A CASE STUDY ON COST ESTIMATION AND PRO_TABILITY ANALYSIS AT CONTINENTAL AIRLINES.pdf

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A CASE STUDY ON COST ESTIMATION AND PRO_TABILITY ANALYSIS AT CONTINENTAL AIRLINES.pdf

Attribution Non-Commercial (BY-NC)

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Francisco J. Romn

ABSTRACT: This case exposes students to the application of regression analyses to be used as a tool pursuant to understanding cost behavior and forecasting future costs using publicly available data from Continental Airlines. Specically, the case focuses on the harsh nancial situation faced by Continental as a result of the recent nancial crisis and the challenges it faces to remain protable. It then highlights the importance of reducing and controlling costs as a viable strategy to restore protability and how regression analysis can assist in this pursuit. Students are next presented with quarterly data for various categories of costs and several potential cost drivers, which they must use to perform regressions on operating costs using a variety of cost drivers. They must then use their regression results to forecast operating costs and conduct a protability analysis to project quarterly prots for the upcoming scal year. Finally, students must summarize the main results of their analysis in a memorandum addressed to Continentals management, providing recommendations to restore prots. In particular, the concept of mixed cost functions is reinforced, as is the understanding of the steps required to perform regression analysis in Excel, interpreting the regression output, and the underlying standard assumptions in regression analysis. The case has been tested and well received in an intermediate cost accounting course and it is suitable for both undergraduate and graduate students. Keywords: cost estimation; protability analysis; cost behavior; regression analyses; cost functions. Data Availability: All data are from public sources and are available in hard copy inside the case. Data are also available in electronic form by the author upon request.

INTRODUCTION n 2008, the senior management team at Continental Airlines, commanded by Lawrence Kellner, the Chairman and Chief Executive Ofcer, convened a special meeting to discuss the rms latest quarterly nancial results. A bleak situation lay before them. Continental had incurred an operating loss of $71 million dollarsits second consecutive quarterly earnings de-

I thank Kent St. Pierre editor, Michael Costa, and two anonymous referees for their suggestions on previous versions of the case. Editors note: Accepted by Kent St. Pierre

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cline that year. Likewise, passenger volume was signicantly down, dropping by nearly 5 percent from the prior years quarter. Continentals senior management needed to act swiftly to reverse this trend and return to protability. Being the fourth largest airline in the U.S. and eighth largest in the world, Continental was perceived as one of the most efciently run companies in the airline industry. Nonetheless, 2008 brought unprecedented challenges for Continental and the entire industry as the United States and much of the world was heading into a severe economic recession. Companies cutting deeply into their budgets for business travel, the highest yielding component of Continentals total revenue, together with a similar downward trend from the leisure and casual sector, combined to sharply reduce total revenue. Concurrent with this revenue decline, the price of jet fuel soared to record levels during 2008.1 Thus, while revenue was decreasing, Continental was paying almost twice as much in fuel costs. Interestingly, fuel costs surpassed the rms salaries and wages as the highest cost in Continentals cost structure. This obviously had a negative impact on the bottom line, squeezing even further the already strained prot margins. The outlook for a quick recovery in the U.S. economy and, consequently, an upturn in the demand for air travel in the short term did not seem likely. Continentals internal forecasts indicated that a further decline in passenger volume should be anticipated throughout 2009, with a recovery in travel possibly occurring by the middle of 2010. To summarize, adverse economic conditions in the U.S., coupled with the rise in fuel costs, were dragging down Continentals prots and relief was unlikely through the foreseeable future. THE DECISION TO REDUCE FLYING CAPACITY AND THE IMPACT ON OPERATING COSTS Given the situation described above, management needed to act swiftly to restore protability. Several strategic options were evaluated. Since the U.S. and much of the world was facing a severe recession, the prospect for growing revenues by either raising airfares or passenger volume seemed futile. Contrary to raising revenue, Continentals managers believed that raising fares could potentially erode future revenues beyond the present level. Discounting fares did not seem a plausible solution either, because given the severity of the economic situation a fare cut could fall short in stimulating additional passenger demand and lead to lowering revenues. Thus, because management anticipated that revenues would remain at for most of the year, the only viable short-term solution to restoring prots was a substantial and swift reduction in operating costs. This could most effectively be accomplished in two ways. First, through a reduction in ying capacity adjusted to match projected passenger demand. With this in mind, Continentals management agreed to reduce ying capacity by 11 percent on domestic and international routes.2 As a result of this action, Continental would eliminate the least protable or unprotable ights and, accordingly, would ground several planes in the eet. Management anticipated that this decision would reduce several of the rms operating costs. Apart from this, Continental could achieve further reductions in costs by implementing several cost-cutting initiatives and through operational efciencies. For example, management pro-

To illustrate, jet fuel is tied to the price of oil and, over the past year, oil prices surged from about $70 to $135 per barrel. Consequently, the price of jet fuel increased markedly, from an average of $1.77 per gallon to $4.20 by the mid-summer of 2008. Specically, on June 13, 2008, Continental Airlines announced that it planned to reduce its ight capacity by 11 percent. By shrinking capacity, Continental expected to reduce the number of domestic and international ights from its three major hubs in Houston, Cleveland, and Newark Maynard 2008.

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jected that it could achieve reductions in Passenger Services expenses by consolidating several tasks during passenger check-in and by reducing food and beverage waste served during ights. Additionally, the rm could reduce various miscellaneous expenses through targeted cuts in discretionary spending. In sum, to close the gap in protability, Continentals strategy was geared toward slashing operating costs by cutting capacity and through aggressive identication and implementation of cost-cutting initiatives. The next step would be for management to know precisely how their decision to downsize capacity would impact the rms future operating costs, and also identify specic areas in which the rm could achieve additional cost reductions. Additionally, the cost analysis would help forecast the rms operating costs and projected prots or losses for the upcoming scal year. However, before we can proceed with such analysis, an examination of how the various categories of Continentals costs behave is in order. Before we begin, let us prepare with an overview of the airline industry and its competitive landscape, and an understanding of why cost behavior bears particular relevance in this case. Relative to other industries, airlines are a very difcult business to manage. In particular, they are exposed to tremendous risks brought by volatility inherent in their business model, as they deal with high xed costs, labor unions, instability in fuel prices, weather and natural disasters, passenger safety, and security regulations. These aspects bring a large burden to airlines cost structures. Moreover, competition within the industry is erce; the proliferation of discount carriers, such as Southwest Airlines and, most recently, Jet Blue, and the end of fare regulation in 1978, has hindered airlines pricing power and their ability to spur revenues. For these reasons, cost containment is a critically important aspect of protability in this industry. In order for Continental to restore protability in this harsh environment of weak demand for air travel, it must be able to contain its operating costs, especially its massive xed costs, which are visible in several ways. For example, salaries for pilots, ight attendants, and mechanics, as well as aircraft leasing costs, are typically xed, varying little with shifts in passenger volume. Because xed costs typically embody the amount of operating capacity of a rm, they are commonly referred as capacity costs. Since xed costs do not self-adjust to uctuations in passenger volume, the only way in which they can be decreased or increased is if management adjusts them in accordance to the level of operating capacity. In contrast, other costs, such as passenger services and reservation and distribution costs, behave as variable and would self-adjust with variations in volume or operating activity. Hence, to assess the impact of this strategic decision to alter Continentals cost structure, and identify the areas that could achieve the greatest reduction in costs, we must resolve how Continentals operating costs behave and what drives them. In what follows, we learn how to apply regression analyses to examine cost behavior and forecast future costs, and then use that knowledge to assess how the reduction in ying capacity would affect Continentals operating costs and protability in the near term. ESTIMATING COSTS USING REGRESSION ANALYSES The previous discussion highlighted the importance of examining the behavior of Continentals operating costs to pave the way for a cost and protability analysis using regression analysis. Regression analysis is a powerful statistical tool that is frequently used by rms to examine cost behavior and predict future costs. The idea behind regression analysis is straightforward: historical data for costs, and the various activities that could potentially drive operating costs, are inserted into a mathematical calculation which yields the average amount of change in that particular cost that has occurred over time. Average values provided by regression calculations may then be applied to estimate future change that will occur in that cost given a one-unit change in one or

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more of the business activities which drive that cost.3 More precisely, in a regression model, cost is a function of one or more business activities or factors underlying a business operation. Simply put, the business activities are the drivers of operating costs. Therefore, since activities drive costs, our rst step in the estimation of a cost function is to identify the underlying activities or other potential factors that drive the cost in questionthe cost drivers. This requires extensive knowledge of the business operation. In the case of Continental Airlines, the potential drivers of operating costs vary greatly. For instance, as previously noted, the number of passengers that Continental ies may drive the costs related to Passenger Services. Likewise, Aircraft Maintenance and Repairs costs could be driven by the number of aircraft in the eet and by the level of ying capacity set by Continental i.e., available seat miles. In synthesis, to predict how Continentals operating costs would be affected by the decision to reduce capacity, and to identify those areas in which additional room is available for cost cutting, we need to identify which costs in this rms cost structure behave as variable, xed, or mixed in which elements of both variable and xed are observable. Equally important, we should also identify the specic drivers if any of each cost. Your job is to assist management in their quest to restore protability at Continental Airlines. Specically, you must conduct regression analyses to examine cost behavior and then use this information to forecast operating costs and protability for the upcoming year. As part of your cost analysis, you should investigate how the decision to cut ying capacity would impact the rms future operating costs and, equally important, identify those specic expense categories or operating areas in which this rm could attain additional costs saving by implementing cost-cutting initiatives. Your conclusions should be outlined in a memorandum directed to Continentals Executive management team. You are provided next with a description of Continentals operating costs and the potential drivers of costs so you can conduct regression analysis to estimate the corresponding cost functions. To help you in estimating the regressions, a comprehensive set of instructions for performing regression analysis using Microsoft Excel is provided in the Appendix. Immediately following the description of costs, a series of questions is provided that should help guide your analysis. Additionally, to help you estimate your regressions, Exhibit 1 presents past quarterly data for all of the above expenditures for the period of January 2000 through December 2008, while Exhibit 2 provides quarterly operations data for the same period of time. CONTINENTALS OPERATING COSTS AND POTENTIAL COST DRIVERS As shown in Exhibit 1, there are ten categories of operating costs. These include salaries and wages, aircraft fuel and related taxes, aircraft rentals, airport fees, aircraft maintenance and repairs, depreciation and amortization, distribution costs, passenger services, regional capacity purchases, and other expenses. Of these, some represent a single expense item. For example, the cost of aircraft rentals and airport fees together comprise a single cost item. Other costs represent cost pools comprising several cost items. Such is the case of passenger services and other expenses. The following provides a detailed description of each cost, along with the potential cost drivers.4

3 4

For ease in exposition, cost functions and regression analyses are discussed briey here. For further insight on cost functions and on the mechanics of regression analyses, I refer the reader to the Appendix. A cost driver represents a particular business activity, which usually tends to have a cause-and-effect relationship with a given cost. For example, for airlines, a typical cost driver for landing fees is the number of daily ights carried by the airline, as well as the number of passengers own. An increase decrease in the number of ights or passengers own would increase decrease landing fees.

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Obs. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 Period 1Q-2000 2Q-2000 3Q-2000 4Q-2000 1Q-2001 2Q-2001 3Q-2001 4Q-2001 1Q-2002 2Q-2002 3Q-2002 4Q-2002 1Q-2003 2Q-2003 3Q-2003 4Q-2003 1Q-2004 2Q-2004 3Q-2004 4Q-2004 1Q-2005 2Q-2005 3Q-2005 4Q-2005 1Q-2006 2Q-2006 3Q-2006 4Q-2006 1Q-2007 2Q-2007 3Q-2007 4Q-2007 1Q-2008 2Q-2008 3Q-2008 4Q-2008 Revenues Fuel Salaries and Wages Capacity Purchases Aircraft Rentals Landing Fees 129,000,000 138,000,000 133,000,000 132,000,000 141,000,000 153,000,000 139,000,000 148,000,000 161,000,000 160,000,000 163,000,000 149,000,000 152,000,000 152,000,000 165,000,000 151,000,000 160,000,000 163,000,000 171,000,000 160,000,000 171,000,000 181,000,000 182,000,000 174,000,000 185,000,000 198,000,000 195,000,000 186,000,000 193,000,000 190,000,000 209,000,000 198,000,000 207,000,000 210,000,000 225,000,000 210,000,000

2,277,000,000 334,000,000 672,000,000 206,000,000 2,571,000,000 313,000,000 719,000,000 210,000,000 2,622,000,000 354,000,000 748,000,000 215,000,000 2,429,000,000 392,000,000 736,000,000 213,000,000 2,451,000,000 345,000,000 758,000,000 214,000,000 2,556,000,000 349,000,000 800,000,000 223,000,000 2,223,000,000 322,000,000 779,000,000 230,000,000 1,739,000,000 213,000,000 684,000,000 236,000,000 1,993,000,000 208,000,000 732,000,000 228,000,000 2,192,000,000 254,000,000 746,000,000 231,000,000 2,178,000,000 276,000,000 743,000,000 227,000,000 2,039,000,000 285,000,000 738,000,000 216,000,000 2,042,000,000 347,000,000 778,000,000 223,000,000 2,216,000,000 302,000,000 762,000,000 224,000,000 2,365,000,000 316,000,000 778,000,000 225,000,000 2,247,000,000 290,000,000 738,000,000 158,000,000 224,000,000 2,307,000,000 333,000,000 688,000,000 317,000,000 220,000,000 2,553,000,000 387,000,000 711,000,000 328,000,000 222,000,000 2,602,000,000 414,000,000 703,000,000 347,000,000 224,000,000 2,437,000,000 453,000,000 717,000,000 359,000,000 225,000,000 2,505,000,000 470,000,000 715,000,000 353,000,000 227,000,000 2,857,000,000 575,000,000 649,000,000 382,000,000 229,000,000 3,001,000,000 684,000,000 646,000,000 406,000,000 234,000,000 2,845,000,000 714,000,000 639,000,000 431,000,000 238,000,000 2,947,000,000 672,000,000 661,000,000 415,000,000 245,000,000 3,507,000,000 744,000,000 791,000,000 454,000,000 248,000,000 3,518,000,000 858,000,000 743,000,000 475,000,000 249,000,000 3,156,000,000 760,000,000 680,000,000 447,000,000 248,000,000 3,179,000,000 684,000,000 726,000,000 430,000,000 248,000,000 3,710,000,000 842,000,000 821,000,000 444,000,000 248,000,000 3,820,000,000 895,000,000 836,000,000 446,000,000 249,000,000 3,523,000,000 933,000,000 744,000,000 473,000,000 249,000,000 3,570,000,000 1,048,000,000 729,000,000 506,000,000 247,000,000 4,044,000,000 1,363,000,000 704,000,000 589,000,000 246,000,000 4,072,000,000 1,501,000,000 765,000,000 553,000,000 244,000,000 3,471,000,000 993,000,000 760,000,000 425,000,000 240,000,000 Aircraft Maintenance 159,000,000 171,000,000 167,000,000 149,000,000 160,000,000 162,000,000 Passenger Services 85,000,000 91,000,000 97,000,000 89,000,000 91,000,000 96,000,000

Obs. 1 2 3 4 5 6

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Obs. 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

Period 3Q-2001 4Q-2001 1Q-2002 2Q-2002 3Q-2002 4Q-2002 1Q-2003 2Q-2003 3Q-2003 4Q-2003 1Q-2004 2Q-2004 3Q-2004 4Q-2004 1Q-2005 2Q-2005 3Q-2005 4Q-2005 1Q-2006 2Q-2006 3Q-2006 4Q-2006 1Q-2007 2Q-2007 3Q-2007 4Q-2007 1Q-2008 2Q-2008 3Q-2008 4Q-2008

Distribution Costs 194,000,000 142,000,000 172,000,000 158,000,000 138,000,000 124,000,000 127,000,000 138,000,000 131,000,000 135,000,000 137,000,000 140,000,000 139,000,000 136,000,000 138,000,000 154,000,000 154,000,000 142,000,000 160,000,000 178,000,000 157,000,000 155,000,000 161,000,000 176,000,000 171,000,000 174,000,000 182,000,000 194,000,000 182,000,000 159,000,000

Aircraft Maintenance 142,000,000 104,000,000 114,000,000 119,000,000 119,000,000 124,000,000 133,000,000 126,000,000 135,000,000 115,000,000 112,000,000 102,000,000 107,000,000 93,000,000 112,000,000 106,000,000 116,000,000 121,000,000 127,000,000 140,000,000 140,000,000 140,000,000 144,000,000 169,000,000 166,000,000 142,000,000 159,000,000 167,000,000 152,000,000 135,000,000

Depreciation 120,000,000 131,000,000 106,000,000 112,000,000 112,000,000 114,000,000 116,000,000 110,000,000 110,000,000 108,000,000 104,000,000 105,000,000 104,000,000 102,000,000 99,000,000 98,000,000 97,000,000 95,000,000 96,000,000 97,000,000 99,000,000 99,000,000 99,000,000 101,000,000 106,000,000 107,000,000 106,000,000 108,000,000 112,000,000 111,000,000

Passenger Services 89,000,000 71,000,000 77,000,000 73,000,000 78,000,000 68,000,000 70,000,000 73,000,000 81,000,000 73,000,000 69,000,000 76,000,000 84,000,000 77,000,000 77,000,000 84,000,000 91,000,000 80,000,000 82,000,000 90,000,000 97,000,000 87,000,000 90,000,000 99,000,000 105,000,000 95,000,000 96,000,000 107,000,000 113,000,000 91,000,000

Other Expenses 121,000,000 166,000,000 382,000,000 454,000,000 276,000,000 277,000,000 320,000,000 91,000,000 250,000,000 455,000,000 304,000,000 279,000,000 287,000,000 278,000,000 316,000,000 280,000,000 282,000,000 305,000,000 293,000,000 323,000,000 313,000,000 333,000,000 340,000,000 357,000,000 357,000,000 328,000,000 356,000,000 427,000,000 461,000,000 372,000,000

Obs. 1 2 3 4 5 6 7 8 9 10 11 12 13 14

Period 1Q-2000 2Q-2000 3Q-2000 4Q-2000 1Q-2001 2Q-2001 3Q-2001 4Q-2001 1Q-2002 2Q-2002 3Q-2002 4Q-2002 1Q-2003 2Q-2003

Total Aircraft 514 522 535 522 548 557 501 522 538 570 570 554 562 570

OPERATIONS AND COST DRIVER DATA Leased Aircraft Flights Passengers Available Seat Miles 403 410 414 398 406 416 377 393 400 404 401 410 419 428 98,820 97,871 97,967 98,378 98,590 99,018 98,564 81,109 81,883 82,815 81,737 78,809 75,178 75,617 11,201,000 12,084,000 12,155,000 11,456,000 11,220,000 12,256,000 11,254,000 9,508,000 12,062,000 13,099,000 13,006,000 12,874,000 11,518,000 13,044,000 20,951,000,000 21,384,000,000 22,356,000,000 21,409,000,000 21,459,000,000 22,813,000,000 21,994,000,000 18,219,000,000 20,375,000,000 22,286,000,000 22,626,000,000 21,054,000,000 20,843,000,000 21,241,000,000

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Obs. 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

Period 3Q-2003 4Q-2003 1Q-2004 2Q-2004 3Q-2004 4Q-2004 1Q-2005 2Q-2005 3Q-2005 4Q-2005 1Q-2006 2Q-2006 3Q-2006 4Q-2006 1Q-2007 2Q-2007 3Q-2007 4Q-2007 1Q-2008 2Q-2008 3Q-2008 4Q-2008

Total Aircraft 570 579 586 587 592 594 598 604 611 622 630 634 648 648 630 625 631 628 641 630 653 632

OPERATIONS AND COST DRIVER DATA Leased Aircraft Flights Passengers Available Seat Miles 428 434 437 440 445 448 453 459 466 477 483 484 482 480 446 418 415 415 414 390 412 397 76,297 75,650 74,859 75,816 74,211 74,443 71,494 74,651 74,630 75,886 74,962 77,729 77,468 79,030 78,601 82,582 81,118 80,850 76,719 76,096 78,599 76,000 13,727,000 13,769,000 12,810,000 14,558,000 14,862,000 14,252,000 14,122,000 15,540,000 15,905,000 15,448,000 15,594,000 17,596,000 17,328,000 16,601,000 16,176,000 18,120,000 17,901,000 16,733,000 16,440,000 17,108,000 17,962,000 15,183,000 22,819,000,000 21,907,000,000 22,670,000,000 24,150,000,000 24,674,000,000 23,588,000,000 23,585,000,000 25,482,000,000 26,833,000,000 25,720,000,000 26,117,000,000 28,259,000,000 29,262,000,000 27,280,000,000 27,250,000,000 29,592,000,000 30,346,000,000 28,550,000,000 28,376,000,000 30,304,000,000 30,383,000,000 26,448,000,000

Available Seat Miles Regional 1,605,000,000 2,980,000,000 2,400,000,000 2,603,000,000 1,999,000,000 3,408,000,000 2,740,000,000 3,026,000,000 3,112,000,000 3,095,000,000 3,082,000,000 3,374,000,000 3,503,000,000 3,292,000,000 3,126,000,000 3,177,000,000 3,193,000,000 3,104,000,000 3,098,000,000 3,450,000,000 3,390,000,000 3,046,000,000

Obs. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

Period 1Q-2000 2Q-2000 3Q-2000 4Q-2000 1Q-2001 2Q-2001 3Q-2001 4Q-2001 1Q-2002 2Q-2002 3Q-2002 4Q-2002 1Q-2003 2Q-2003 3Q-2003 4Q-2003 1Q-2004 2Q-2004 3Q-2004 4Q-2004 1Q-2005 2Q-2005

Passenger Miles Flown 15,005,000,000 16,491,000,000 17,325,000,000 15,340,000,000 15,114,000,000 17,053,000,000 16,206,000,000 12,767,000,000 14,867,000,000 16,489,000,000 16,960,000,000 17,252,000,000 14,352,000,000 16,129,000,000 18,041,000,000 16,412,000,000 16,255,000,000 18,735,000,000 19,922,000,000 18,239,000,000 18,112,000,000 20,292,000,000

Employees 45,000 45,500 46,000 45,944 38,396 39,000 39,500 39,461 40,229 41,011 41,809 40,244 38,960 39,000 39,500 39,000 38,240 37,496 36,766 38,255 41,831 45,742

Fuel Price $0.829 $0.797 $0.865 $0.885 $0.856 $0.815 $0.824 $0.826 $0.644 $0.723 $0.760 $0.740 $1.029 $0.881 $0.857 $0.872 $1.041 $1.787 $1.199 $1.190 $1.453 $1.670

Fuel Consumed 377,000,000 386,000,000 398,000,000 372,000,000 369,000,000 391,000,000 373,000,000 369,000,000 308,000,000 332,000,000 340,000,000 316,000,000 305,000,000 308,000,000 330,000,000 314,000,000 320,000,000 347,000,000 345,000,000 321,000,000 324,000,000 344,000,000

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Obs. 23 24 25 26 27 28 29 30 31 32 33 34 35 36

Period 3Q-2005 4Q-2005 1Q-2006 2Q-2006 3Q-2006 4Q-2006 1Q-2007 2Q-2007 3Q-2007 4Q-2007 1Q-2008 2Q-2008 3Q-2008 4Q-2008

Passenger Miles Flown 21,762,000,000 20,033,000,000 20,336,000,000 23,367,000,000 24,042,000,000 21,772,000,000 21,450,000,000 24,623,000,000 25,422,000,000 22,670,000,000 22,280,000,000 24,836,000,000 24,746,000,000 20,825,000,000

Employees 50,018 42,200 42,600 43,450 41,500 38,033 41,800 43,300 41,400 39,640 43,000 40,100 43,500 42,490

Fuel Price $1.880 $1.776 $1.904 $2.110 $2.215 $2.064 $1.895 $2.079 $2.206 $2.499 $2.797 $3.856 $3.450 $2.925

Fuel Consumed 364,000,000 344,000,000 347,000,000 375,000,000 387,000,000 362,000,000 361,000,000 395,000,000 406,000,000 380,000,000 375,000,000 389,000,000 395,000,000 339,000,000

Variable Revenues Available seat miles Available regional seat miles Number of passengers Number of planes Number leased planes Price of fuel per gallon Gallons of fuel consumed Quarter 1 $2,962,000,000 26,323,000,000 2,971,000,000 14,408,000 634 398 $1.82 403,000,000 Quarter 2 $2,767,000,000 28,007,000,000 3,044,000,000 16,348,000 617 394 $2.07 430,000,000 Quarter 3 $2,947,000,000 28,933,000,000 3,130,000,000 16,795,000 604 380 $1.99 369,000,000 Quarter 4 $2,462,000,000 26,291,000,000 3,002,000,000 15,258,000 601 379 $1.98 479,000,000

All nancial and operational data represent quarterly data for the quarter beginning January 2000 Observation 1 through December 2008. Data have been compiled from Continentals 8-K and10-K reports, submitted to the Securities and Exchange Commission. Denitions of Operations Variables: Available seat miles the number of seats available multiplied by the number of miles own; Available regional seat miles available seat miles on regional routes; Number of passengers number of paying passengers own; Number of planes number of planes in the eet, including regional routes aircraft; Number of leased planes number of leased planes; Price of jet fuel average price per gallon of jet fuel in the respective quarter; and Gallons of fuel consumed number of gallons of fuel consumed in the respective quarter.

Salaries and Wages This account represents costs related to salaries and wages, as well as fringe benets, of Continentals workers. These include salaries for pilots and wages for ight attendants and ground crew, as well as wages for Continentals mechanics. Additionally, a signicant portion of this salary pool represents wages of reservation specialists, customer service representatives at airports, and the salaries for administrative and support personnel e.g., ight schedulers, technology

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personnel, accountants, and division managers. A possible cost driver of salaries is the available seat miles.5 Aircraft Fuel and Related Taxes This represents the cost of jet fuel and related fuel taxes. Jet fuel cost tends to be driven by the current price of jet fuel and gallons of jet fuel consumed. Aircraft Rentals These are expenses for capital leases of aircraft. The main driver is the number of leased planes in Continentals eet, including regional jets operated on behalf of Continental by four regional airlines under various capacity purchase agreements. Airport Fees Represents landing fees and passenger security fees paid to the various domestic and international airports where Continental ies. Landing fees are driven by the number of passengers. Aircraft Maintenance and Repairs These are expenses associated with the service and maintenance of planes. These include expenses related to scheduled maintenance, spare parts and materials, and airframe and engine overhauls. The main drivers of these costs are the number of planes in the eet and the number of miles own. Depreciation and Amortization This represents depreciation and amortization expenses of aircraft, ground equipment, buildings, and other property. It must be emphasized that the largest portion of depreciation expense relates to the depreciation of aircraft. Although depreciation expenses are driven by the acquisition cost of Continentals capital assets, depreciation is greatly inuenced by both company policy and accounting principles, such as the depreciation method, that a rm adopts. Distribution Costs These expenses represent credit card discount fees, booking fees, and travel agency commissions, all of which are affected by passenger revenue. Therefore, the driver of these costs is total revenue. Passenger Services This is also a cost pool that includes expenses related to processing and servicing passengers prior to take-off, during ight, and after arrival at their destination. A signicant portion of these costs is generated by Continentals Field Services Division, the main function of which is to provide service to planes prior to take-off. Some of these expenses relate to checking in passengers, handling luggage on and off planes, cleaning planes, stocking planes with beverage and food, and refueling the aircraft prior to take-off. The potential cost driver of these costs is the number of passengers. Regional Capacity Purchases These are costs related to the purchase of regional routes served by several regional airlines on behalf of Continental ExpressJet, Chautauqua, CommutAir, and Cogan. These costs are

5

Available seat miles is calculated as the number of seats available for passengers multiplied by the number of scheduled miles those seats are own.

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driven by the combined ying capacity of the four airlines: available regional seat miles. Other Expenses This is a cost pool that comprises many ancillary and discretionary expenditures, including technology expenses, security and outside services, general supplies, and advertising and promotional expenses. Further, this cost pool contains various special charges for gains and losses from the sale of retired aircraft and costs of future leases. Given the large variety of miscellaneous items, there is no clear driver of these expenses; however, a large portion of them, such as advertising and promotional expenses, are driven by total revenue. DISCUSSION QUESTIONS 1. Using the quarterly data for operating costs and the various cost drivers of costs provided by Exhibits 1 and 2, estimate regression for cost category of costs. Then, write the appropriate cost function for each category of cost and then interpret your regression results. Based on your regression results, where do you see the largest reductions in costs if ying capacity is lowered by 11 percent? Also, in which areas do you see opportunities to achieve further cost reductions and why? Exhibit 2 provides a quarterly forecast of revenues, jet fuel prices,6 and the projected operating activity for 2009. Using the information from your regressions and the forecast information provided in Exhibit 2, estimate Continentals operating costs and expected prot for the upcoming scal year. Based on the results of your protability analysis, what can you say about the rms nancial outlook? Would Continental be earning an operating prot in 2009? If not, what should Continentals management do to restore protability in 2009? Summarize your conclusions in a memorandum addressed to Continentals CEO. In the memo, you must clearly communicate your main ndings, emphasizing specic areas in which you see the greatest potential to achieve further reductions in costs and, based on your protability analysis, sum up the nancial outlook for 2009.

2.

3.

4.

5.

You should note that Continental has entered into several future contracts to hedge the exposed risks of rising fuel prices. The projected costs for jet fuel on exhibit reects the value of the various future contracts which guarantee Continental a xed price for jet fuel at various maturity dates in 2009, as well the estimated gallons of fuel that Continental plans to use during the year.

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CASE LEARNING OBJECTIVES AND IMPLEMENTATION GUIDANCE Cost estimation is a fundamental aspect of managerial/cost accounting Datar et al. 2008; Eldenburg and Wolcott 2005. For example, cost estimation is critical for developing budgets, setting up cost standards, inventory valuation, product costing, and many other applications. Ultimately, rms ability to accurately predict production and operating costs has a profound impact on decision-making. Additionally, given the frequency with which rms downsize or expand their operations in response to economic or market-wide conditions, knowing how this strategic decision of scaling output impacts rms future operating costs, and which tools can facilitate this task, has become increasingly relevant for rms. Nonetheless, despite its importance, cost estimation is a topic that merits further discussion in accounting textbooks. Although several managerial/cost accounting textbooks provide rich theoretical discussions of cost estimation, including cost behavior, cost functions, and, to some extent, regression analyses, the examples that are typically used to illustrate such an important concept often lack a sense of realism. Either ctitious data are commonly used in cost estimation, or the examples covered fail to capture realistic situations faced by rms in a real world context. Accordingly, this case aims to close this gap. The objective is to support students in learning how to apply regression analyses to understand cost behavior and forecast future costs using real data from rms. The case focuses on the harsh nancial situation faced by Continental Airlines as a result of the recent nancial crisis and the challenges it faces to remain protable. It then highlights the importance of reducing and controlling costs as a viable strategy to restore protability, and how regression analysis can assist in this pursuit. Students are next presented with quarterly data for various categories of costs and several potential cost drivers, which they must analyze and then perform regressions on operating costs using a variety of cost drivers. Based on these results, students have to examine how costs behave and then use the regression output to forecast the rms operating costs for year 2009. As part of the cost analysis, students must also identify specic areas in which Continental could achieve the largest cost savings as a result of cutting capacity and implementing other cost-cutting measures. Apart from this, they must conduct a protability analysis to project quarterly prots for the upcoming scal year. The learning objectives of the case are as follows: 1. 2. Students learn to conduct regression analysis in Excel and use this technique to study cost behavior and forecast future costs. Students also learn how to use actual rm-level data from public sources for estimating costs, and apply cost estimation in a real world context that involves a widespread decision among rms: downsizing capacity. Moreover, learning to use public nancial information in cost estimation could have implications that reach beyond accounting; learning to access public nancial information exposes students to the possibilities of applying regression analysis for business analysis in general, including cost and protability analyses. The case requires students to synthesize their ndings in a memorandum addressed to Continentals CEO; thus, students are also exposed to rening their writing skills in a business setting.

3.

Implementation Guidance This case is primarily designed for use in an intermediate managerial/cost accounting undergraduate class; however, it could also work well in a graduate-level managerial accounting course, at either the masters level or M.B.A.

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The realistic nature of the setting everyone can easily identify with the business model of airlines makes a particularly appealing environment for students to learn how regression analyses can be applied in cost estimation in a real-world context. The questions presented in the case include both practical and theoretical questions. As an augmentation of the principles contained in the application of this case, instructors could enhance the student experience by devoting time to reviewing the concepts of cost functions and cost estimation, as well as discussing the fundamentals of regression analyses, so students can be exposed to these concepts prior to receiving the case. Alternatively, students can review these concepts on their own. The Appendix provides a detailed explanation of cost functions and regression analysis and describes the steps to perform regression analysis in Excel. Additionally, it provides students with broad guidelines to write an effective memorandum. Student Feedback The case was administered to two sections of an upper-level intermediate undergraduate cost accounting class at a major U.S. university. Seventy-seven students responded to an evaluation survey to assess whether they improved their understanding of the concepts illustrated in the case, as well as to whether the case illustrated a real world application in predicting operating costs. As shown in Table 1, students agreed that the case enhanced their understanding of the use of regression analyses in predicting future costs mean of 4.17, based on a ve-point scale, the case encouraged them to think critically about the behavior of operating costs in a real world context mean of 4.03, based on a ve-point scale; plus, they found the case interesting and recommended it for use in teaching cost estimation via regression analyses mean of 4.07, based on a ve-point scale; see also Table 2. Similar positive responses are shown in Table 2. For example, Table 2 reports students knowledge on the use of regression analysis before and after working on the case. As shown, students signicantly enhanced their knowledge on cost estimation after reading the case mean 2.80 before and a mean of 4.47 after on a ve-point scale.

Survey Questions The case helped me improve my understanding of how regression analysis can be used in predicting future costs. The context of the assignment represents a realistic real world scenario. The case taught me the necessary skills to perform regression analysis in Excel and to use such techniques to estimate future costs. The case encouraged me to think critically about the behavior of operating costs in a real world context. I found the case interesting and recommend its use for teaching cost estimation.

Scale: 1 strongly disagree to 5 strongly agree.

4.03 4.07

4.00 4.00

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TABLE 2 Students Perception of Skills Prociency Before and After the Case

Survey Questions Understanding of how regression analyses are conducted Interpreting the regression output and applying it in cost estimation Understanding the main statistics in regression Understanding the difference between univariate and multivariate regression Understanding the advantage/limitations of regression analysis for cost estimation

Scale: 1 least knowledgeable to 5 knowledgeable.

Additionally, students were asked to write specic comments about their experience working on this case. Some of these comments are as follows: Useful assignment, especially for students who are unskilled at statistics This case improved my understanding of regression analysis and how to use it for predicting costs APPENDIX Fundamentals of Regression Analyses Regression analysis is a powerful statistical technique that is commonly used to predict a future value of a variable of interest, such as costs, revenues, etc., based on data from the past. To perform regression analysis, we must specify a regression model of the relationship between the variable of interest, the dependent variable, and one or several explanatory variables, the independent variables. One simple and frequently used way to describe the underlying relationship between the dependent variable and the independent variable is with a linear regression model. A linear model assumes that the relationship between the variables of interest is strictly linear and is described in the following way: Y = a + bX + e. To better illustrate, suppose that you want to estimate Aircraft Maintenance and Repair costs at Continental Airlines. In this case, the dependent variable is the underlying cost that we are trying to predict and the independent variable is whatever factor causes that cost to rise or drop. For example, a common factor that tends to affect Aircraft Maintenance and Repair costs for airlines is the number of aircraft in their eet. Therefore, this would be the independent or predictor variable of Aircraft Maintenance and Repair costs. In its most simple term, what the above model indicates is whether the variable Y is related to X. More formally, the regression model represents the mean of Y for a given change in X. That is, whether the mean of Y is linearly related to X plus some error term. Where Y represents the dependent variable Aircraft Maintenance and Repair costs, X is the independent variable number of aircraft, a and b are the estimated coefcients, the constant and the slope of the regression model, respectively, which will be explained next, and e is the residual

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or estimated error of the model. The a coefcient is a value at which the line intercepts the Y-axis. It is the value of the mean of Y when X0. With respect to a cost function, it represents the xed costs in the cost function. The b coefcient is called the slope because it measures the slope of the regression line. In our example, it represents the amount by which the mean of Y maintenance costs changes if X number of the aircraft changes by one unit. The next question is how do we perform regression analysis in Excel? To explain the procedure, consider the following quarterly data for Continental Airlines for Aircraft Maintenance and Repair costs and the potential cost driver of such costs, the number of aircraft in Continentals eet:

Observation 1 2 3 4 5 Maintenance Costs $340,000 $400,000 $440,000 $480,000 $530,000 No. of Aircraft 10 40 50 80 110

The rst step in regression analysis is to see whether a linear relationship exists between the dependent variable and the independent predictor variable. This may be accomplished by plotting the data on a graph. Data for maintenance costs, the dependent variable, is plotted on the Y vertical axis, and data for the number of aircraft, the independent variable, on the X horizontal axis. To create this graph in Excel, follow these steps: 1. 2. 3. 4. 5. 6. follows: Copy the data into an Excel spreadsheet, copying the data pertaining to the cost driver in the rst column and the cost data in the second column. Click on the Insert menu bar and select the Chart option; alternatively, you may also select the Chart Wizard toolbar. Select the XY Scatter graph option. Select the cells that contain the data you want to use for your chart. Press Next to add a title and to label the Y and X axis. Press Finish to display the chart. Using the above data, the Scatter plot chart looks as

Maintenance Costs vs. No. of Aircraft

$600,000 $500,000 $400,000 $300,000 $200,000 $100,000 $0 0 20 40 60 No. of Planes 80 100 120

As shown above, though the relationship scatter plots of Y and X will not outline a perfectly straight line, we could observe that the scatter graph shows that this relationship is indeed linear and, thus, indicates that the number of planes is a good predictor of Maintenance costs. Moreover, by plotting the data, we could identify potential outliers data points that do not represent normal activity and eliminate them from the analysis. In this particular case, it can be observed that no outliers are present.

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Next, well proceed to estimate the regression model, where maintenance costs would be a function of the number of airplanes serviced. In this particular case, since we have a single predictor variable, we refer to it as a univariate regression. The regression model is expressed as follows: Maintenance costs = a + bnumber of planes + e

where maintenance costs substitutes for the Y variable and the number of planes for the X variable described previously; e is called the residual or error term and is dened as the difference between an actual observation of the dependent variable cost and its estimated or forecasted value from the regression estimation that we will run next. The idea of regression analysis is to calculate the values of the dependent variables that minimize the sum of square of these residuals. The mechanics of regression analysis work as follows: Using the data in your sample, regression would calculate a mean and would use this mean as a benchmark to compare as a central value in the calculations. Simply put, the regression equation in this example will provide an estimate of the relationship between maintenance costs and the number of ights that Continental Airlines offered, on average, in the quarter. Let us now perform the regression in Excel. To estimate a regression in Excel MS Ofce 97 thru 2005 versions, follow these steps: On the Tools menu bar, select the Data Analysis command, and then select regression. Note that if the Data Analysis command is not available, you need to install the Analysis Toolpak add-in. Here is how to add it: on the Tools menu bar, select the Add-in command. Then, select Analysis Toolpak and press OK. 2. Enter the cell reference for the dependent variable i.e., maintenance costs; the range selected must consist of a single column of data; then proceed to select the cell reference for the independent variable i.e., number of airplanes. 3. Select if the rst row or column of the input ranges contain labels or headings; clear if your input has no labels; Excel generates appropriate data labels for the regression output table. 4. Click to create a new worksheet containing the regression output. 5. Press OK to generate the Regression Output Table. To estimate a regression in Excel MS Ofce 2007 version, follow these steps: 1. On the Data menu bar, select the Data Analysis command located on the right hand corner, and then select Regression Analysis. Note that if the Data Analysis command is not available, you need to install the Analysis Toolpak add-in. Here is how to add it: press the Ofce icon located on the left-hand side of the Excel menu bar, select the Excel Option, then select Add-ins command. Then, select Analysis Toolpak and press OK. Enter the cell reference for the dependent variable i.e., maintenance costs; the range selected must consist of a single column of data; then proceed to select the cell reference for the independent variable i.e., number of airplanes. Select if the rst row or column of the input ranges contain labels or headings; clear if your input has no labels; Excel generates appropriate data labels for the regression output table. Click to create a new worksheet containing the regression output. 1.

2.

3.

4.

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5. Press OK to generate the Regression Output Table. Using the above data, the Regression Output Table looks as follows:

Regression Statistics Multiple R R2 Adjusted R2 Std Error Observations ANOVA df Regression Residual Total 1 3 4 Coefcients SS 20878639456 401360544.2 21280000000 Standard Error t-stat p-value Lower 95% Upper 95% MS 20878639456 133786848.1 F 156.0589831 Signicance F 0.001105628 0.990524645 0.981139072 0.974852096 11566.62648 5

Intercept 328707.483 10163.56279 32.3417575 6.49662E05 296362.4902 361052.4758 No. of Aircraft 1884.353741 150.8405294 12.49235699 0.001105628 1404.311856 2364.395627

Let us now proceed to analyze each main statistic of the regression output. The intercept, with a value of 328,707.48, is commonly referred to as the alpha coefcient and is a constant value in the regression function. In the specic case of cost estimation, this value represents the amount of xed costs present in the cost function. In our example, this value indicates that $328,707 of Maintenance costs is xed and would not change at all given any change in the number of planes in Continentals eet. Further, the second statistic of interest is the coefcient estimate for the Number of Aircraft, which has a value of 1,884.35. This is the slope of the regression function and it is referred as the beta coefcient. In cost estimation, this value represents the portion of variable costs in the cost function; that is, the portion of Maintenance costs that would vary given any changes in the number of planes. In our example, the slope coefcient is interpreted as follows: for each plane in which Continental provides scheduled maintenance, the amount of Maintenance costs is expected to increase, on average, by $1,884.35 dollars. An important issue in the examination of both coefcients is that neither the intercept nor the slope is ever examined in isolation. Each coefcient must be analyzed in combination with its corresponding t-statistic, or the respective p-value. The t-statistic is the ratio of the value of the coefcient to its standard error. The standard error of the coefcient represents the amount of variation in costs that is unexplained by the cost driver; in our example, the number of planes. The lower higher the standard error, the better worse each coefcient is. Going back to the t-statistic, this value indicates whether each of the two coefcients is different from zero. A rule of thumb is that if the t-statistic is at least 1.96 or greater, then we are 95 percent condent that the value of the coefcient is signicantly greater than zero. This implies that the coefcient is a valid estimate and, therefore, could be used in the cost function as a way to predict future costs. If the t-value is less than 1.96, then we cannot rule out the possibility that the coefcient is zero and, therefore, the coefcient should not be used in the prediction of costs. If we take a look at the Regression Output Table, the t-statistics for the intercept and the slope coefcients are 32.34 and 12.49, respectively. Therefore, we can conclude that both coefcients are not zero and, thereby, the estimates of xed costs and variable costs per unit are valid estimates. The second statistic of importance in the examination of each coefcient is the probability

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value, or the p-value. Each t-statistic has a corresponding p-value. The p-value is the reciprocal of the t-statistic in that it tells us the probability that the coefcient estimate is signicantly different from zero. If the p-value is less than or at least equal to 0.05, we are 95 percent condent that the coefcient estimate for the intercept or the slope coefcient is statistically signicant different from zero. The smaller the p-value, the larger the t-statistic. For example, the p-value for the t-statistic in the intercept coefcient equals 0.0000649, and 0.0011 for the slope coefcient. This means that both coefcients are not zero. More formally, this means that xed costs have a probability of being zero about six in 100,000 times, and the variable cost about one in 1,000 times. The last statistic of interest in our analysis is the R2, or the Adjusted R2. The R2 represents the goodness of t of the model, or the explanatory power of the model. In the case of the Adjusted R2, it measures the same thing, but after adjusting for degrees of freedom in the regression model. Simply put, the R2 Adjusted R2 represents the percentage of variation in the dependent variable maintenance costs that is explained by the independent variable number of planes. This value ranges between 0 and 1, with the larger value representing a higher explained variation in costs. In our example, the R2 equals 0.98, which indicates that approximately 98 percent of the variation in maintenance costs is explained by the number of planes which were serviced. A follow-up question is which cutoff value is acceptable? This is subjective and will denitely depend on the underlying analysis. In the case of cost estimation, perhaps we may want to have at least 30 percent of the variation in costs explained by the cost driver. Multivariate Regression Analyses Thus far, we have explored regression analyses with one independent variable. Then, the question becomes what happens if we have two or more independent variables in our case, two cost drivers as predictors of the dependent variable Aircraft Maintenance and Repair costs. For example, it is feasible that besides the number of planes in Continentals eet, Aircraft Maintenance and Repair costs may also be driven by other factors, such as the average utilization of each plane in miles or hours. In this case, the regression model varies subtly from the case of a single predictor variable. The mathematical notation for a multivariate regression model is expressed as follows: Y = a + b 1X 1 + b 2X 2 + b 2X 2 + b kX k . . . + e where Y represents the dependent variable Aircraft Maintenance and Repair costs, X1 is independent variable one number of aircraft in the eet, and X2 average daily miles own on each aircraft. Just as in the case of a univariate regression, a and b are the estimated coefcients of the constants and the slopes of the regression model; that is, the xed costs and the slopes of the cost function, respectively, and e is the residual or estimated error of the regression model. Assume the following quarterly data for Aircraft Maintenance and Repair costs and for each of the potential cost drivers discussed above:

Observation Maintenance Costs No. of Aircraft Daily Miles Flown 1 2 3 4 5 $340,000 $400,000 $440,000 $480,000 $530,000 10 40 50 80 110 1,166 1,270 1,457 1,450 1,433

To estimate a multivariate regression in Excel, we must follow Step 1, described previously, plus the following additional steps:

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Enter the cell reference for the dependent variable i.e., maintenance costs; the range selected must consist of a single column of data. 2. Then, proceed to select the cell reference for all the independent variables number of airplanes, average age, and the average number of hours own daily; the range selected must consist of two or more columns. Note that all independent variables must be listed in sequential order; that is, next to each other. 3. Select if the rst row or column of the input ranges contain labels or headings; clear if your input has no labels; Excel generates appropriate data labels for the regression output table. 4. Click to create a new worksheet containing the regression output. 5. Press OK to generate the Regression Output Table. Using the above data, the Regression Output Table for the multivariate regression looks as follows: 1.

Regression Statistics Multiple R R2 Adjusted R2 Standard Error Observations ANOVA df Regression Residual Total 2 2 4 Coefcients SS 21268062401 11937599.25 21280000000 Standard Error t-stat p-value Lower 95% Upper 95% MS 10634031200 5968799.625 F 1781.60298 Signicance F 0.000560977 0.999719472 0.999439023 0.998878045 2443.112692 5

Intercept 147096.4284 22586.32684 6.512631708 0.022774575 49915.30752 244277.5492 No. of Aircraft 1324.949381 76.23333561 17.38018375 0.003294134 996.943811 1652.95495 Daily Miles Flown 155.6548193 19.27060294 8.077319625 0.014983671 72.74010699 238.5695317

The statistics of interest are the same from the case of the univariate regression. The only difference is that now we have two slope coefcients. Let us summarize the main statistics of interest. The Intercept represents the alpha coefcient or the constant value in the regression function and, thus, indicates that there is $147,096 of xed costs. The coefcient estimate for the Number of Aircraft has a value of $1,324.94 and indicates that for every aircraft in Continentals eet, Maintenance and Repair costs rise by this amount. And, the coefcient estimate for Daily Miles Flown indicates that for every mile that each aircraft in the eet is own daily, Maintenance costs increase, on average, by $155. Note that the t-statistic for each coefcient is greater than 2 and, thus, indicates that both coefcients are different from zero. The Adjusted R2 indicates that 99 percent of the variation in Maintenance costs is explained by both cost drivers. An additional statistic of interest in multivariate regression is the F-statistic, which indicates the tness of the model; that is, how well all predictors as a whole explain changes in the dependent variable. An F-statistic of two or greater indicates that the independent variables as a whole make a good prediction of changes in Maintenance costs. Let us now proceed to discuss how we can develop the cost functions as a way to estimate Aircraft Maintenance and Repair costs.

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Development of the Cost Function to Estimate Future Costs A cost function is simply an algebraic representation of how a given cost would change given a change in the cost driver. For example, in our example, the cost function would represent how Aircraft Maintenance and Repair costs would change given a one-unit change in the number of aircraft. Using our prior results from the univariate regression, the cost function is written as follows: Y = $328,707.48 + $1,324.94X The above cost function indicates that $328,707.48 of Aircraft Maintenance and Repair costs is xed and would not change irrespective of changes in the number of aircraft in the eet, and Maintenance and Repair costs would rise by $ 1,884.35 for every aircraft in Continentals eet. After setting up the cost function, we can now proceed to estimate Maintenance and Repair costs. Let us assume that Continental Airlines plans to have 142 planes in its eet next year. Plugging this gure into the cost function, we obtain the following result: Y = $328,707.48 + $1,884.35142 Y = $596,285.18 Therefore, given the projection with respect to the number of airplanes, we can conclude that Continental Airlines would incur approximately $596,285.18 in Aircraft Maintenance and Repair Costs for next year. The same procedure is applied to the case in which there are multiple cost drivers. Referring to our prior results from the multivariate regression, the cost function is written as follows: Y = $147,096.42 + $1,324.94X1 + $155.65X2 Using the same projection as before of 142 planes for next year, plus assuming that the average utilization of miles for each plane is 1,550 miles, then total Aircraft Maintenance costs for next year is calculated as follows: Y = $147,096.42 + $1,324.94142 + $155.651,550 Y = $576,495.40 Hence, given the projection of the number of airplanes and the average utilization of miles that Continental plans to y each plane, we can conclude that Continental Airlines would incur approximately $576,495 in Aircraft Maintenance and Repair costs for next year. TEACHING NOTES Teaching Notes are available only to full-member subscribers to Issues in Accounting Education through the American Accounting Associations electronic publications system at http:// aaapubs.org/. Full-member subscribers should use their usernames and passwords for entry into the system where the Teaching Notes can be reviewed and printed. Please do not make the Teaching Notes available to students or post them on websites. If you are a full member of AAA with a subscription to Issues in Accounting Education and have any trouble accessing this material, then please contact the AAA headquarters ofce at info@aaahq.org or 941 921-7747.

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REFERENCES

Datar, S., C. Horngren, G. Foster, and C. Ittner. 2008. Cost Accounting: A Managerial Emphasis. 13th edition. Englewood Cliffs, NJ: Prentice Hall. Eldenburg, L., and S. Wolcott. 2005. Cost Management: Measuring, Monitoring, and Motivating Performance. 1st edition. New York, NY: John Wiley and Sons. Maynard, M. 2008. Big airlines in a rush go small. The New York Times June 6.

Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.

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