Accounting Rate of Return
The accounting rate of return (ARR), also known as the return on investment (ROI), uses accounting information, as revealed by financial statements, to measure the profitability of an investment. The accounting rate of return (ARR) is the ration of the average after tax profit divided by the average investment. The average investment would be equal to half of the original investment if it were depreciated constantly. Alternatively, it can be found out by dividing the total of the investments book values after depreciation by the life of the project. The accounting rate of return (ARR), thus, is an average rate and can be determined by the following equation,
- ARR = Average income / Average investment
Acceptance rule
As an accept or reject criterion, this method will accept all those projects whose accounting rate of return (ARR) is higher than the minimum rate established by the management and reject those projects which have accounting rate of return (ARR) less than the minimum rate. This method would rank a project as number one if it has highest accounting rate of return (ARR) and lowest rank would be assigned to the project with lowest accounting rate of return (ARR)
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