3.2 Assessing costs using a scatter graph

Scatter graphs plot data points on a graph and are useful as another means of examining the relationship between fixed and variable costs. By drawing in the line of best fit, which plots a line which best fits the spread of the data, we are, in effect, setting out the total cost line, as in Figure 9. This meets the vertical axis at an activity level of zero, so the total costs at that point must be the fixed costs. It follows that if we take the total costs at a particular level of activity, deduct the fixed costs and divide the resulting answer by the level of activity, we arrive at the variable cost per unit.

Figure 9 Using a scatter graph to find the line of best fit

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The figure has x and y axes. The x axis represents level of activity in number of units. The y axis represents unit cost in pounds. The graph shows changing fixed cost per unit as the level of activity changes by using scatter approach. Data plots a line which best fits the spread of the data, which, in effect, sets out the total cost line.

Figure 9 Using a scatter graph to find the line of best fit

A scatter graph is a useful visual insight into the relationship between fixed and variable costs and, indeed, can be regarded as superior to the high–low method, which uses only two data points. However, remember that it is only a guide to the relationship: ultimately, the precise answer can only be calculated by a detailed analysis of the cost data such as by regression analysis, which was covered in B126.

Now that you have explored cost behaviour in terms of fixed and variable costs, you will look at the notion of direct versus indirect costs.