paper p2 (also P4 and P5)
Management Accounting –
Decision Management
Several techniques are available to help managers with complex decisions to make.
Bob Scarlett explains the strengths and weaknesses of four popular approaches.
Decision-makers typically have to choose a course of action from
a number of alternatives. The information they consider may be
purely financial or it may involve a mix of quantitative and
qualitative factors. The criteria upon which they base their decision
can sometimes be simple – eg, “contribution maximisation” –
but it will usually entail trade-offs between a number of different
criteria relating to expected reward, risk and behavioural factors.
A body of technique known as decision analysis has been
developed to aid decision-makers confronted with the more
complex type of situation. Let’s apply some common decision
analysis methods to the following scenario and consider their
advantages and limitations. Say we’re seeking to hire office space
for an eight-year period and we’ve identified six alternative
suites (see panel 1). The four criteria by which we will judge them
are floor space; proximity to the town centre; ambience on a
scale of one (dilapidated) to five (immaculate); and cost.
Elimination by aspects (EBA)
This approach involves ranking the decision criteria in order
of importance, deciding acceptable limits in each case and then
applying those limits in sequence to consider each option.
Applying EBA in this example entails the following steps:
n Floor space should be greater than 500sq m, so A and D are
rejected, leaving B, C, E and F.
n Cost NPV should be less than £1.2m, so B is rejected, leaving
C, E and F.
n The ambience score should be at least three, so C is rejected,
leaving E and F.
n The distance from the town centre should be no more than
25 minutes’ walk, so F is rejected, leaving E.
Would this be a good decision? Maybe not. Compare site E
with site B, which we rejected at an earlier stage. B is far closer
to the town centre and offers a much better ambience. It costs
£100,000 more, but that may not amount to much spread over
eight years. E is 500sq m larger than B, but will that extra space
be of any real use?
It’s possible, therefore, that using EBA has resulted in a
sub‑optimal decision. The problem is that it does not weight the
various factors in a way that allows a balanced comparison.
The lexicographic approach
This general method involves identifying the most important
(prime) decision criterion and choosing from the alternatives on
1 Alternative Office suites compared
Office
suite
A
B
C
D
E
F
Floor space
(sq m)
450
850
900
380
1,350
1,250
Walking time to
town centre (mins)
2
8
15
20
25
30
Environmental
ambience
1
5
2
2
3
3
Cost NPV
(£k)
480
1,220
1,050
560
1,120
920
that basis. Where two options score equally on the prime
decision criterion, we turn to a secondary criterion to rank them.
Say we’re considering B, C and F, using cost as our prime
criterion (with a difference of £180,000 or less giving a draw)
and proximity to the town centre as our secondary criterion.
The lexicographic approach gives the following result:
n B is preferred to C (a draw on cost with B ahead on proximity).
n C is preferred to F (a draw on cost with C ahead on proximity).
n F is preferred to B (F wins conclusively on cost).
Make of that what you will. The analysis in this case does not
help us to choose a clear winner. Where we’re confronted with
multiple decision criteria it’s not always meaningful to base our
decision on only one of them.
Satisficing
The assumption that we have made until now is that all of the
accommodation options present themselves simultaneously,
so we can choose between them at the same time. In practice,
options often arrive sequentially – ie, every time an option
presents itself you have to decide whether to accept or decline it
and then wait for another to appear. Satisficing is an approach to
handling such situations and property is an arena where it’s
commonly applied.
Decision-makers first have to decide an aspiration level that
has to be applied in the evaluation of options. Say our
aspiration level is as follows: “We want an office that is located
no more than 20 minutes’ walk from the town centre; offers at
least 500sq m of floor space; provides at least level-three
ambience; and costs less than £1m NPV. But we can be flexible
on any one of these criteria for the right property.”
financial
March 2006 management
51
Paper P2 (also P4 and P5)
2 space and proximity ratings
4 office suites rated on Mava Graph
Points
awarded
5
4
3
2
1
Utility points
Floor space
(sq m)
900+
701-900
501-700
401-500
0-400
Walking time to
town centre (mins)
0-2
3-5
6-12
13-20
20 +
3 Utility ratings versus cost
Office suiteUtility points
A
8
B
12
C
8
D
5
E
9
F
9
Cost NPV (£k)
480
1,220
1,050
560
1,120
920
Say F becomes available first. We’d probably reject it because
it’s located too far from the town centre. F is then let to another
tenant and is no longer available.
Shortly afterwards, option E becomes available. Again, we’d
probably reject it, because of its poor location and high cost. E is
also let to another tenant. After two rejected options, we may
get a little worried and start to lower our aspirations.
C now becomes available. It doesn’t satisfy every one of our
needs – specifically, it fails marginally on cost and more
decisively on ambience. But it beats the other criteria
convincingly. We’ll probably accept C under the circumstances.
We never get to consider A, B or D, which is something that we
may regret when those properties later become available. At the
point of choosing C, of course, we have no idea that A, B or D
will become available later. Satisficing is in essence a behavioural
approach to decision-making that may have to be applied in
many practical business situations.
Multiple-attribute value analysis (MAVA)
MAVA is a generic term that covers a wide range of techniques.
It can be used at varying levels of refinement. The general idea is
that mathematics can be applied to issues of value, allowing
decisions to be made on a transparent and legitimate basis.
The criteria in our office decision involve three elements of
value and one of cost. Let’s place points values on the office
space and proximity criteria (see panel 2). The values reflect the
utilities that can be derived from the various levels of the two
benefit attributes. These values can be arrived at using whatever
factors are considered relevant, financial or otherwise.
Applying the values and the ambience ratings to the six office
suites gives the result in panel 3. This may be represented
graphically (see panel 4). The further a point is away from the
graph’s origin, the better it is. A line drawn connecting the points
52
financial
management March 2006
12 B
Efficient frontier
E F
C 4
1,200
D
Cost NPV (£k)
plotted furthest from the origin denotes an “efficient frontier”
that identifies the best combinations of cost and utility available.
In this case the line incorporates the points representing options
A, B and F. On that basis, options E, C and D are not worth
considering, since they lie below the frontier.
The particular MAVA approach we have used does not give a
definitive answer on whether to choose A, B or F. Arriving at such
an answer involves making a trade-off between cost and benefits
that allows for a subjective element.
All of the analytical methods I have described are possible
ways to tackle complex decisions. They can be applied at varying
levels of refinement and the examples should not be considered
definitive in any way. Decision-makers often have to “sell” a
decision to a governing body – eg, a board of directors. The use
of a formal technique may help to legitimise the decision and
make everyone feel comfortable with it. The fact that a decision
is widely accepted by all those concerned may be at least as
important as the detailed merits of that decision.
Try this fun exercise for a non-serious example of how you
might apply decision analysis to choosing a marriage partner.
Potential husbands or wives present themselves in varying ways
at various stages in your life. At school or college you are
surrounded by young single people. If you are lucky, you can
select a marriage partner from a panel of willing candidates.
As you get older the choice tends to diminish. Potential partners
tend to present themselves in sequence and in each case you
have to make an accept/reject decision. In certain cultures and
communities, of course, arranged marriages and/or marriage
brokers may aid the decision-making process.
EBA may help to thin out potential candidates by excluding
those who exhibit, or fail to exhibit, certain attributes. For
example, one may eliminate candidates who have obvious
antisocial tendencies. Some personal attributes are easy to spot,
but others require some investigation. For example, some
decision-makers may require a partner with a certain earning
potential or one who is prepared to bring up three children.
At a later stage in life, satisficing may be more applicable. If
candidates are presenting themselves in sequence, you have to
judge each one individually and make an accept/reject decision
A
400
Correction
On page 41 of
February’s “Study notes”
section, panel 5 referred
to “Opening inventory
completed”. This should
have read “Completed
in the month”. The
published wording was
misleading, since the
figure of 1,720 units
(for both materials
and conversion)
represented the total of
all units finished during
the period – ie, it
included both opening
stock completed and
units started and
finished in the period.
Paper P2 (also P4 and P5)
Exam notice
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based on your own aspirations. This can cause
problems. If you have low aspirations, you are
likely to marry the first person who appears.
What happens if you meet a better candidate
soon afterwards? At the other extreme, some
people have such high aspirations that no
candidate is good enough for them. In such
cases, experience usually causes a gradual
lowering of aspirations. But this can mean that
they return to a candidate whom they
previously rejected – which can be tricky if that
person is now with someone else.
MAVA is particularly applicable where a
marriage broker is involved. A broker will ask a
client to specify the importance that he/she
attaches to the various attributes of a potential
husband or wife. For example, some people
attach a lot of importance to physical
attractiveness, whereas others may see that as a
possible source of danger. Some may attach
importance to the earning potential of a partner,
while others may be more concerned about
their willingness to have children. A MAVA
exercise allows clients to score each candidate
on the basis of their individual preferences and
rank the potential partners.
Those seeking marriage partners should be
aware that some have higher operating costs
than others, so they may have to make a tradeoff between costs and benefits. A cost-benefit
graph can be drawn with the positions of all
potential partners plotted. Only candidates near
the efficient frontier need to be considered.
The high marriage failure rate in many
countries is often attributed to a lack of proper
decision analysis before entering the contract.
Counselling is widely available to young people
in developed nations on matters such as
careers, finance, health and family planning.
But choosing a marriage partner is largely
considered to be such a personal thing that
many of us wouldn’t be very comfortable about
seeking counselling on which decision analysis
technique to use. FM
Bob Scarlett is an accountant and consultant.
54
financial
management March 2006
n May 2006 exam entry
The May exams take place on Tuesday 23,
Wednesday 24 and Thursday 25. Online
exam entry opened on February 1 at
www.cimaglobal.com/examentry.
The standard closing date for entry is
March 14. If you enter after this date, it
will be accepted only as a late entry and
you will have to pay a late entry fee. The
deadline for late entries is March 21.
You must pay exam fees online when
you enter for them. They are as follows:
n Managerial level: £57 per subject.
n Strategic level: £62 per subject.
n TOPCIMA: £83.
The late entry fee is £165.
n Cancellations and changes
We do not accept cancellations and will
not refund fees. To change papers or exam
centres, you must e-mail cima.contact@
cimaglobal.com and pay the admin fee by
March 31. Changes before March 14 cost
£26. Changes after March 14 cost £52.
n Exam centre changes
A full list of exam centres is available
online at www.cimaglobal.com/
examcentres. Special centres will charge an
extra fee, which must be paid directly to
them, on top of the standard exam fees.
The following will be reclassified as
special exam centres from May:
n Abu Dhabi (850).
n Budapest (871).
n Dhaka (874).
n Kuching (920).
n Muscat (913).
n Nicosia (910).
n Ahmedabad (916) will become a new
special centre from May.
n Bangalore (526) will be reclassified as
a regular exam centre from May.
n Ask a tutor – April event
Visit CIMA’s web site to find out about the
next “ask a tutor” event, to be held in April.
Use this chance to ask an experienced
tutor a syllabus-related question.
n TOPCIMA pre-seen material
The pre-seen material and assessment
matrix for TOPCIMA will be available at
www.cimaglobal.com/topcima from
March 13. It is your responsibility to
download this and familiarise yourself
with it before the exam. A “clean” copy
will be given to you in the exam. You
cannot take any notes in with you.
n Important CBA deadline
If you wish to sit managerial level exams
in May, you must complete all certificate
level computer-based assessments (CBAs)
by March 1. For full information about
entering for a certificate level CBA, visit www.cimaglobal.com/certificateentry.
n CIMA Professional Development
Certificate in Business Taxation
If you have passed intermediate level
paper 6 Financial Accounting but have not
passed intermediate level paper 5
Business Taxation after the November
2004 exams, you can use a pass in the
CBA Introduction to Business Taxation
(UK) to gain credit from the new
managerial level paper P7 Financial
Accounting & Tax Principles. This CBA pass
must be gained by March 1 if the credit
for paper P7 is needed for the completion
of managerial level to gain eligibility to sit
strategic level exams in May.
Visit www.cimaglobal.com/
certificateinbusinesstax for further details.
n Queries
If you have any questions, please visit the
CIMA web site (www.cimaglobal.com) to
see if they are answered there, or get in
touch with CIMA Contact (see page 43 for
details) or your local office. FM