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When interpreting a scatter graph, it is important to remember that different people would likely draw different lines, which would lead to different estimations of fixed and variable costs. Because the trend line is somewhat subjective, the scatter graph is often used as a preliminary tool to explore the possibility that the relationship between cost and activity is generally a linear relationship. Once the scatter graph is constructed, we draw a line (often referred to as a trend line) that appears to best fit the pattern of dots. A diagnostic tool that is used to verify this assumption is a scatter graph.Ī scatter graph shows plots of points that represent actual costs incurred for various levels of activity. In other words, costs rise in direct proportion to activity. One of the assumptions that managers must make in order to use the cost equation is that the relationship between activity and costs is linear. Total Variable Cost per Unit = ?75 + ?11 + ?5 = ?91 per unit.ĭemonstration of the Scatter Graph Method to Calculate Future Costs at Varying Activity Levels Direct Materials per Unit = ?75,000 / 1,000 Units = ?75 per unit. Using this information and the cost equation, predict Waymaker’s total costs for the levels of production in (Figure). In March, Waymaker produced 1,000 units and used 2,000 hours of production labor. March Cost Information for Waymaker Furniture Information gathered from March is presented in (Figure). They plan to use the cost equation to formulate these predictions. Waymaker Furniture has collected cost information from its production process and now wants to predict costs for various levels of activity. Using this equation, the Beach Inn can now predict its total costs ( Y) for the month of July, when they anticipate an occupancy of 93 nights.
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Now, the Beach Inn can apply the cost equation in order to forecast total costs for any number of nights, within the relevant range. Using this equation, J&L can now predict its total costs ( Y) for the month of February when they anticipate preparing 25 corporate tax returns:
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Where Y is the total mixed cost, a is the fixed cost, b is the variable cost per unit, and x is the level of activity. Cost equations can use past data to determine patterns of past costs that can then project future costs, or they can use estimated or expected future data to estimate future costs. The cost equation is a linear equation that takes into consideration total fixed costs, the fixed component of mixed costs, and variable cost per unit.