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ACCOUNTING TECHNICIAN DIPLOMA (ATD)

LEVEL II

STUDY TEXT

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Page 1

KASNEB SYLLABUS

GENERAL OBJECTIVE

This paper is intended to equip the candidate with knowledge, skills and attitudes that will enable him/her

to apply mathematical and statistical skills in business transactions.

7.0 LEARNING OUTCOMES

A candidate who passes this paper should be able to:

Compute simple and compound interests

Solve problems involving appreciation, depreciation, hire purchase and foreign exchange

Solve business problems using matrix algebra

Solve business problems involving commercial mathematics

Present data in form of tables, graphs and curves

Calculate measures of location, dispersion skewness and kurtosis

Compute simple, general and weighted index numbers.

CONTENT

7.1Equations

Quadratic equations: solving and graphs

Differentiation

Simultaneous equations; solving

Break-even analysis

Total revenue, total cost and profit equations; application of errors

7.2 Matrices

Addition, subtraction and multiplication

Determinants of 2x2 matrices

Inverses of 2x2 matrices

Application of matrices to business problems

Buying and selling; discounts, profit and loss, margins and mark-ups

Commissions and salaries: piece and hourly rates, gross and net pay, PAYE

Bills calculations; water and electricity /

Simple and compound interest

Depreciation and appreciation of assets

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Hire purchase

Foreign exchange

7.4 Elementary statistics

Methods of data collection: primary and secondary data./

Sampling techniques J

Presentation of data:

Tables

Diagrams: bar charts and pie charts

Graphs: Basic time series graphs, Z-charts, Lorenz curves and semi-log graphs

Frequency distribution tables

Histogram and frequency polygons'

Cumulative frequency curve (ogive) and its application

Measures of central tendency:

Mean: arithmetic mean, weighted arithmetic mean, geometric mean and harmonic mean

Mode

Median

Measures of dispersion: range, quartile, deciles, percentiles, mean deviation, standard deviation

and coefficient of variation

Measures of skewness and kurtosis excluding computation of the coefficients

7.6 Set theory

Types of sets: universal, empty/null. Sublets, finite and infinite

Operation of sets: unions, intersecting, complements and set difference

Venn diagrams

Types of events: simple, compound, independent, mutually exclusive,

Mutually inclusive, dependent events

Rules of probability: additive and multiplicative rules

Bayes Theorem

Elementary probability trees

Construction of index numbers Purpose of index numbers

Simple index numbers; fixed base method and chain base method

Consumer Price Index (CPI)

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Weighted index numbers; Laspeyres, Paasche's, Fishers ideal and Marshall- Edgeworths

methods (both price and quantity index numbers)

Limitations of index numbers

Emerging issues and trends

7.9 Emerging trends

CONTENT

PAGE

Chapter 1: Equations5

Chapter 2: Matrices....31

Chapter 3: Commercial mathematics.52

Chapter 4: Elementary statistics.....77

Chapter 5: Descriptive statistics....109

Chapter 6: Set theory.146

Chapter 7: Basic probability theory...176

Chapter 8: Index numbers .....205

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CHAPTER 1

EQUATIONS

Linear and Quadratic Equations

Equations often express relationships between given quantities (the knowns) and quantities yet to

be determined (the unknowns). By convention, unknowns are denoted by letters at the end of the

alphabet, x, y, z, w, , while knowns are denoted by letters at the beginning, a, b, c, d, . The

process of expressing the unknowns in terms of the knowns is called solving the equation. In an

equation with a single unknown, a value of that unknown for which the equation is true is called

a solution or root of the equation. In a set simultaneous equations, or system of equations,

multiple equations are given with multiple unknowns. A solution to the system is an assignment

of values to all the unknowns so that all of the equations are true. Two kinds of equations are

linear and quadratic.

LINEAR EQUATIONS

It takes the form

y = a + bx

e.g

y = 20 + 2x

y = 5x

y = 15-0.3x

represents the gradient of the slope.

The linear equation can be presented either as 2 by 2 simultaneous equation. In general 2 by 2

equations are given as follows:

2x2

+

+

=

=

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+

+

+

+

=

=

Page 5

Solve for x in the following equation.

Example 1:

5x-6=3x-8

Subtract 3x from both sides of the equation:

Add 6 to both sides of the equation:

Divide both sides by 2:

The answer is x = - 1

Check the solution by substituting -1 in the original equation for x. If the left side of the equation

equals the right side of the equation after the substitution, you have found the correct answer.

Left side: 5(-1) - 6 = - 11

Right side: 3(-1) - 8 = - 11

Exercise

Solve each of the following equations.

(a)

(b)

(c)

(d)

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Solve this system of equations graphically.

4x - 6y = 12

2x + 2y = 6

Example using a graphical method:

Solve graphically:

4x - 6y = 12

2x + 2y = 6

To solve a system of equations graphically, graph both equations and see where

they intersect. The intersection point is the solution.

First, solve each equation for "y =".

4x - 6y = 12

2x + 2y = 6

slope = -1

y-intercept = 3

slope =

y-intercept = -2

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CHAPTER 2

MATRICES

Definition of Matrix

A matrix is a collection of numbers arranged into a fixed number of rows and columns. Usually

the numbers are real numbers. In general, matrices can contain complex numbers but we won't

see those here. Here is an example of a matrix with three rows and three columns:

The top row is row 1. The leftmost column is column 1. This matrix is a 3x3 matrix because it

has three rows and three columns. In describing matrices, the format is:

Rows X columns

Each number that makes up a matrix is called an element of the matrix. The elements in a matrix

have specific locations.

The upper left corner of the matrix is row 1 column 1. In the above matrix the element at row 1

col 1 is the value 1. The element at row 2 column 3 is the value 4.6.

Matrix Dimensions

The numbers of rows and columns of a matrix are called its dimensions. Here is a matrix with

three rows and two columns:

Sometimes the dimensions are written off to the side of the matrix, as in the above matrix. But

this is just a little reminder and not actually part of the matrix. Here is a matrix with different

dimensions. It has two rows and three columns. This is a different "data type" than the previous

matrix

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TYPES OF MATRICES

Row Matrix

Column Matrix

Rectangular Matrix

A rectangular matrix is formed by a different number of rows and columns, and its dimension is

noted as: mxn.

Square Matrix

The elements of the form aii constitute the principal diagonal.

The secondary diagonal is formed by the elements with i+j = n+1.

Zero Matrix

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In an upper triangular matrix, the elements located below the diagonal are zeros.

In a lower triangular matrix, the elements above the diagonal are zeros.

Diagonal Matrix

In a diagonal matrix, all the elements above and below the diagonal are zeros.

Scalar Matrix

A scalar matrix is a diagonal matrix in which the diagonal elements are equal.

Identity Matrix

An identity matrix is a diagonal matrix in which the diagonal elements are equal to 1.

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CHAPTER 3

COMMERCIAL MATHEMATICS

Introduction

Commercial mathematics is concerned with mathematics used in the practical world of

commerce and in everyday life. It includes topics like percentage, discounts, profit & loss,

banking, shares and dividends and taxes.

This section comprises:

percentage,

discount, profit and loss, and

margin and markups

commissions and salaries

Simple interest.

compound interest

depreciation and appreciation of assets

hire purchachase

foreign exchange

Cost Price, Selling Price, Profit & Loss

The terms profit and loss are used in business transactions. A merchant buys goods at a price to

sell to customers. The price at which he/she buys the goods is its cost price (C.P.). He/She sells

the goods at a price to the customer, which is known as the selling price (S.P.).

The difference between the selling price and the cost price determines the profit or loss the

merchant makes. If S.P. > C.P., the merchant makes a profit of (S.P. C.P.). If S.P. < C.P., the

merchant makes a loss of (C.P. S.P.).

However, it is not enough to merely know the actual value of profit/loss it is important to

consider the size of profit/loss in proportion to the cost of the goods. For this reason, profit/loss

is often determined as a percentage of the cost price.

Hence, a profit of Ksh.100 on an item with a C.P. of Ksh.1000 might appear greater in absolute

terms when compared with a profit of Ksh.50 on another item worth Ksh.100, but in the former

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10% = (

100%),

If the merchant makes a profit, the formula for calculating the profit percentage is:

. .

profit%=(

. .

.

100)%

.......[1]

If the merchant makes a loss, the formula for calculating the loss percentage is:

loss%=(

. .

. .

.

100)%

.......[2]

Of course, you can always use only Eq. [1], in which case if there is a negative value for the

profit percentage, it is equivalent to a loss percentage.

Example 1

If toys are bought at Ksh.80 each, and sold at Ksh.89 each, what is the profit percentage?

C.P. of the toy = Ksh.80; S.P. of the toy = Ksh.89

The profit %

= (

= (

. .

. .

.

100)%

100)% =

100 = 11.25%

Example 2

I sell 20 articles for the same money as I paid for 25. What is my profit percent on my outlay?

Let the cost of each article I purchased be x.

The money spent in purchasing 25 articles is 25x, while for 20 articles the money spent is 20x.

However, 20 articles are sold for the cost of 25, i.e. the S.P. of 20 articles is 25x, for which the

C.P. was 20x.

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the profit %

= (

. .

. .

.

100)%

= (

100)=25%

An overhead is the additional cost which is added to the C.P. of an item purchased by a merchant

to arrive at a new C.P., which reflects the true cost incurred by him/her. These additional costs

are a result of extra operations like transportation and storage of items.

A discount is the reduction in the selling price of an item which a merchant offers to a customer.

It is almost always expressed as a percentage of the advertised price, which is known as the

marked price (M.P.) or list price (L.P.). The amount that the customer pays to the merchant after

the discount (M.P. - discount) is called the net price, which is the S.P. of the item.

So, an item which is available at a list price of Ksh.200 with a discount percentage of 10% will

have a discount amount of Ksh.20 (=10100200) and a net price, which the customer pays, of

Ksh.180 (= 200 - 20).

Thus,

Discount = M.P.S.P........[3]

discount%=(

100)%=(M.P.S.P.M.P.100)%

.......[4]

Sometimes, some merchants offer successive discounts on the M.P. In such cases, the first

discount is calculated on the M.P. and is subtracted from it. The next discount is calculated on

the resulting amount from the previous step and is again subtracted from it to yield the next

amount of the article. These steps are continues till all discounts are used up, and the final

amount obtained is the S.P. of the article.

Gross profit is the total profit made by the merchant in a transaction, without deducting any

taxes and/or expenses. After making the deductions for taxes and/or expenses from the gross

profit, what remains is the net profit.

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CHAPTER 4

ELEMENTARY STATISTICS

Introduction

Statistics have become an important part of everyday life. We are confronted by them in

newspapers and magazines, on television and in general conversations. We encounter them when

we discuss the cost of living, unemployment, medical breakthroughs, weather predictions, sports,

politics and the state lottery. Although we are not always aware of it, each of us is an informal

statistician. We are constantly gathering, organizing and analyzing information and using this

data to make judgments and decisions that will affect our actions.

In this unit of study we will try to improve the students understanding of the elementary topics

included in statistics. The unit will begin by discussing terms that are commonly used in

statistics. It will then proceed to explain and construct frequency distributions, dot diagrams,

histograms, frequency polygons and cumulative frequency polygons. Next, the unit will define

and compute measures of central tendency including the mean, median and mode of a set of

numbers. Measures of dispersion including range and standard deviation will be discussed.

Following the explanation of each topic, a set of practice exercises will be included.

There are several basic objectives for this unit of study. Upon completion of the unit, the student

will be able to:

Compute simple measures of central tendency.

Compute measures of dispersion.

Construct tables and graphs that display measures of central tendency.

The material developed here may be used as a whole unit, or parts of it may be extracted and

taught in various courses. The elementary concepts may be incorporated into general

mathematics classes in grades seven to twelve, and the more difficult parts may be used in

advanced algebra classes in the high school. Depending upon the amount of material used,

several days or several weeks may be allotted to teach the unit.

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Statistics is a branch of mathematics in which groups of measurements or observations are

studied.

Throughout the study of statistics certain basic terms occur frequently. Some of the more

commonly used terms are defined below:

A population is a complete set of items that is being studied. It includes all members of the set.

The set may refer to people, objects or measurements that have a common characteristic.

Examples of a population are all high school students, all cats, all scholastic aptitude test scores.

A relatively small group of items selected from a population is a sample. If every member of the

population has an equal chance of being selected for the sample, it is called a random sample.

Examples of a sample are all algebra students at Central High School, or all Siamese cats.

Data are numbers or measurements that are collected. Data may include numbers of individuals

that make up the census of a city, ages of pupils in a certain class, temperatures in a town during

a given period of time, sales made by a company, or test scores made by ninth graders on a

standardized test.

Variables are characteristics or attributes that enable us to distinguish one individual from

another. They take on different values when different individuals are observed. Some variables

are height, weight, age and price. Variables are the opposite of constants whose values never

change.

Branches of statistic

The subject is divided into two general categories

1. Descriptive statistics

2. Inferential statistics

In descriptive statistics one deals with methods used to collect, organize and analyze numerical

facts. Its primary concern is to describe information gathered through observation in an

understandable and usable manner. Similarities and patterns among people, things and events in

the world around us are emphasized.

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Inferential statistics takes data collected from relatively small groups of a population and uses

inductive reasoning to make generalizations, inferences and predictions about a wider

population.

Data Collection Methods

Data collection is a process of collecting data using different methodologies. It is a very

important topic of statistics as well as mathematics. The data collections are known as, any

information collected from some person or some other ways to get news. Data collection can be

defined as a term which is used to explain the process of preparing and collecting data, such as, a

part of a process improvement. The purpose of data collection is to collect important information

to keep on record for further use, to make important decisions about different issues, and to pass

vital information on to others.

What is Data Collection Methods?

The data collection is to collect important information to keep on record for further use, to make

important decisions about different issues, and to pass vital information on to others.

In terms of the method of data collection that will be used for the study, there are mainly two

types of data:

Primary data

Secondary data

Primary Data

They are collected afresh and for the first time, and thus happens to be original in character.

They are the most original data and mostly have not undergone any sort of statistical test.

Secondary Data

They are those that has already been collected by someone else and which has been already been

passed through the statistical process. They are not pure and have undergone some treatment at

least once.

Data Edition:

After collecting the required data, either from primary or secondary means, the next step leads to

edition. Editing is a process by which the data collected is examined to discover any error and

mistake before it is presented. It has to be understood before hand it self to what degree the

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CHAPTER 5

DESCRIPTIVE STATISTICS

Introduction

Statistics is the art and science of getting information from data or numbers to help in decision

making.

As a science, statistics follows a systematic procedure to reach objective decisions or solutions

to problems.

As an art statistics utilizes personal judgment and intuition to reach a solution. It depends on

experience of the individual involved. It is more subjective.

Statistics provides us with tools that aid decision making. For example, using statistics we can

estimate that expected returns and associated risks of a given investment opportunity.

Statistics involves collection of data, analysis, presentation and interpretation of data.

There are various types of summary measures including averages and measures of dispersion.

An average is a figure which represents the whole data. It removes all unnecessary details and

gives a clear picture of the data under investigation.

Definitions of key terms

Statistical inference is deduction about a population based on information obtained from a

sample drawn from it. It includes:

point estimation

interval estimation

hypothesis testing (or statistical significance testing)

prediction

Measures of central tendency are single numbers that are used to summarise a larger set of

data in a distribution of scores. The three measures of central tendency are mean, median, and

mode.

Measures of dispersion These are important for describing the spread of the data, or its

variation around a central value. Such measures of dispersion include: standard deviation,

interquartile range, range, mean difference, median absolute deviation, avarage absolute

deviation (or simply average deviation)

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Variance is the sum of squared deviations divided by the number of observations. It is the

average of the squares of the deviation of the individual values from their means.

Skewness describes the degree of symmetry in a distribution. When data are uni-modal and

symmetrical, the mean, mode and median will be almost the same value.

Kurtosis describes the degree of peakedness or steepness in a distribution.

Statistics has two broad meanings

1.

Statistics refers to the mass of components or measures such as the mean, mode,

standard deviation etc. that help in describing the characteristics of a given set of

data or distribution. In this respect, statistics is simply, numerical facts about a given

situation.

This is the original meaning of statistics. Governments were the first organisations to

collect vital statistics such as death rates, birth rates, economic growth etc.

2.

method.

Statistics is the process that gives thorough systematic steps to aid problem solving

or decision making.

a)

possible. The questions to be answered will clearly be defined at this point. This is necessary

because it enables us to make appropriate conclusion from the study.

b) Research methodology design

After formulating the problem, we need to come up with a defined plan on how the study will

be conducted to solve the problem.

Research design entails the following:

i.

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collection of objects or subjects for which we want to make a decision e.g. the

number of customers of a supermarket; the number of students in public universities,

the number of matatus in Nairobi, the number of employees in campus, the number

of hospitals in Nyeri.

ii. Decide whether to use a census or a sample study. A census entails studying each

and every element in a population. A sample study entails studying a portion of the

population

iii. Decide the data collection techniques to use e.g. observation, questionnaires,

interviews, Internet pop-ups etc.

iv. Identify the data analysis technique to be used.

Data analysis

After data is collected, it is analysed so as to enable us make decisions. Data analysis involves

the following:

Organisation of data- This enables us to check for completeness, accuracy and reference.

Organising data can also involve coding the data for ease of analysis.

Data presentation Diagrams, graphs, tables etc. are used to present data so asto highlight the

visual impression of the data. The kinds of graphs and charts used will depend on the audience.

Type of graphs and charts may also be determined by type of information being presented

Statistical inference

The four steps above are referred to as descriptive statistics. Descriptive statistics helps us to

organise, summarise and present data in a convenient and informative way.

Inferential statistics, on the other hand, enables us to draw conclusions about the characteristics

of a population. Because most studies depend on samples, we use the sample results to draw

conclusions about the population from which the sample was drawn. The process of making

conclusions about the population based on sample statistics is known as sample inference.

Use sample statistics

Based on the statistical inference, then we answer the question or make the decision or solve the

problem that we set out to do.

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CHAPTER 6

SET THEORY

A set can be defined as a collection of things that are brought together because they obey a

certain rule.

These 'things' may be anything you like: numbers, people, shapes, cities, bits of text ..., literally

anything.

The key fact about the 'rule' they all obey is that it must be well-defined. In other words, it

enables us to say for sure whether or not a given 'thing' belongs to the collection. If the 'things'

we're talking about are English words, for example, a well-defined rule might be:

'... has 5 or more letters'

A rule which is not well-defined (and therefore couldn't be used to define a set) might be:

'... is hard to spell'

Requirement of a set

1. A set must be well defined i.e. it must not leave any room for ambiguities e.g sets of all

students- which? Where? When?

A set must be defined in terms of space and time

2. The objective (elements or members) from a given set must be distinct i.e each object must

appear once and only once, Must appear but not more than once

3. The order of the presentation of elements of a given set is immaterial

4. e.g 1,2,3 = 1,3,2 = 3,2,1

Types of Sets

In set theory, there are different types of sets. All the operations in set theory could be based on

sets. Set should be a group of individual terms in domain. The universal set has each and every

element of domain. We are having different types of sets. We will see about the different types

of sets.

Different Types of Sets

There are different types of sets in set theory. They are listed below:

Universal Set

Empty set

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Singleton set

Finite and Infinite set

Union of sets

Intersection of sets

Difference of sets

Subset of a set

Disjoint sets

Equality of two sets

Universal Set

The set of all the 'things' currently under discussion is called the universal set (or sometimes,

simply the universe). It is denoted by U.

The universal set doesnt contain everything in the whole universe. On the contrary, it restricts us

to just those things that are relevant at a particular time. For example, if in a given situation

were talking about numeric values quantities, sizes, times, weights, or whatever the

universal set will be a suitable set of numbers (see below). In another context, the universal set

may be {alphabetic characters} or {all living people}, etc.

Singleton Set:

For example:

A = {x : x is neither prime nor composite}

It is a singleton set containing one element, i.e., 1.

B = {x : x is a whole number, x < 1}

This set contains only one element 0 and is a singleton set.

Let A = {x : x N and x = 4}

Here A is a singleton set because there is only one element 2 whose square is 4.

Let B = {x : x is a even prime number}

Here B is a singleton set because there is only one prime number which is even, i.e., 2.

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Finite Set:

A set which contains a definite number of elements is called a finite set. Empty set is also

called a finite set.

For example:

The set of all colors in the rainbow.

N = {x : x N, x < 7}

P = {2, 3, 5, 7, 11, 13, 17, ...... 97}

Infinite Set:

The set whose elements cannot be listed, i.e., set containing never-ending elements is

called an infinite set.

For example:

Set of all points in a plane

A = {x : x N, x > 1}

Set of all prime numbers

B = {x : x W, x = 2n}

Note:

All infinite sets cannot be expressed in roster form.

For example:

The set of real numbers since the elements of this set do not follow any particular pattern.

The number of distinct elements in a given set A is called the cardinal number of A. It is

denoted by n(A).

For example:

A {x : x N, x < 5}

A = {1, 2, 3, 4}

Therefore, n(A) = 4

B = set of letters in the word ALGEBRA

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CHAPTER 7

BASIC PROBABILITY THEORY

Introduction

Probability is a measure of likelihood, the possibility or chance that an event will happen in

future.

It can be considered as a quantification of uncertainty.

Uncertainty may also be expressed as likelihood, chance or risk theory. It is a branch of

mathematics concerned with the concept and measurement of uncertainty.

Much in life is characterized by uncertainty in actual decision making.

Probability can only assume a value between 0 and 1 inclusive. The closer a probability is to zero

the more improbable that something will happen. The closer the probability is to one the more

likely it will happen.

Random experiment results in one of a number of possible outcomes e.g. tossing a coin

Outcome is the result of an experiment e.g. head up, gain, loss, etc. Specific outcomes are

known as events.

Trial- Each repetition of an experiment can be thought of as a trial which has an observable

outcome e.g. in tossing a coin, a single toss is a trial which has an outcome as either head or tail

Sample space is the set of all possible outcomes in an experiment e.g. a single toss of a coin,

S=(H,T). The sample space can be finite or infinite. A finite sample space has a finite number of

possible outcomes e.g. in tossing a coin only 2 outcomes are possible.

An infinite sample space has an infinite number of possible outcomes e.g. time between arrival

of telephone calls and telephone exchange.

An Event of an experiment is a subset of a sample space e.g. in tossing a coin twice S=

(HH,HT,

TH, TT) HH is a subset of a sample space.

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Mutually exclusive event - A set of events is said to be mutually exclusive if the occurrence of

any one of the events precludes the occurrence of other events i.e. the occurrence of any one

event means none of the others can occur at the same time e.g. the events head and tail are

mutually exclusive

Collectively exclusive event - A set of events is said to be collectively exclusive if their union

accounts for all possible outcomes i.e. one of their events must occur when an experiment is

conducted.

Favourable events refer to the number of possible occurrences of a given event in an

experiment e.g. if we pick a card from a deck of 52 cards the number favorable to a red card is

26, in tossing coin the number favourable to a head is one.

Independent events Events are independent if the happening or non-happening of one has no

effect on the future happening of another event. E.g. in tossing two times of a coin, the outcome

of 1st toss does not affect 2nd toss.

Equally likely events Events are equally likely if the happening of one is not favored over the

happening of others. In tossing a coin the tail and head are equally likely.

OTHER CONCEPTS

Unconditional and conditional probabilities with unconditional probability we express

probability of an event as a ratio of favourable outcomes to the number of all possible outcomes.

A conditional probability is the probability that a second event occurs if the first event has

already occurred.

Joint probability joint probability gives the probability of the joint or simultaneous

occurrence of two or more characteristics.

Marginal probability is the sum of two or more joint probabilities taken over all values of one

or more variables. It is the probability that the results when we ignore one or more criteria of

classification when computing probability.

Probability is used throughout business to evaluate financial risks and decision-making.

Every decision made by management carries some chance for failure, so probability analysis is

conducted formally.

In many natural processes, random variation conforms to a particular probability distribution

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known as the normal distribution, which is the most commonly observed probability

distribution.

Laws of Probability

1. Rules of Addition

a) Special rule of addition

If two events A and B are mutually exclusive the probability of one or other occurring is equal to

the sum of their probability

P (A or B) = P (A) + P (B)

P (A or B or C) = P (A) + P (B) + P(C)

Illustration

An automatic plastic bag - a mixture of beans, broccoli and other vegetables, most of the bags

contain the correct weight but because of slight variations in the size of beans and other

vegetables. A package may be slightly under or overweight. A check of 4,000 packages of past

reveals the following:

Weight

Event No of packages

Underweight

A

B

C

Satisfactory

Overweight C

100

3600

300

What is the probability that a particular package will be either underweight or overweight?

The two events are mutually exclusive

P (A or C) = P (A) + P (C)

P(A) =100/4000

P(C) =300/4000

P(A or C) =400/4000 = 1/10 =0.1

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CHAPTER 8

INDEX NUMBERS

Introduction

An index is a numerical figure which measures relative change in variables between two periods.

The index numbers are important because they show that the value of money, securities,

commodities is fluctuating i.e. appreciating or depreciating accordingly as the index numbers of

prices are rising/falling. A rise in the index numbers of prices will signify deterioration in the

value of money and vice versa.

Index number classification will depend on variables they are intended to measure. An index is

used to measure changes, which have occurred. Share indexes are used to measure changes,

which have occurred for shares in specific stock exchange e.g. stock indices measures the

changes of price or value changes where the value changes are brought about by changes in the

capitalization of the share in the exchange. NSE index is based on share trading of 20 companies,

which are considered very active. The 20 companies account nearly 30% of NSE capitalization.

- A fall in NSE share index represents a fall in market price per share. Arise in NSE index

represent arise in the market price per share.

- An index may act as an indicator of activities in NSE the higher the demand of the share, the

higher is it market price and as a result the higher will be index.

1. Price index numbers are used to measure changes in a particular group of prices and help

us in comparing the movement in prices of one commodity with another. They are also

designed to measure changes in purchasing power of money

2. Index numbers of industrial production provide a measure of change in the level of

industrial production in a country.

3. Quantity index numbers show the rise/fall in the volume of production exports and

imports

4. Import and export prices indices are used to measure changes in terms of trade of a

country by the terms of trade is meant ratio of import to export prices.

5. Index numbers are also used to forecast business condition of a country and to discover

seasonal fluctuations and business cycle.

6. Consumer price indices indicate the movement in retail prices of consumption goods and

services.

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Factors to consider when computing index numbers

1. Purpose of index numbers

When the purpose is known the true results can be obtained from the proper construction and

type of index numbers

2. Selection of commodities

Its easy when the purpose is known is accurate to reasonable extended. When selecting

commodities, a great care and skill should be used as the proper selection of the commodities is

the main thing in construction of index numbers.

3. Price quotation

Its impossible to collect the prices for selected commodities from all places in the country where

they are marketed. A sample of marked will therefore have to be selected randomly. The criteria

of selecting the sample will be those places where given commodities are marketed in a large

number. Its just possible that a sample may serve purpose for many commodities rather than one

commodity

4. Choice of the base period

It should be fairly normal year neither of very low prices nor of very high prices however its

probable that no one year is sufficiently normal to be a good basis for comparison.

5. Choice of the average

Studying index numbers of a single commodity, average is not needed but in case of more than

one commodity, price relatives are computed and averaged

6. Choice of proper weights

Index numbers include many commodities which are not equally important therefore its

important to give weights according to importance of different commodities keeping in mind

purpose of index numbers

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I.

Computation procedure

When construction of an index number involves a single commodity it is called simple index

numbers. There are two methods/procedures for construction of simple index numbers

a) Fixed base method

b) Chain base method

In the fixed base method the base period is fixed and prices of subsequent years are expressed as

relatives of the prices of the base year.

Price relative is simply the price of an item in one year, relative to another year i.e.

For example: given the following information about a commodity Compute the price indices for

each year using fixed base method?

year

1991

1992

1993

1994

1995

1996

price

8

10

12.5

18

22

25

Solution:

P0 = 8

1991_______8 8 100 = 100%

1992________10 8 100 = 125%

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