ABRAMS COMAPANY

Prepared by: Milan Padariya, 63-MBA(Pharma) Page 1

CASE 5-4 ABRAMS COMPANY

Que. 1: Evaluate each of the concerns expressed by top management, and if

necessary, make recommendation appropriate to the circumtences described

in the case

The Abrams case is about using profitability measures to evaluate profit centers. The case also

reflects a long academic debate in the US-literature about ROI problems. In EU companies it is

more common to evaluate PCs with Income measures like RI and EVA. This case covers the

tree main problems in controlling profit centers:

1. The ROI behavior

2. Transfer pricing disputes

3. Operational trouble shouting

It is very difficult to find a relevant and fair capital base for the ROI measure. Abrams use

book value for fixed assets which inflate the ROI measure as the assets age.

The age and mix of assets also differs among divisions which give unfair measures. It is also

easy for the divisions to manipulate the capital base at the end of the year. ROI based bonus

may rob the future, who want to invest in assets if that reduce the bonus.

I recommend this company to use RI or EVA instead of ROI and to control the investments

separately using NPV and capital turnover measures. The bonus should be based on the

budgeted income level, the RI target.

The problem with the inventory level can not be controlled with ROI management. If the

company change to RI/EVA it will be possible to to negotiate relevant inventory levels in the

budget process. High inventory levels can also be managed with differentiated capital charges

ABRAMS COMAPANY

Prepared by: Milan Padariya, 63-MBA(Pharma) Page 2

that will create high interest costs. The best way to control operational tasks is to us non

financial measures such as inventory turnover.

Use non financial measures to control the inventory levels. If it is an strategic issue you can

connect this measure to the bonus system.

Que. 2: What is overall evaluation of Abrams management control system?

Describe any strength or weakness that you identified but did not include in

answering the previous question. What changes, if any, would you recommend

to top management?

In general, Abrams Company adopts the lowest cost, differentiation, market focus and ROI

strategies to accomplish the organization’s goal. Furthermore, In order to implement the

strategies the firm establishes its own management control systems.

Evaluation of Abrams’ Management Control System:

The current measurement system of the company is ROI. The ROI target is set based on

budget profit divided by actual beginning of the year net assets. Actual ROI is calculating by

actual profit divided by actual beginning of the year net asset. The advantage of the Abrams

Company ROI system is it does not consider the investment added during the year, because

the investments provide little effort to the year, but more benefit to the future. However, the

ROI measurement system has some weakness, such as defer asset replacement, short-term

focus at the expense of long-term.

The incentive compensation plan of Abrams Company is bonus plan, and it calculate

accurately based on an equation, and it seems equal for all members. In addition, some

adjustments also are made associate with the performance of the managers. The performance is

measured by compare of actual profit and budget profit. However, all the measurement is

ABRAMS COMAPANY

Prepared by: Milan Padariya, 63-MBA(Pharma) Page 3

associate with data, sometimes the performance will be influence by variance elements, such as,

economic environment, the demand level, material price, cost of labor, and government

policy, so the measurement need to improve in some areas. The dollar amount of corporate

bonus pool was established by a fixed formula linked to company earning per share. This

incentive compensation plan can be considered as a reward system. Using this method the

company can increase or maintain motivation.

STRENGTH :

-The company has a clear management structure.

-The company has employed a bonus plan for employees.

-The AM Marketing division will input products form the other three divisions, and sell it to

domestic and foreign market, it helps the company save cost when it input internal.

WEAKNESS:

The Abrams Company has three totally independent divisions, and the three divisions are lack of

connection. They purchase their materials separately, and they carried excessive inventories

most of the year. Also, inside sales sometimes need a negotiation on price, the may lead to low

productivity.

SUGGESTIONS TO PERFORMANCE MEASUREMENT SYSTEM:

1) ROI: can be used combination with other performance measures to avoid the limitations of

ROI. The company can establish a non-financial performance measurement system such as

the balanced scorecard .With a good performance measurement system, the incentive

compensation plan will be improved.

(2) EVA ( Economic value added): can be used instead of ROI Suggestions to transfer

pricing… A transfer price fixed by the top management in compliance with the AM division

and the other divisions involved which could be revised when it is out of date. This fixed price

ABRAMS COMAPANY

Prepared by: Milan Padariya, 63-MBA(Pharma) Page 4

could be adjusted due to inflation. There should be an internal policy on it. Therefore, top

management should implement a cost-based transfer prices because when competitive prices

are not available, transfer prices may be set on the basis of cost plus a profit markup.

RECOMMENDATION:

The non-financial performance measurement system should be established. The

balanced scorecard is a good choice for company measure performance. With a good

performance measurement system, the incentive compensation plan will be

improved.