need to be reviewed and possibly adjusted or eliminated. In other words, you dont want incorrect data to distort your calculations under any of the three methods
Cost Accounting Prof. K. Viswanathan

Presented by Ricky R. Gupta (Roll Call # 9)

Thank you &, Good Day..

Cost Accounting

Prof. K. Viswanathan