LESSON: QUANTITATIVE TECHNIQUES ▪ decision-making under conditions of uncertainty – each

decision alternative has several events or outcomes; the

- (rationale) management accountants use quantitative
probability distribution of the possible future states of nature
techniques in developing the necessary information needed by
is now known and must be determined subjectively.
management in carrying out their functions that include
planning, controlling, and decision-making.
Probability Distribution – specifies the values of the variables
- (quantitative/mathematical models) real-life decision
and their respective probabilities.
situations are modeled mathematically under certain
assumptions in order to achieve a deterministic solution. Probability – a mathematical expression of doubt or assurance
about the occurrence of a chance event; its value varies from o
Simulation – a technique for experimenting with
to 100%.
mathematical/logical models using a computer.
- probability of 0: the event cannot occur.
- steps in the simulation process:
- probability of 1 or 100%: the event is certain to occur.
i. defining the objective;
- probability between 0 and 1: indicates the likelihood of the
ii. formulating the model – the variables, their behavior, and
event’s occurrence.
their interrelationships are spelled out in precise
logical/mathematical terms;

iii. validating the model – to ensure realistic results of the Types of Probabilities:
experiment;
a. objective probabilities – calculated from either logic or
iv. designing the experiment – involves sampling the actual experience; e.g., the probability that a coin will yield
operation of the system; heads is 50% on any single toss.

v. conducting the simulation and evaluating the results. b. subjective probabilities – estimates of the likelihood of
future events are based on judgment and past experience.
Commonly Used Quantitative Tools:
- e.g., the likelihood that a winner in an amateur singing
a. probability analysis contest will become a successful recording artist.

b. decision tree

c. gantt chart Basic Terms Used in Probability Analysis:

d. program evaluation and review technique (PERT) ▪ mutually exclusive – if the two events cannot occur
simultaneously.
e. linear programing
▪ joint probability – both events will occur.
f. queuing
▪ conditional probability – one event will occur given that the
g. learning curves other event has already occurred.

h. sensitivity analysis ▪ independent events – the occurrence of one event has no

effect on the other event.
i. regression analysis
▪ dependent events – the occurrence of one event has an
j. present values
effect on the other event.
k. inventory models
▪ payoff – the value assigned to the difference outcomes from
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A. Probability Analysis – commonly used in planning, as well
as in decision making under uncertainty.
A.1. Expected Value – the expected value of an action is
▪ decision-making under certainty – for each decision calculated by multiplying the probability of each outcome by its
alternative, there is only one event, and therefore only one payoff and summing the products. Expected value represents
outcome; the event has a 100% chance of occurrence. the long-term average pay-off from repeated trials.

▪ decision-making under conditions of risk – the probability - illustration: White Covered Store sells balut in the city’s
distribution of the possible future states of nature is known. central bus terminal. For this coming weekend, the probability
distribution of the demand for balut is as follows:
 Estimated Sales - expected value of perfect information: (EVPI) the difference
Probability Result
in Units between the expected value without perfect information and
750 0.2 150 the result if the best action is taken given perfect information.
900 0.25 225
1,300 0.55 715 - illustration: using the previous example, assume that if Mr.
Expected Value 1,090 B knew the daily sales demand for pansit with certainty, he
would prepare exactly the number of boxes demanded. The
A.2. Payoff Decision Table – presents the outcomes/pay-offs expected value of perfect information is computed as
of specific decisions when certain states of nature (events follows:
which are not controllable by the decision-maker) occur. The
Daily
payoff table is a helpful tool for identifying the best solution CM per Expected
Sales Total CM Probability
given several decision alternatives and future conditions that Box Value
Demand
involve risk. 500 20 10,000 0.2 2,000
600 20 12,000 0.7 8,400
- illustration: Mr. B cooks and sells pansit in a box. Each box
700 20 14,000 0.1 1,400
of pansit is sold for P 50 during regular hours, that is, from 10
Expected CM given Perfect Information 11,800
a.m. to 8 p.m. If every box is sold by 8 p.m., Mr B calls it a day.
However, all unsold boxes by 8 p.m. are sold at half the regular
Expected CM given Perfect Information 11,800
price up to 9 p.m. The variable cost per box is P 30. The
Expected Value of CM using Best Course
contribution margin per box is as follows: (11,500)
of Action without Perfect Information
10 am – 8 pm after 8 pm Expected Value of Perfect Information 300
Selling Price 50 25
Variable Cost (30) (30) Cost of Perfect Information – management may have the
Contribution Margin (Loss) 20 (5) opportunity to acquire additional information that may help in
choosing the best alternative. However, obtaining information
Past experience has shown that the daily sales demand (up requires incurrence of cost.
to 8 p.m.) and their probabilities are as follows:
- in the pansit in a box example, additional information, if
Sales per Day Probability available, would increase the expected value of contribution
500 boxes 0.2 margin by P 300 (from P 11,500 to P 11,800). In this case,
600 boxes 0.7 management would be willing to incur cost of up to P 300 to
700 boxes 0.1 obtain additional information.
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Expected
A. Prepare 500 Boxes: B. Decision Tree – a graphic representation of the decision
Value
(500) 500 x 20 10,000 x 0.2 points, the alternative course of action available to the decision
(600) 500 x 20 10,000 x 0.7 maker, and the possible outcomes from each alternative, as
(700) 500 x 20 10,000 x 0.1 10,000 well as the relative probabilities and the expected values of
each event.
B. Prepare 600 Boxes:
(500) 500 x 20 – 100 x 5 9,500 x 0.2 - node – the intersections in a decision tree.
(600) 600 x 20 12,000 x 0.7
□ – Decision Points (Node) – the points at which the
(700) 600 x 20 12,000 x 0.1 11,500
decision maker must choose some action.
C. Prepare 700 Boxes:
○ – Chance Points (State of Nature Node or Probability
(500) 500 x 20 – 200 x 5 9,000 x 0.2
Node) – the points at which some event related to the
(600) 600 x 20 – 100 x 5 11,500 x 0.7
previous decision will occur.
(700) 700 x 20 14,000 x 0.1 11,250
⎯ – Branches – connectors.
A.3. Expected Value of Perfect Information

- perfection information: the knowledge that a future state of
nature will occur with certainty; in this case, it is assumed
that the probability distribution in an accurate representation
of the relative frequency of future demand and that the
decision-maker knows exactly when each possible event will
occur.
Advantages of Using Decision Tree:
a. Decision trees facilitate the evaluation of alternatives by
giving the decision maker a visual presentation of the expected
results of each alternative.
b. Decision trees are useful when sequential decisions are c. A gantt chart can be used to monitor the activities in a
involved. project. It shows which activity should be in progress as of a
certain date and how close it is to completion time.

Limitations of Decision Tree:

Disadvantages:
a. It may be difficult to determine all the possible events,
outcomes, and their probabilities. a. A gantt chart does not show the interrelationships among
the activities in a project. Only simple relationships can be
b. A case involving so many events and sequential decisions
shown on the chart.
may result into a more complex decision tree which may not be
that easy to use.

Steps in Preparing a Decision Tree:

i. Identify the decision points and the chance points.

ii. Determine the events that may result from the chance
points.

iii. Estimate the outcomes (payoffs) of each event, as well as

their estimated probabilities.

iv. Compute the expected values of the outcomes.

v. Evaluate the results and choose the best course of action. D. Program Evaluation and Review Technique (PERT) – a
networking technique used for planning and controlling the
activities in a project. It provides management pertinent
Illustration: Using the pansit in a box example, the decision tree information about a project such as:
is presented as follows:
- expected completion time of the project;

- when each activity in a project is scheduled to start and

finish;

- which part of the project must be finished on time to avoid

making the whole project late;

- how resources may be shifted from one part to another part

of the project without affecting the overall completion time of
the project;

- the progress of each part of the project as of a certain date.

- (decision) prepare 600 boxes of pansit because the quantity
has the highest expected value of contribution margin.
PERT Diagram – an arrow diagram on a network showing the
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interrelationships or interdependencies of the various activities
C. Gantt Chart – shows the different activities or tasks in a of a project. Although more complex than Gantt Charts, a PERT
project as well as their estimated start and completion times. Diagram has the advantage of incorporating probabilistic time
estimates and identifying the critical path.

Advantages:

a. A gantt chart is simple to construct and use, requiring no

special tools or mathematics. It can be used on all types of
projects.

b. A gantt chart is a very useful control. As the project

progresses, actual completion time can be compared with the
plan.
 ○ - node – can be called events when all the activities leading
to a node are finished.
event – represents a specified accomplishment at a
particular instant in time; it represents the start or finish of an
activity, such as 1 or 2 in the network.
⎯ - branch – represents the activities in a project.
activity – task to be accomplished; it represents the time
and resources necessary to move from one node or event to
another; e.g., activity 1 → 2 in the network.
a. series – an activity cannot be performed unless its
predecessor activity is finished; e.g., activities 1 → 2 and 2
→ 5 are series of activities; activity 2 → 5 cannot be
performed unless activity 1 → 2 is finished.
b. parallel – activities that can be performed
simultaneously; e.g., activity 1 → 2 can be performed while
activity 1 → 3 is performed.
Time Estimates
optimistic time – 1 week
pessimistic time – 6 weeks
most likely time – 5 weeks
expected time – 4.5 weeks (the average time an activity
would require if it were repeated a large number of times)
Path Time – a series of activities from start to finish.
Path Path Time
1-2-5-6 4.5 w - 6.5 w - 3 w 14 w
1-3-6 8w-7w 15 w
1-4-6 6w-2w 8w
Critical Path - the longest path through the network. (path 1 - 3
- 6 requiring 15 weeks is the critical path)
- a delay in the completion of the activities in the critical path
would cause a delay in the completion of the entire project.
- shortening the total completion time of the whole project
can be accomplished by shortening the critical path.
Slack Time - the length of time by which a particular activity can
slip or be delayed without having any delaying effect on the end
event.
- activities along the critical path have a slack of zero.
- all non-critical activities have positive slack.
Critical Path Critical Path Path Time Combined
Time Slack Time
1-2-5-6 15 14 1
1-3-6 15 15 0
1-4-6 15 8 7
Critical Path Method (CPM) - maybe considered as a subset of
PERT, CPM is a network technique that uses deterministic time
and cost estimates; aside from cost estimates, CPM includes
the concept of crash efforts and costs.
- crash time: the time required to complete an activity
assuming that all available resources (overtime, extra
manpower, etc.) are devoted such activity.
- crashing the network: determining the minimum cost for
completing the project in minimum time so that an optimum
trade-off between time and cost is achieved.
▪ activity times and costs are estimated for both the normal
and crash efforts; with these estimates, the project manager
can determine the costs of completing the project if some of
the activities are completed on a crash basis.
Accountant’s Role in PERT:
a. Determination of cost estimates and actual costs of each
activity in a project.
b. Preparation of activity/project cost reports and
computation/analysis of cost variances.
Benefits of PERT:
a. PERT is a very useful technique for planning and controlling
activities in a project or the entire project itself.
b. Some of the procedures included in PERT or in PERT/CPM
are in harmony with the accountant’s budgetary tasks and in
the application of a responsibility accounting system.
c. The technique may be used to solve managerial problems
pertaining to project scheduling, information systems design,
and transportation system designs.
d. PERT helps to keep the project on schedule and to provide
feedback to management about the progress of each part of
the project.
Limitations of PERT:
a. Reliable time and cost data may not be readily available snf
obtaining them may be difficult. Persons involved may
overstate budgeted costs and time estimates to avoid
unfavorable variances and pressure from their superiors.
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E. Linear Programming - a quantitative technique used to find G B
the optimal solution to short-term resource allocation Contribution Margin per
32 24
problems, such as: Unit
Required Hours per Unit:
(1) maximization of the revenue, contribution margin, or profit Sewing 4 hours 2 hours
function; and, Finishing 2 hours 4 hours

(2) minimization of a cost function, subject to constraints

Graphical Method:
(e.g., limited resources, production capacity levels, etc.)
(1) Restate the information in mathematical terms by
expressing the objective function and the constraints.
Other Business Applications of Linear Programming:
objective function: Maximize CM = 32G + 24B
i. determination of the best product mix
subject to the constraints:
ii. determination of the optimum materials mix
4G + 2B ≤ 240 (sewing dept.)
iii. assignment of jobs to manufacturing equipment
2G + 4B ≤ 192 (finishing dept)
iv. workforce scheduling
G ≥ 0 (non-negativity constraints)
v. determination of transportation routes
B≥0

Steps in Formulating a Linear Program: (2) Plot the contraints in the problem on a graph.

a. Identify the decision veriables. ▪ locate the terminal points (the x and y intercepts; where one
of the variables is equal to zero)
b. Express the objective and constraint functions in terms of
the decision variables identified in step 1. ▪ join the terminal points by a straight line.

▪ decision variables: the unknowns used to construct the

objective and constraint functions; the values of such
variables are the outputs from the linear programming
process.

▪ constraints - limit the values of variables; the constraint

equations reflect the types of inputs or resources being
allocated.

Methods for Solving Linear Programming Problems

i. Graphical Method - limited to problems with only two

variables.
(3) Locate Point E.
ii. Simplex Method - applicable even when there are more than
two variables; it is based on matrix or linear algebra and ▪ point E may be located by reading an accurately drawn
provides a systematic way of algebraically evaluating each graph; or
corner point in the feasible area.
▪ it may be located algebraically by solving the two equations
simultaneously.
Illustration: M Corporation produces two products: girl rag doll
4G + 2B = 240
(G) and boy rag doll (B), which must be processed in two
departments: sewing and finishing. Sewing has 240 hours (2G + 4B = 192) x (-2)
available per month while finishing has 192 hours.
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The number of hours required to process the products in the 4G + 2B = 240

two departments and the contribution margin per unit of the
products are as follows: -4G - 8B = -384

-6B = -144
 4G + 2B = 240 4G + 2B = 241

-4G - 8B = -384 (2G + 4B = 192) x (-2)

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-6B = -144
4G + 2B = 241
B = 24
------------------------------------------ -4G - 8B = -384

4G + 2 (24) = 240 -6B = -143

4G = 240 - 48 B = 23.83
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4G = 192
4G + 2 (23.83) = 241
G = 48
4G = 241 - 47.66
E (24, 48)
4G = 193.34
(4) Using the objective function, test the four corner points A, B,
C, and D to see which yields the greatest contribution margin: G = 48.335

Objective Function: Maximize CM = 32G + 24B G (24, 48.335)

Equation Point CM Equation Point CM

CM = 32 (0) + 24 (0) F (0, 0) 0 CM = 32 (48) + 24 (24) E (24, 48) 2,112
CM = 32 (0) + 24 (48) C (48, 0) 1,152 CM = 32 (48.335) + 24 G (23.83, 2,118,64
CM = 32 (48) + 24 (24) E (24, 48) 2,112 (23.83) 48.335)
CM = (32 (60) + 24 (0) D (0, 60) 1,920 Shadow Price 6.64
- if the company could acquire an additional hour for the sewing
department, it could earn contribution margin of P6.64; in deciding
Shadow Price (dual value of a scarce resource) - the amount by whether to acquire an additional hour for the sewing department, the
which the value of the optimal solution of the objective function actual cost of such additional hour should be less than P 6.64 so that the
in a linear programming problem will change if one unit change company would benefit from such expansion of capacity.
is made in a binding constraint. ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

→ computation of shadown price is an application of
sensitivity analysis.
→ shadow price is the income that would be lost (opportunity
cost) by not adding an additional unit of a scarce resource
(constraint)
→ in deciding whether to add an additional resource or not,
the shadow price must be greater than the accrual cost of
such additional resource.
F. Queuing Theory (working-line theory) - a study of random
arrivals of a processing or servicing facility of limited capacity;
it allows the decision maker to calculate the:
a. lengths of future waiting lines
b. average time spent in the line awaiting service or
processing
c. additional facilities required

d. service level or capacity that maximizes waiting and

operating costs
Computation of Shadow Price
- examples of queing theory applications:
(1) Add one unit of the scarce resource under consideration.
i. check out counters (cashiers) in groceries/malls;
(2) Find the new optimal solution after adding one unit of the
scarce resource. (constraint) ii. movie ticket booths;
(3) The shadow price is the difference between the profit in iii. expressway toll booths;
original optimal solution and the profit in the new optimal
solution. iv. school registrar’s office windows;

v. bank teller windows.

Illustration: Considering the data in the previous example, - costs involved:
determine the shadow price for the sewing constraints.
 ▪ facility costs and operating costs - the cost of providing Illustration: An 80% learning curve means that each time
service. cumulative production is doubled, the time required to produce
is reduced by 20%.
▪ waiting cost - the cost of idle resources waiting in line,
including the income foregone (opportunity cost) in the case Assume that the first unit takes 100 hours to finish. Each time
of waiting customers. cumulative production is doubled, the average time required
will be as follows:
- objective of queuing theory: to minimize total cost involved.
(both the service and waiting costs) Cumulative Ave. Time Cumulative
Units per Unit Total Time
1st 1 100 100
Formulae for a Single Service Facility and Random Arrival of 80 160
2nd 2
Working Units (100 x 80%) (80 x 2)
64 256
B 3rd - 4th 4
a. N = where: N - average number of work units waiting in (80 x 80%) (64 x 4)
T-B
51.2 409.6
line or being serviced. 5th - 8th 8
(64 x 80%) (51.2 x 8)
B - average number of work units arriving in ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

one unit of time. H. Sensitivity Analysis - the study of how the outcome of a
T - average number of work units serviced in decision process changes as one or more of the assumptions
one unit of time (assuming there is no change.

shortage of work units)

B
it is assumed that < 1; otherwise the queue Illustration: With sales of 100 units, the company’s projected
T
profit is P 500:
will grow to infinite length.
B 𝟐
Sales P 5,000
b. Nq = where: Nq - average number in the waiting line.
T(T-B) Variable Costs (3,000)
Nq Contribution Margin 2,000
c. W = where: W - average waiting time before service.
B
Fixed Costs (1,500)
Profit P 500
Illustration: In a supermarket, customers arrive at the cashier’s
counter at the average rate of 20 (B) customers per hour. The A. Sales in Units Increases by 20%:
cashier can serve an average of 30 (T) customers per hour. Sales P 6,000
Variable Costs (3,600)
(1) The average number of customers waiting in line or paying Contribution Margin 2,400
for their groceries at any time is: Fixed Costs (1,500)
B 20
Profit P 900
N= = = 2 customers
T-B 30 - 20
B. Variable Costs per Unit Decreases by 5%:
(2) The average number of customers in the waiting line, not Sales P 5,000
being serviced is: Variable Costs (2,850)
Contribution Margin 2,150
B2 202
Nq = = = 1 1/3 customers Fixed Costs (1,500)
T(T-B) 30 (30-20)
Profit P 650
(3) The average waiting time is:
C. Fixed Costs Decreases by P 500:
Nq 1 1/3
W= = = 0.0665 hour or 4 minutes Sales P 5,000
B 20
Variable Costs (3,000)
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Contribution Margin 2,000
G. Learning Curves (experience curve) - a mathematical Fixed Costs (1,000)
expression of the phenomenon that incremental unit costs to Profit P 1,000
produce (or incremental unit time used to produce) decrease as
managers and labor gain experience from practice.

- the learning curve model shows a constant percentage

reduction (usually from 20% to 40%) in the average direct
labor input time required per unit as the cumulative output
doubles.