In Accounting, what is a Decision Rule?

Mary McMahon
Mary McMahon

A decision rule is a guide for decision making which is designed to ensure that accounting decisions are consistent, effective, and in accordance with the principles of the business. There are a number of standardized decision rules which companies and individuals can adopt and it is also possible to develop a decision rule from scratch for a specific company or situation. These rules are part of the policies and procedures which provide guidance for a range of business activities.

Man climbing a rope
Man climbing a rope

There are two aspects to a decision rule. The first is a description of a hypothetical set of conditions. The second is a directive about the action to be taken in those conditions. For example, a business might use the net present value method to evaluate potential investments. Under this decision rule, the company would determine the difference between the initial investment cost and the present value of a given investment, and if the difference was positive, the investment would be accepted.

A decision rule cannot violate the law, and should not violate accepted accounting standards and practices unless there is a very compelling reason to do so. Using decision rules takes much of the guess work out of making decisions, which can be beneficial, and it also provides people with a firm rubric to apply when making choices about business activities. This allows people to view options more objectively, which reduces the risk of making a bad decision.

Many decision rules revolve around hard numbers and supporting documentation, which are needed to make any business decision. These rules can be applied to internal decisions as well as external investments and related activities. It is generally accepted that companies considering activities such as investments will need to be able to see numbers in order to make a decision; a company will not approach an investment without access to information which can be used to make an informed choice.

There can be other factors to a decision as well. For instance, if a company is using the net present value method and an investment appears acceptable under this method, the company might still refuse to accept the investment. The investment might conflict with the company's mission statement, for example, or it might be an investment in something which is about to be banned or more heavily regulated, which means that it could lose value rapidly after acquisition, making it a poor choice of investment.

Mary McMahon
Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a wiseGEEK researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.

You might also Like

Readers Also Love

Discuss this Article

Post your comments
Forgot password?