Certain costs, such as direct materials and direct labor, vary in proportion with the level of activity. These are known as variable costs. As the level of activity increases, the total variable costs increases directly with the change in the level of activity.
Fixed costs, on the other hand, do not change. They remain constant regardless of the level of activity.
For cost data to be more useful in analysis, costs are classified into variable costs and fixed costs. A problem arises when a cost contain features of both fixed and variable costs. Some costs do not have a clear pattern of behavior in relation to the cost driver.
Several cost segregation methods are employed to separate fixed costs and variable costs. The commonly used segregation methods include the high-low method, the scatter graph method, and the least squares method.
The high-low method considers the highest and lowest points of activity only. The scatter graph considers all data, hence provides more reliable results. The scatter graph method is done graphically and visually. The least squares method provides the most accurate results through a series of mathematical computations.