The document defines accounting rate of return (ARR) as the ratio of estimated accounting profit to average investment. ARR is calculated by taking the average accounting profit and dividing it by the average investment. Projects should be accepted if their ARR is greater than or equal to the required accounting rate of return, and between mutually exclusive projects the one with the highest ARR should be accepted. An example calculation is shown to illustrate determining ARR for a project with initial investment, annual cash inflows, depreciation, and scrap value.

1. By: Kristel Pamela Caluya

2.  Accounting rate of return (also known as
simple rate of return) is the ratio of
estimated accounting profit of a project to
the average investment made in the project.
ARR is used in investment appraisal.

3.  Accounting Rate of Return is calculated using
the following formula:
Average Accounting Profit
 ARR =
Average Investment

4.  Accept the project only if its ARR is equal to
or greater than the required accounting rate
of return. In case of mutually exclusive
projects, accept the one with highest ARR.

5.  Example 1: An initial investment of ₱5.2M is
expected to generate annual cash inflow of
₱1.2M for 5 years. Depreciation is allowed on
the straight line basis. It is estimated that
the project will generate scrap value of
₱420,000 at end of the 5th year. Calculate its
accounting rate of return assuming that
there are no other expenses on the project.

6. Average Accounting Profit
 ARR =
Average Investment
Annual Depreciation = (Initial Investment − Scrap Value) ÷
Useful Life in Years
Annual Depreciation = (₱5,200,000 − ₱P420,000) ÷ 5 ≈
P956,000
Average Accounting Profit = ₱1,200,000 − ₱956,000 = ₱244,000
Accounting Rate of Return = ₱244,000 ÷ ₱5,200,000 ≈ 4.69%

7.  The 4 Pillars Clothing Factory wants to replace an old machine
with a new one. The old machine can be sold to a small factory
for ₱400,000. The new machine would increase annual revenue
by ₱6,000,000 and annual operating expenses by ₱2,400,000. The
new machine would cost ₱14,400,000. The estimated useful life
of the machine is 12 years with zero salvage value.
Required:
 Compute accounting rate of return of the machine using above
information.
 Should 4 Pillars Clothing Factory purchase the machine if
management wants an accounting rate of return of 15% on all
capital investments?

8. Average Accounting Profit
 ARR =
Average Investment
 = ₱2,400,000 * / ₱14,000,000**
 = 17.14%
*Average Accounting Profit
Incremental revenues – Incremental expenses including depreciation
6,000,000-(2,400,000+1,200,000)
=6,000,000-3,600,000
= ₱ 2,400,000
** The amount of initial investment has been reduced by net realizable value of the old
machine
(₱ 14,400,000 – ₱400,000)
= ₱ 14,000,000

9.  The Superfriends manufacturing company has
the following different alternative investment
proposals:
Kten’s Proposal Ren’s Proposal Maw’s Proposal
Expected
incremental
income per year
(a)
₱2,000,000 ₱3,000,000 ₱3,600,000
Initial
investment (b)
₱10,000,000 ₱12,000,000 ₱20,000,000
Expected
accounting rate
of return (a)/(b)

10. Thank You....