The document discusses the Abrams Company case focusing on the drawbacks of using ROI for profit center evaluation, suggesting a shift to RI or EVA for better investment control and to address issues like transfer pricing and operational challenges. It analyzes the strengths and weaknesses of Abrams' management control system, highlighting a need for a balanced scorecard approach to improve performance measurement and incentive compensation. Recommendations include establishing non-financial performance metrics and adjusting transfer pricing methods to better align with company goals.

1. ABRAMS COMAPANY
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
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2. ABRAMS COMAPANY
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
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3. ABRAMS COMAPANY
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
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4. ABRAMS COMAPANY
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.
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