The ARR (Accounting Rate of Return) method is used to rank capital projects as per their earning. Projects that are earning the highest are chosen while those which are not performing up to the standard are discarded. The ARR is further sub-divided into average rate of return, average investment, and earnings per division.
The ARR (average rate of return) method
With the ARR method, the online cheap accountants in east London calculates the average profit that is made. The average rate of return method thus takes into consideration, specific assets earnings in its entire financial run. A project will get approved only if its return percentage is higher.
The return of amount on average investment is the method that is used by the online cheap accountants in east London to calculate the return percentage on the amount of average investment.
Earnings per Division
This method is helpful when the calculation of the total earnings is done. This helps to bring out the rate of average return on every single unit of the amount that has been invested in a specific project.
The 8 advantages of accounting rate of return are:
- Helps to compare
This method helps in comparing a new project with that of projects that are cost-efficient or with other projects that are competitive in nature.
- Easier to Calculate
The method makes it easier to understand and calculate the period of payback. It takes into consideration the profits or the savings occurring over the period of the project’s total financial span.
- Clear view of profitability
The method presents a clear view of a particular project’s profitability.
- Creates the perception of net Earning
The method presents a perception of net earnings, that is, the earnings after tax payments and depreciation.
- Satisfies the owner’s interests
The owners are much more interested in the returns of their investments. So, the method helps to satisfy the owner’s interest regarding their investment returns.
- The Accounting of Profit
The method takes into consideration the concept of accounting profit. The profit can be determined by calculating the return rates. The accounting profit can easily be calculated with the help of accounting records.
- Measuring the Current Performance
The method is extremely helpful when trying to measure the present performance of a firm.
- Calculation of the return rates
Investments that have extremely large span the method helps to calculate the simple return rate to that of the true return rate.
There are, however, certain disadvantages when it comes to the ARR method. The 8 disadvantages of accounting rate of return are:
- The ignorance of the time factor
The method is known to ignore time factor when selecting an alternate use of a fund.
- Ignorance of external factors
The method is known not to take the external factors that hinder the profit earning capacity of a project, into consideration.
- Creates decision-making problems
People will arrive at different results if the ROI (return on investment) and the ARR (accounting rate of returns) are calculated separately.
- Only considers accounting profits
The method does not take the cash inflow into consideration and is only interested in accounting profits.
- ARR is not all that is required
To calculate the rate of return only the ARR method is not required.
- Unhelpful at sometimes
Cannot appraise projects where installments of the investments have been made more than two times and in separate parts.
- Life period investment
The lifetime of multiple investments is not considered by the method. But while calculating the average earnings, the lifetime of investments are taken into account.
- Ignores time frame
The method overlooks the period that the investments take to earn profits.