Vol. 26, No. 1
American Accounting Association
A Case Study on Cost Estimation and
Proﬁtability Analysis at Continental Airlines
Francisco J. Román
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 Continental’s 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.
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 ﬁrm’s latest quarterly ﬁnancial results. A bleak situation lay before them. Continental had incurred an operating loss of $71 million dollars—its second consecutive quarterly earnings de-
Francisco J. Román 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.
Editor’s note: Accepted by Kent St. Pierre
Published Online: February 2011
cline that year. Likewise, passenger volume was signiﬁcantly down, dropping by nearly 5 percent from the prior year’s quarter. Continental’s 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 Continental’s 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 ﬁrm’s salaries and wages as the highest cost in Continental’s cost structure. This obviously had a negative impact on the bottom line, squeezing even further the already strained proﬁt margins.