Stochastic Risk Analysis Of Budgeted Financial Statements

Abstract

Stochastic modeling of financial statements facilitates risk analysis by explicitly introducing uncertainty for key input variables.  When input variables are modeled as probability distributions, then Monte Carlo simulation can be performed for the budgeted financial statements.  Critical outputs within the financial statements can be displayed with cumulative graphs that show a range of outcomes with its likelihood of occurrence.  Stochastic modeling techniques are superior to scenario analysis in assessing risk and are another innovative use of technology in support of managerial decision-making.  Students for a cost/managerial accounting course reported a better understanding of risk analysis for accounting relationships, and a greater interest in modeling uncertainty in other financial relationships.