Quantitative Techniques for

Business Decision Making

Management accountants are devoting more attention to providing management and
other interested parties with data they can use in cost control, planning and decision
making rather than emphasizing cost accumulation and determination.  Emphasis is now
given on the predictive ability of data rather than solely emphasizing the past. 
Accountants are now integrating planning and control models within the accounting
system for monitoring actual results against plans to provide feedback for corrective
action.
The quantitative analysis is a problem-solver which attempts to formulate decision
problem in mathematical terms.  The accountant must concern also himself with the
decision-making process since he is the one who must design the accounting information
system.  To be effective in this role, the accountant must acquaint with the objectives.
assumptions and requirement of the decision models employed.  A decision model is
intended to be the sole basis for making a decision.  Rather, it is tool that the decision
maker uses in addition to other inputs in arriving at a decision.  The use of a decision
model helps to ensure that the alternatives are logically evaluated in the light of specific
criterion and explicit assumptions.
The accountant must concern also himself with the decision making process since he is
the one who must design the accounting information system.  To be effective in this
role, the accountant must acquaint himself with the objectives, assumptions and
requirement of the decision models employed.  A decision model is not intended to be
the sole basis for making a decision.  Rather, it is a tool that the decision maker uses in
addition to other inputs in arriving at a decision.  The use of a decision model helps to
ensure that the alternatives are logically evaluated in the light of a specific criterion and
explicit assumptions.
The more commonly used quantitative models for planning, control and decision making
are as follows:
1.  Probability
2.  Payoff (Decision) Tables
3.  Value of Perfect Information
4.  Decision Tree
5.  Learning Curve
6.  Simulation Technique
7.  Monte Carlo Technique
8.  Sensitivity Analysis
9.  Queing
10.  Linear Programming
11.  Program Evaluation and Review Technique - Critical Path Method (PERT-CPM)
12.  Gantt Chart
13.  Inventory Modeling
14.  Regression Analysis
15.  Present Value Concept
To understand some concepts and applications of some of the above-mentioned
quantitative tools, click on the link below.

Management Control and Strategic

Performance Measurement
Management control is a systematic process by business management to compare
performance to predetermined standards, plans or objectives in order to determine
whether performance is in line with these standards and presumably in order to take any
remedial action to see that human and other corporate resources are being used in the
most effective and efficient way possible in achieving corporate objectives.  It refers to
the evaluation by upper-level managers of the performance of mid-level managers.
The objectives of management control include the following:
1.  Motivate managers to exert a high level of effort to achieve the goals set by top
management.
2.  Provide the right incentive for managers to make decisions consistent with the goals
set by top management.
3.  Determine fairly the rewards earned by managers for their effort and skill and the
effectiveness of their decision making.
Performance evaluation is the process by which managers at all levels gain information
about the performance of tasks within the firm and judge that performance against :
preestablished criteria as set out in budgets, plans, and goals.  Performance is evaluated
at many different levels in the firm ; top management, mid-management, and the
operating level of individual production and sales employment.  In operations, the
performance of individual production supervisors at the operating level are evaluated by
the plant managers, who in turn are evaluated by executives at the management level. 
Similarly, individual salespersons are evaluated by sales managers who are evaluated in
turn by upper-level sales management.
Review Questions:
1.  How is performance in a cost strategic business unit (SBU) generally measured?
Performance in a profit center?  Performance in an investment center?
Cost centers are evaluated by means of performance reports.  Profit centers are evaluated by
means of contribution income statements (including cost center performance reports), in
terms of meeting sales and cost objectives.  Investment centers are evaluated by means of the
rate of return which they are able to generate on invested assets.
 
2.  When the ROI formula is being used to measure performance, what three
approaches to improving the overall profitability are open to the manager?
Overall profitability can be improved (1) by increasing sales, (2) by reducing expenses, or (3)
by reducing assets.

3.  In what way can ROI lead to dysfunctional decisions on the part of the investment
SBU manager?  How does the residual income approach overcome this problem?
ROI may lead to dysfunctional decisions in that divisional managers may reject otherwise
profitable investment opportunities simply because they would reduce the division’s overall
ROI figure.  The residual income approach overcomes this problem by establishing a minimum
rate of return which the company wants to earn on its operating assets, thereby motivating
the manager to accept all investment opportunities promising a return in excess of this
minimum figure.
 
4.  Distinguish between a cost SBU, a profit SBU, and an investment SBU?
A cost center manager has control over cost, but not revenue or investment funds.  A profit
center manager, by contrast, has control over both cost and revenue.  An investment center
manager has control over cost and revenue and investment funds.
 
5. What is transfer price and why are transfer pricing systems needed?
The term transfer price means the price charged for a transfer of goods or services between
units of the same organization, such as two departments or divisions.  Transfer prices are
needed for performance evaluation purposes.
 
6.  If a market price for a product is determinable, why is it generally considered to be
the best transfer price?
The use of market price for transfer purposes will create the actual conditions under which
the transferring and receiving units would be operating if they were completely separate,
autonomous companies. It is generally felt that the creation of such conditions provides
managerial incentive, and leads to greater overall efficiency in operations.
 
7.  Under what situation might a negotiated price be a better approach to pricing
transfers between divisions than the actual market price?
Negotiated transfer prices should be used (1) when the volume involved is large enough to
justify quantity discounts, (2) when selling and/or administrative expenses are less on
intracompany sales, (3) when idle capacity exists, and (4) when no clear-cut market price
exists (such as a sister division being the only supplier of a good or service).
 
8.  In what ways can suboptimization result if divisional managers are given full
autonomy in setting, accepting, and rejecting transfer prices?
Suboptimization can result if transfer prices are set in a way that benefits a particular division,
but works to the disadvantage of the company as a whole. An example would be a transfer
between divisions when no transfers should be made (e.g., where a better overall contribution
margin could be generated by selling at an intermediate stage, rather than transferring to the
next division).  Suboptimization can also result if transfer pricing is so inflexible that one
division buys from the outside when there is substantial idle capacity to produce the item
internally.  If divisional managers are given full autonomy in setting, accepting, and rejecting
transfer prices, then either of these situations can be created, through selfishness, desire to
“look good”, pettiness, or bickering.
 
IMPORTANT NOTES ON TRANSFER PRICING
In many organizations, one sub-unit manufactures a product or provides a service that is
then transferred to another sub-unit in the same organization.  The price at which
products or services are transferred between two sub-units in an organization is called
transfer price.  Transfer prices guide managers to make the best possible decision as to
whether they should buy or sell products and services inside the total organization.
Since a transfer price affects the profit of both the buying and selling divisions, the
transfer price affects the performance evaluation of these responsibility centers.  Thus,
the problem of measuring performance in profit centers or investment centers is made
more complicated by transfer of goods or services between responsibility centers.
Management's objective in setting a transfer price is to encourage goal congruence
among the division managers involved in the transfer, where the interest of both the
division and the whole company coincide.  In a decentralized organization, the managers
of profit centers and investment centers often have considerable autonomy in deciding
whether to accept or reject orders and whether to buy inputs from inside the
organization or from outside.
Organizations may have to make trade-offs between pricing for congruence and pricing
to prompt managerial effort.  Furthermore, the optimal price for either may differ from
that employed for tax reporting or for other external needs.  Income taxes, property
taxes, and other similar taxes often influence the setting of transfer prices so that the
firm as a whole will benefit even to the expense of the performance of a segment.  For
multinational companies, transfer pricing is affected by some international laws were the
company is affected.