Abrams Company Case Analysis

MANAGEMENT CONTROL SYSTEMS

Lecturer : Supriyadi, Ph. D. Nama : Handy nugroho ————————————————- No: 1157021 Case : Abrams Company Abrams’Company manufactured a wide variety of parts for use in automobiles, trucks, buses, and farm equipment. Abrams sold their product both to the OEMs and the wholesalers. top management is satisfied with their management systems and performance measurement scheme but they are three areas of concern that need to be discussed. * First, the transfer prices disagreements of parts sold by the product divisions to the AM division.

Second, is in the product divisions too often tended to treat the AM division as a captive customer and in the performance measurement system. * Third, the excessive yearly inventory carried by both the AM division and the three product divisions. 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.

Weaknesses

Abrams’ business model weakness is that its divisions operate as independent companies. Furthermore, all of these profit centers, participate in an incentive compensation plan that the higher the participant is in the organizational hierarchy, the more “incentive points” he or she will receive based on division profit variance. The Abrams Company has three totally independent divisions, and the three divisions are lack of connection. The transactions between the three divisions dispute the transfer pricing. Case Analysis and Recommendation

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

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In EU companies it is more common to evaluate PCs with Income measures like RI and EVA. 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.

Abrams Company Case Solution

Recommendation to this company was 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 current transfer price system seems to work well with few disputes. Market prices are more used as a top-level for the TP. An advantage with cost base TP is that it will give all internal partners full information about the cost structure and you will avoid “upstream fixed costs” The problem with the inventory level cannot 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 that will create high interest costs. The best way to control operational tasks is to use nonfinancial measures such as inventory turnover. Use nonfinancial measures to control the inventory levels. If it is an strategic issue you can connect this measure to the bonus system.

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. 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 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.