ISSUES IN ACCOUNTING EDUCATION

Vol. 26, No. 1

2011
pp. 181200

American Accounting Association

DOI: 10.2308/iace.2011.26.1.181

A Case Study on Cost Estimation and

Profitability Analysis at Continental Airlines
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. Specifically, the case focuses on
the harsh financial situation faced by Continental as a result of the recent financial crisis
and the challenges it faces to remain profitable. It then highlights the importance of
reducing and controlling costs as a viable strategy to restore profitability 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 profitability
analysis to project quarterly profits for the upcoming fiscal year. Finally, students must
summarize the main results of their analysis in a memorandum addressed to Continentals management, providing recommendations to restore profits. 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; profitability 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 Officer, convened a special meeting to discuss the
firms latest quarterly financial results. A bleak situation lay before them. Continental had
incurred an operating loss of $71 million dollarsits second consecutive quarterly earnings de-

Francisco J. Romn is an Assistant Professor at Texas Tech University.

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

Published Online: February 2011

181

182

Romn

cline that year. Likewise, passenger volume was significantly 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 profitability.
Being the fourth largest airline in the U.S. and eighth largest in the world, Continental was
perceived as one of the most efficiently 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 firms 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 profit 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 profits 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 profitability.
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 flat for most of the year,
the only viable short-term solution to restoring profits was a substantial and swift reduction in
operating costs. This could most effectively be accomplished in two ways. First, through a reduction in flying capacity adjusted to match projected passenger demand. With this in mind, Continentals management agreed to reduce flying capacity by 11 percent on domestic and international
routes.2 As a result of this action, Continental would eliminate the least profitable or unprofitable
flights and, accordingly, would ground several planes in the fleet. Management anticipated that this
decision would reduce several of the firms operating costs.
Apart from this, Continental could achieve further reductions in costs by implementing several cost-cutting initiatives and through operational efficiencies. 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.
Specifically, on June 13, 2008, Continental Airlines announced that it planned to reduce its flight capacity by 11 percent.
By shrinking capacity, Continental expected to reduce the number of domestic and international flights from its three
major hubs in Houston, Cleveland, and Newark Maynard 2008.

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A Case Study on Cost Estimation and Profitability Analysis at Continental Airlines

183

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 flights.
Additionally, the firm could reduce various miscellaneous expenses through targeted cuts in discretionary spending.
In sum, to close the gap in profitability, Continentals strategy was geared toward slashing
operating costs by cutting capacity and through aggressive identification 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 firms future operating costs, and also identify specific areas in which
the firm could achieve additional cost reductions. Additionally, the cost analysis would help
forecast the firms operating costs and projected profits or losses for the upcoming fiscal 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 difficult business to manage. In particular, they
are exposed to tremendous risks brought by volatility inherent in their business model, as they deal
with high fixed 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 fierce; 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 profitability in this industry.
In order for Continental to restore profitability in this harsh environment of weak demand for
air travel, it must be able to contain its operating costs, especially its massive fixed costs, which
are visible in several ways. For example, salaries for pilots, flight attendants, and mechanics, as
well as aircraft leasing costs, are typically fixed, varying little with shifts in passenger volume.
Because fixed costs typically embody the amount of operating capacity of a firm, they are commonly referred as capacity costs. Since fixed costs do not self-adjust to fluctuations 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 flying capacity would affect Continentals operating costs and
profitability 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 profitability analysis using regression analysis.
Regression analysis is a powerful statistical tool that is frequently used by firms 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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Romn

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 first 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 flies may drive the costs related to Passenger Services. Likewise, Aircraft Maintenance and Repairs costs could be driven by the number of aircraft in the fleet and by the level of
flying 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 firms cost structure behave as variable, fixed, or mixed in
which elements of both variable and fixed are observable. Equally important, we should also
identify the specific drivers if any of each cost.
Your job is to assist management in their quest to restore profitability at Continental Airlines.
Specifically, you must conduct regression analyses to examine cost behavior and then use this
information to forecast operating costs and profitability for the upcoming year. As part of your cost
analysis, you should investigate how the decision to cut flying capacity would impact the firms
future operating costs and, equally important, identify those specific expense categories or operating areas in which this firm 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 briefly 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 flights carried by the
airline, as well as the number of passengers flown. An increase decrease in the number of flights or passengers flown
would increase decrease landing fees.

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A Case Study on Cost Estimation and Profitability Analysis at Continental Airlines

185

EXHIBIT 1
REVENUES AND OPERATING COSTS DATA
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

Obs.
1
2
3
4
5
6

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

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

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

Period

Distribution Costs

Aircraft
Maintenance

Depreciation

Passenger
Services

Other Expenses

1Q-2000
2Q-2000
3Q-2000
4Q-2000
1Q-2001
2Q-2001

248,000,000
261,000,000
255,000,000
217,000,000
243,000,000
230,000,000

159,000,000
171,000,000
167,000,000
149,000,000
160,000,000
162,000,000

95,000,000
98,000,000
102,000,000
107,000,000
105,000,000
111,000,000

85,000,000
91,000,000
97,000,000
89,000,000
91,000,000
96,000,000

286,000,000
284,000,000
288,000,000
277,000,000
318,000,000
295,000,000

(continued on next page)

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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

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

Romn

Period

Distribution Costs

Aircraft
Maintenance

Depreciation

Passenger
Services

Other Expenses

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

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

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

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

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

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

Period

Total
Aircraft

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

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

Available Seat
Miles Regional

1,767,000,000
2,073,000,000

(continued on next page)

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A Case Study on Cost Estimation and Profitability Analysis at Continental Airlines

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

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

Period

Total
Aircraft

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

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

187

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

Available Seat
Miles Regional

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

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

Period

Passenger Miles
Flown

Employees

Fuel Price

Fuel Consumed

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

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

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

$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

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
(continued on next page)

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

Period

Passenger Miles
Flown

Employees

Fuel Price

Fuel Consumed

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

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

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

$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

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

EXHIBIT 2
PROJECTIONS OF REVENUES AND OPERATING ACTIVITY FOR YEAR 2009
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

Quarter 2

Quarter 3

Quarter 4

$2,962,000,000
26,323,000,000
2,971,000,000
14,408,000
634
398
$1.82
403,000,000

$2,767,000,000
28,007,000,000
3,044,000,000
16,348,000
617
394
$2.07
430,000,000

$2,947,000,000
28,933,000,000
3,130,000,000
16,795,000
604
380
$1.99
369,000,000

$2,462,000,000
26,291,000,000
3,002,000,000
15,258,000
601
379
$1.98
479,000,000

All financial 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.
Definitions of Operations Variables:
Available seat miles the number of seats available multiplied by the number of miles flown;
Available regional seat miles available seat miles on regional routes;
Number of passengers number of paying passengers flown;
Number of planes number of planes in the fleet, 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 benefits, of
Continentals workers. These include salaries for pilots and wages for flight attendants and ground
crew, as well as wages for Continentals mechanics. Additionally, a significant 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., flight 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 fleet, 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 flies. 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 fleet and the number of
miles flown.
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 influenced by both company policy and
accounting principles, such as the depreciation method, that a firm 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 flight, and after arrival at their destination. A significant 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 flown.

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driven by the combined flying 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.

2.

3.

4.

5.

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 flying
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
profit for the upcoming fiscal year.
Based on the results of your profitability analysis, what can you say about the firms
financial outlook? Would Continental be earning an operating profit in 2009? If not, what
should Continentals management do to restore profitability in 2009?
Summarize your conclusions in a memorandum addressed to Continentals CEO. In the
memo, you must clearly communicate your main findings, emphasizing specific areas in
which you see the greatest potential to achieve further reductions in costs and, based on
your profitability analysis, sum up the financial outlook for 2009.

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 reflects the value of the various future contracts which guarantee
Continental a fixed 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, firms ability to accurately predict production and operating costs has a profound impact
on decision-making. Additionally, given the frequency with which firms downsize or expand their
operations in response to economic or market-wide conditions, knowing how this strategic decision of scaling output impacts firms future operating costs, and which tools can facilitate this task,
has become increasingly relevant for firms.
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 fictitious data are commonly used in cost estimation, or the
examples covered fail to capture realistic situations faced by firms 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 firms. The case focuses on the
harsh financial situation faced by Continental Airlines as a result of the recent financial crisis and
the challenges it faces to remain profitable. It then highlights the importance of reducing and
controlling costs as a viable strategy to restore profitability, 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 firms operating costs for year 2009. As
part of the cost analysis, students must also identify specific 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 profitability analysis to project quarterly profits for
the upcoming fiscal year.
The learning objectives of the case are as follows:
1.
2.

3.

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 firm-level data from public sources for estimating
costs, and apply cost estimation in a real world context that involves a widespread
decision among firms: downsizing capacity. Moreover, learning to use public financial
information in cost estimation could have implications that reach beyond accounting;
learning to access public financial information exposes students to the possibilities of
applying regression analysis for business analysis in general, including cost and profitability analyses.
The case requires students to synthesize their findings in a memorandum addressed to
Continentals CEO; thus, students are also exposed to refining their writing skills in a
business setting.

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 five-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 five-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 five-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 significantly enhanced their knowledge on cost estimation after reading the
case mean 2.80 before and a mean of 4.47 after on a five-point scale.

TABLE 1
Students Assessment of Case Learning Objectives
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.

Mean
(n 58)

Median
(n 58)

4.17

4.00

4.29

4.00

4.34

4.00

4.03

4.00

4.07

4.00

Scale: 1 strongly disagree to 5 strongly agree.

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TABLE 2
Students Perception of Skills Proficiency 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

Mean Before
(n 58)

Mean After
(n 58)

2.81

4.47

2.60

4.34

2.79

4.50

2.43

4.24

2.38

4.12

Scale: 1 least knowledgeable to 5 knowledgeable.

Additionally, students were asked to write specific 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 fleet. 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 coefficients, 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 coefficient 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 fixed costs in the cost function. The b coefficient 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
fleet:
Observation

Maintenance Costs

No. of Aircraft

$340,000
$400,000
$440,000
$480,000
$530,000

10
40
50
80
110

1
2
3
4
5

The first 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 first 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

80

100

120

No. of Planes

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 defined 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 flights that Continental Airlines offered, on average, in the quarter. Let us now
perform the regression in Excel.
To estimate a regression in Excel MS Office 97 thru 2005 versions, follow these steps:
1.

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 first 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 Office 2007 version, follow these steps:
1.

2.

3.

4.

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 Office 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 first 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.

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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

0.990524645
0.981139072
0.974852096
11566.62648
5

ANOVA
df

SS

MS

Significance F

Regression
Residual

1
3

20878639456
401360544.2

20878639456
133786848.1

156.0589831

0.001105628

Total

21280000000

Coefficients

Standard
Error

t-stat

p-value

Lower 95%

Upper 95%

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 coefficient and is a constant value in the
regression function. In the specific case of cost estimation, this value represents the amount of fixed
costs present in the cost function. In our example, this value indicates that $328,707 of
Maintenance costs is fixed and would not change at all given any change in the number of planes
in Continentals fleet. Further, the second statistic of interest is the coefficient 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 coefficient. 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 coefficient 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 coefficients is that neither the intercept nor the
slope is ever examined in isolation. Each coefficient 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
coefficient to its standard error. The standard error of the coefficient 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 coefficient is. Going back to the
t-statistic, this value indicates whether each of the two coefficients 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 confident that the
value of the coefficient is significantly greater than zero. This implies that the coefficient 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 coefficient is zero and,
therefore, the coefficient 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 coefficients are 32.34 and
12.49, respectively. Therefore, we can conclude that both coefficients are not zero and, thereby, the
estimates of fixed costs and variable costs per unit are valid estimates.
The second statistic of importance in the examination of each coefficient 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 coefficient estimate is significantly different
from zero. If the p-value is less than or at least equal to 0.05, we are 95 percent confident that the
coefficient estimate for the intercept or the slope coefficient is statistically significant 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 coefficient equals 0.0000649, and 0.0011 for the slope coefficient. This
means that both coefficients are not zero. More formally, this means that fixed 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 fit 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 definitely 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 fleet, 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 fleet, and X2 average daily miles flown on each
aircraft. Just as in the case of a univariate regression, a and b are the estimated coefficients of the
constants and the slopes of the regression model; that is, the fixed 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 flown 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 first 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

0.999719472
0.999439023
0.998878045
2443.112692
5

ANOVA
df

SS

MS

Significance F

Regression
Residual

2
2

21268062401
11937599.25

10634031200
5968799.625

1781.60298

0.000560977

Total

21280000000

Coefficients

Standard
Error

t-stat

p-value

Lower 95% Upper 95%

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 coefficients. Let us summarize the main statistics of
interest. The Intercept represents the alpha coefficient or the constant value in the regression
function and, thus, indicates that there is $147,096 of fixed costs. The coefficient estimate for the
Number of Aircraft has a value of $1,324.94 and indicates that for every aircraft in Continentals
fleet, Maintenance and Repair costs rise by this amount. And, the coefficient estimate for Daily
Miles Flown indicates that for every mile that each aircraft in the fleet is flown daily, Maintenance
costs increase, on average, by $155. Note that the t-statistic for each coefficient is greater than 2
and, thus, indicates that both coefficients 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 fitness 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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A Case Study on Cost Estimation and Profitability Analysis at Continental Airlines

199

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
fixed and would not change irrespective of changes in the number of aircraft in the fleet, and
Maintenance and Repair costs would rise by $ 1,884.35 for every aircraft in Continentals fleet.
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 fleet next year.
Plugging this figure 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 fly each plane, we can conclude that Continental Airlines would incur approximately $576,495 in Aircraft Maintenance and Repair costs for next year.
TEACHING NOTES
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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.

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