Hello, What is the accounting rate of return method? Simply put, it is also known as Returning Method / Accounting Statement Method / Accounting Rate of Undiscovered Rate of Return Method. According to this method, capital projects are ranked in order of earnings. Which projects earn the most. And they are also selected. And all others are rejected. This can be expressed in many ways to return on investment method. Let us throw light on all the methods.
Average Rate of Return Method – (ARR)
Under this method, we will calculate the average annual profit. And then we will divide it by the total outlay of the capital project. As such, this method establishes a ratio between the average annual profit and the total outlay of projects.
As per the formula,
Average Annual Profits
Rate of Return = ———————————— x 100
Outlay of the Project
As such, the average rate of return method assumes full earnings over the entire economic life of any asset. This way a higher return percentage and project will be acceptable.
Earnings per unit of Money Invested (EUMI)
According to this method, we can find the total net income. And then divide it by the total investment. Because this gives us the average rate (i.e. per rupee) per unit invested in the project. As per the sources given below.
Earnings per unit of investment = ————————————-
Total Outlay of the Project
The higher the income per unit, the more the project is eligible to be selected.
Return on Average Amount of Investment Method (RAAI)
We will know under this method, the way the percentage return on the average amount of investment is calculated. Similarly, the outlay of the projects is divided by two to calculate the average investment. According to the sources mentioned below.
Unrecovered Capital at the beginning +
Unrecouped capital at the end
Average Investment = —————————————————-
Initial investment + scrap value
Or = —————————————————-
Or = —————————————————-
Average Annual Net Income (Savings)
Rate of Return = —————————————————- x 100
Average Annual Net Income = Average Annual Cash-
Inflow – Depreciation
As mentioned above, we see that it can be applied to the rate of return approach in various ways. But, however, in our opinion, the third approach is more appropriate and consistent.
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