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HOLY NAME UNIVERSITY

CPA Review
Tagbilaran

MANAGEMENT ADVISORY SERVICES

QUANTITATIVE TECHNIQUES

Rationale in Using Quantitative Techniques

Management accountants use quantitative techniques in developing the necessary information needed by management in
carrying out their functions that include planning, controlling, and decision-making.

Quantitative Models (Mathematical Models)

Real-life decision situations are modeled mathematically under certain assumptions in order to achieve a deterministic
solution.

Simulation
A technique for experimenting with mathematical/logical models using a computer.

Steps in the simulation procedure

1. Defining the objective
2. Formulating the model – the variables, their behavior, and their interrelationships are spelled out in precise
logical/mathematical terms.
3. Validating the model – to ensure realistic results of the experiment.
4. Designing the experiment – involves sampling the operation of the system.
5. Conducting the simulation and evaluating the results.

COMMONLY USED QUANTITATIVE MODELS

1. Probability Analysis
2. Decision Tree
3. Gantt chart
4. Program evaluation & Review Technique (PERT)
5. Linear Programming
6. Queuing
7. Learning curves
8. Sensitivity analysis
9. Regression analysis
10. Present values
11. Inventory models

PROBABILITY ANALYSIS

Probability Analysis – commonly used in planning, as well as in decision-making under uncertainty.

Decision making under certainty – for each decision alternative, there is only one event, and therefore only one
outcome. The event has a 100% chance of occurrence.

Decision-making under conditions of risk – the probability distribution of the possible future states of nature is
known.

Decision-making under conditions of uncertainty – each decision alternative has several events or outcomes.
The probability distribution of the possible future states of nature (events) is not known and must be determined
subjectively.

Probability Distribution – specifies the values of the variables and their respective probabilities.

Probability – a mathematical expression of doubt or assurance about the occurrence of a chance event. Its value varies
from zero (0) to one (1) or 100%.

Probability of 0 – the event cannot occur.

Probability of 1 or 100% - the event is certain to occur.
Probability between 0 and 1 - indicates the likelihood of the event’s occurrence.

Types of Probabilities
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1. Objective Probabilities – calculated from either logic or actual experience. Example, the probability that a coin
will yield heads is 0.50 or 50% on any single toss.
2. Subjective Probabilities – estimates of the likelihood of future events are based on judgments and past
experience. Example, the likelihood that a winner in an amateur singing contest will become a successful
recording artist.

BASIC TERMS USED IN PROBABILITY ANALYSIS

 Mutually Exclusive – if two events cannot occur simultaneously.

 Joint Probability – both events will occur.
 Conditional Probability – one event will occur given that the other event has already occurred.
 Independent Events – the occurrence of one event has no effect on the other event.
 Dependent Events – the occurrence of one event has an effect on the other event.
 Payoff - the value assigned to the different outcomes from a decision.

Expected Value
The expected value of an action is calculated by multiplying the probability of each outcome by its payoff
and summing the products. Expected value represents the long-term average payoff from repeated trials.

Payoff (decision) table

Presents the outcomes (payoff) of specific decisions when certain states of nature (events which are not
controllable by the decision-maker) occur. The payoff table is a helpful tool for identifying the best
solution given several decision alternatives and future conditions that involve risk.

Expected Value of Perfect Information

Perfect Information – the knowledge that a future state of nature (event) will occur with certainty. In this
case, it is assumed that the probability distribution is an accurate representation of the relative frequency
of future demand and that the decision maker knows exactly when each possible event will occur.

Expected value of perfect information – the difference between the expected value without perfect
information and the result if the best action is taken given perfect information.

Cost of perfect information – management may have the opportunity to acquire additional information
that may help in choosing the best alternative. However, obtaining information requires the incurrence of
cost.

DECISION TREE

Decision Tree – a graphic representation of the decision points, the alternative courses of actions available to the decision
maker, and the possible outcomes from each alternative, as well as the relative probabilities and the expected value of
each event.

Payoff Expected Value

Pxx Pxx

Nodes – the intersections in a decision tree.

- Decision points (decision nodes) – the points at which the decision maker must choose some action.
- Chance points (state of nature node or probability node) – the points at which some point at which some event
related to the previous decision will occur.

---------------------- - Branches – connectors

ADVANTAGES OF USING DECISION TREE

1. Decision trees facilitate the evaluation of alternatives by giving the decision maker a visual presentation of the
expected results of each alternative.
2. Decision tree are useful when sequential decisions are involved.

LIMITATIONS OF DECISION TREE

1. It may be difficult to determine all the possible events, outcomes, and their probabilities.
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2. A case involving so many events and sequential decisions may result into a more complex decision tree which
may not be that easy to use.

STEPS IN PREPARING A DECISION TREE

1. Identify the decision points and the chance points.
2. Determine the events that may result from chance points.
3. Estimate the outcomes (payoff) of each event, as well as their estimated probabilities.
4. Compute the expected values of the outcomes.
5. Evaluate the results and choose the best course of action.

GANTT CHART

GANTT CHART (Bar Chart) – shows the different activities or tasks in a project as well as their estimated start and
completion times.

ADVANTAGES
1. A gantt chart is simple to construct and use, requiring no special tools or mathematics. It can be used on all types
of projects.
2. A gantt chart is a very useful control tool. As the project progresses, actual completion time can be compared with
the plan.
3. A gantt chart can be used to monitor the activities in a project. It shows which activity should be in progress as of
a certain date and how close it is to completion time.

DISADVANTAGE
A gantt char does not show the interrelationships among the activities in a project. Only simple relationships can be
shown on the chart.

Illustration:

PROGRAM EVALUATION AND REVIEW TECHNIQUE (PERT)

PERT – a networking technique used for planning and controlling the activities in a project. It provides management
pertinent information about a project, such as:
 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.

PERT DIAGRAM – an arrow diagram on a network showing the interrelationships or interdependencies of the various
activities of a project. Although more complex that Gantt Charts, a PERT diagram has the advantage of incorporating
probabilistic time estimates and identifying critical path.

Te = 6.5
2 5
3, 7, 8
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Te = 8 Te = 7
1 3 6
2, 9, 10 1, 8, 9

- NODE – can be called an event 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.

- BRACH – 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. For example, activity 1  2 in the network.

TYPES OF ACTIVITIES
Series – an activity cannot be performed unless its predecessor activity is finished. For example, activities 1  2 and 2 
5 are series of activities. Activity 2  5 cannot be performed unless activity 1  are finished.

Parallel – activities that can be performed simultaneously. For example, activity 1  2 can be performed while activity 1
 3 is being performed

TIMES ESTIMATES
In the illustrates diagram, if the estimates are in weeks, the time estimates for activity 1  2, shown in the diagram, are:

to = optimistic time = 1 week

tp = pessimistic time = 6 weeks
tm = most likely time = 5 weeks
te = expected time = 4.5 weeks - the average time an activity would require if it were repeated a large number of times.

( )

Path – a series of activities from start to finish.

In the illustrative PERT diagram, the paths and their corresponding path times are:

Path Path Time (weeks)

1–2–5–6 4.5 + 6.5 + 3 = 14 weeks
1–3–6 8+7 = 15 weeks
1–4–6 6+2 = 8 weeks

Critical Path – the longest path through the network. In the illustrative network, Path 1 – 3 – 6 requiring 15 weeks is the
critical path.

 A delay in the completion of 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 only by shortening the critical
path.

Slack Time – the length of time by which a particular activity can slip (be delayed) without having any delaying effect on
the end event.

 Activities along the critical path have a slack of zero (0)

 All non-critical activities have a positive slack.

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Critical Path Time - Path’s Time = Combined Slack Time

Critical path 1–3–6 15 15 0
Path 1–2–5–6 15 14 1 week
1–4–6 15 8 7 weeks

CRITICAL PATH METHOD (CPM) – may be considered as a subset of PERT. CPM is a network technique that uses
deterministic time and cost estimates. Aside from the cost estimate, CPM includes concept of crash effort and crash costs.

Crash Time – the time required to complete an activity assuming that all available resources (overtime, extra manpower,
etc.) are developed to 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 activity 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.

ACCOUNTANTS ROLE IN PERT

1. Determination of cost estimates and actual costs of each activity in a project.
2. Preparation of activity/project cost reports and computation/analysis of cost variances.

BENEFITS OF PERT
1. PERT is a very useful technique for planning and controlling activities in aproject or the entire project itself.
2. Some of the procedures included in PERT or in PERT-CPM are in harmony iwht the accountant’s budgetary tasks
and in the application of a responsibility accounting system.
3. The technique may be used to solve managerial problems pertaining to project scheduling, information system
design, and transportation systems design.
4. PERT helps to keep the projects on schedule and to provide feedback to management about the progress of each
part of the project.

LIMITATIONS OF PERT
Reliable time and cost data may not be readily available and obtaining them may be difficult. Persons involved may
overstate budgeted costs and time estimates to avoid unfavorable variances and pressure from their superiors.

LINEAR PROGRAMMING

LINEAR PROGRAMMING – is a quantitative technique used to find the optimal solution to short-term resource
allocation problems, such as:
a. Maximization of the revenue, contribution margin or profit function, and
b. Minimization of cost function, subject to constraints (e.g. limited resources, production capacity levels, etc.)

OTHER BUSINESS APPLICATIONS OF LINEAR PROGRAMMING

1. Determination of the best product mix.
2. Determination of the optimum materials mix.
3. Assignment of jobs to manufacturing equipment
4. Workforce scheduling
5. Determination of transportation routes.

STEPS IN FORMULATING A LINEAR PROGRAM

1. Identify the decision variables
2. Express the objective and constraint functions in terms of the decision variables identified in Step 1
a. 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.
b. Constraints – limits the values of variables. The constraint equations reflect the types of inputs or
resources being allocated.

METHODS FOR SOLVING LINEAR PROGRAMMING PROBLEMS

1. Graphical Method – limited to problems with only two variables.
2. Simplex Method – applicable even when there are more than two variables. It is based on matrix or linear algebra
and provides a systematic way of algebraically evaluating each corner point in the feasible area.

Meld – the feasible region,, where all constraints are satisfied, any combination of variables within this region is a feasible
solution.

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SHADOW PRICE (dual value of scarce resource) – the amount y which the value of the optimal solution of the objective
function in a linear programming problem will change if one-unit change is made in a binding constraint.
 Computation of shadow prices 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 of scarce resource or not, the shadow price must be greater that the
accrual cost of such additional resource.

Computation of shadow price:

1. Add one unit for the scarce resource under consideration.
2. Find the new optimal solution after adding one unit of the scarce resource (constraint)
3. The shadow price is the difference between the profit in original optimal solution and the profit in the new
optimal solution.

QUEUING THEORY

QUEUTING THEORY (waiting-line theory) – a study of random arrivals at the processing or servicing facility of limited
capacity. It allows the decision maker to calculate the:
1. Lengths of future waiting lines.
2. Average time spent in line awaiting service or processing.
3. Additional facilities required
4. Service level of capacity that minimizes waiting and operating costs

EXAMPLES OF QUEIUING THEORY APPLCIATIONS

1. Check-out counters (cashiers) in groceries/malls.
2. Movie ticket booth
3. Expressway toll booths
4. School registrar’s office windows
5. Bank teller windows

COST INVOLVED
1. Facility costs and operating costs – the cost of providing service
2. Waiting cost – the cost of idle resources waiting in line, including the income foregone (opportunity cost) in the
case of waiting customers.

OBJECTIVE OF QUEUING THEORY

To minimize total cost involved (both service and waiting costs).

FORMULAS FOR A SINGLE SERVICE FACILITY AND RANDOM ARRIVAL

1. where: N = average number of work units waiting in line or being serviced.

B = average number of work units arriving in one unit of time

T = average number of work units serviced in one unit of time (assuming thre is no
shortage of work units)

2. It is assumed that < 1, otherwise, the queue will grow to infinite length.

3. ( )
where: Nq = average number in the waiting line.

4. where: W = average waiting time before service.

LEARNING CURVES

LEARNING CURVES (Experience curves) – a mathematical expression of the phenomenon that incremental unit costs to
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 form 20% to 40%) in the average direct
labor input time required per unit as the cumulative output doubles.

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SENSITIVITY ANALYSIS

SENSITIVITY ANALYSIS – the study of how the outcome of a decision process changes as one or more of the
assumption change.

EXERCISES:

1. White Covered Store sells balut in the city’s central bus terminal. For this coming weekend, the probability
distribution of the demand for balut is as follows:
Estimated Sales in units Probability
750 0.20
900 0.25
1.300 0.55

What is the estimated demand for balut this coming weekend?

2. Jess Company operates three shipping terminals, A, B, and C. Terminals A, B, and C handle approximately 60%,
30% and 10%, respectively of the total cargo shipped, with error rates of 3% for A, 4% for B, and 6% for C.
Jess Company’s internal auditor randomly selects one shipping document, ascertaining that this document
contains an error. What is the probability that the error occurred in Terminal B?

3. Nitz Company is planning to produce a new product, Duhat Soap. A marketing consultant prepared the following
payoff probability distribution describing the relative likelihood of monthly sales volume levels and related
contribution margin for Duhat Soap.

Monthly sales volume Probability Contribution margin

15,000 units 40% P75,000
18,000 30% 90,000
27,000 15% 135,000
36,000 10% 180,000
45,000 5% 225,000

Required: Compute for the expected value of the following:

a. Monthly sales volume
b. Monthly contribution margin

4. The country has been experiencing frequent brownouts since its hydroelectric plants experienced some technical
problems. Statistics showed that the country has the following average number of brownouts:
Number of Number of
months brownouts per
month
2 0
3 4
3 6
4 8
For Lanie Company, each brownout costs P10,000. In view of this, the company is considering to lease a
generator for P40,000 per month to provide power during brownouts. If Lanie Company would lease the
generator in the coming year, how much is the estimated savings (additional expense) per month next year?

5. Health Concious, Inc. is planning to open a spa in the City. A market study conducted by an independent market
researcher shows the following estimates of the number of clients (and their probabilities) during the period:
Number of clients Probabilities
0 – 40 10%
41 – 80 40%
81 – 120 30%
121 – 160 20%

Required:
a. What is the probability of having between 81 – 160 clients in the spa during the year?
b. What is the best estimate of the expected number of clients in the spa during the period?

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6. Mr. B. Hon cooks and sells “Pansit in a Box.” Each box of pansit is sold for P50 during regular hours, that is from
10am to 8pm. If every box is sold by 8pm, Mr. B. Hon calls it a day. However, all unsold boxes by 8pm are sold
at half the regular price up to 9pm. The variable cost per box is P30. The contribution margin per box is as
follows:
From 10 am to 8pm
Selling price P50
Variable cost 30
CM per box P20
After 8pm
Selling price P25
Variable cost 30
Loss per box P5
Past experience has shown that the daily sales demand (up to 8pm) and their probabilities are as follows:

Sales per day Probability

500 boxes 0.20
600 boxes 0.70
700 boxes 0.10

Required:
a. If the sales demand will be the same as in the past, prepare the payoff table to determine the
highest value of contribution margin.
b. Compute for the expected value of perfect information.
c. Using the same data, prepare a decision tree and determine the highest expected value of
contribution margin.

7. Trixie Company needs a component part for the production of a new product. The component part is available
from local suppliers, but the company can make it with the use of a special equipment which it can rent for
P10,000 per month.

Each new product requires one component part. Thus, production requirement for the part is the same as the
demand for the new product, which could be high (5,000 units per month), with probability of 70%, or low (2,000
units per month)

The contribution margin per unit of the new product is P12 if the company will make the part, and P8 if the part is
purchased from local suppliers. Prepare a decision tree diagram to determine to select which alternative is better.
(compute for the expected value)

8. The PERT diagram below describes the interrelationships of several activities to complete a project. The arrows
represent the activities. The numbers indicates the expected time in months (te) to complete each activity:

C D

Required:
a. Determine the different parts in the PERT Diagram.
b. Identify the critical path in the PERT Diagram
c. The shortest time to complete the entire project is
d. The slack time for path A – B – E is
e. The slack time for path A – B – C – D – E is

9. Following are taken from a PERT diagram for a project:

Network paths Expected Time to Complete

Path A: 0 -1 -2 – 5 – 7 72 weeks
Path B: 0 -1 -2 – 4 – 7 52 weeks
Path C: 0 -1 -3 – 4 – 7 36 weeks
Path D: 0 -1 -3 – 6 – 7 56 weeks
Required: Determine the slack time in each path and identify the critical path.

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10. Meemon Corporation produces two products, Girl Rag Doll (G) and Boy Rog Doll (B), which must be processes
in two departments, Sewing and Finishing. Sewing has 240 hours available per month, while finishing has 192
hours.

The number of hours required to process the products in the two departments and the contribution margin per unit
of the products are as follows:
G B
Contribution Margin per unit P32 P24
Required hours per unit:
Sewing 4 hours 2 hours
Finishing 2 4

Required:
a. How many units of Girl Rag Dolls and Boy Rag Dolls must be produced to maximize contribution
margin?
b. Compute the shadow price.

11. Jasper Company produces two products, C and D, each of which requires two processes, grinding and mixing.
The contribution margin is P15 per Product C and P20 per product D. The number of hours required to process
the two products are as follows:
Product C Product D
Grinding 10 20
Mixing 10 10

The number of hours available during the period are 400 hours for grinding and 300 hours for mixing.

Required: Determine the following:

a. The objective function
b. The grinding and mixing constraints
c. Combination of Products C and D that will maximize the objective function.

12. In a supermarket, customers arrive at the cashier’s counter at the average rate of 20 customers per hour. The
cashier can serve an average 30 customers per hour.

Required: Compute for the following

a. Average number of customers waiting in line or paying for their groceries
b. Average number of customers in the waiting line not being service
c. The average waiting time

13. An 80% learning curve means that each time cumulative production is doubled, the time required to produce is
reduced by 20%. Assume that the first unit takes 100 hours to finish. Each cumulative production is doubled, the
average time required will be

14. The cumulative average labor cost per unit for the first batch (of 100 units) produced using a new process is P200.
The cumulative average labor cost after the second batch is P140.

Required:
a. The new process has a learning curve percentage of
b. Assuming that the learning curve obtained continues, the cumulative (total) labor cost of four batches
is

15. With sales of 100 units, the company’s projected profit is P500:

Sales P5,000
Less: Variable Cost 3,000
Contribution Margin P2,000
Less: Fixed Cost 1,500
Profit P 500

Required: What would profit be if:

a. Sales in units increases by 20%
b. Variable cost per unit decreases by 5%
c. Fixed cost decreases by 500

-END OF HANDOUTS-

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