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Case 2 Abrams Company

Management Control System

Supriyadi Ph.D

Prepared by :

Andika Adikrishna Gunarjo (31P15071)

1. Evaluate each of the concerns expressed by top management, and if necessary, make recommendation appropriate to the circumstances 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. This case covers the main problems in controlling profit centers.

First one, 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

Second, 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. 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.

Recommendations:

I recommend this company to use Residual Income or Economic Value Added instead of ROI and to control the investments separately using Net Present Value and capital turnover measures. The bonus should be based on the budgeted income level, the Residual Income target.

Top management will decide transfer pricing that is already agreed by all division along with the inflation ratio. This will be calculated with all the production cost plus the profit that management want and agreed with production division and Aftermarket division.

* ROI: can be used combination with other performance measures to avoid the limitations of ROI. The...