Accounting Rate of Return (ARR) Method | Advantages | Disadvantages

Advantages of Accounting Rate of Return Method (ARR Method)

The following are the advantages of Accounting Rate of Return method.

1. It is very easy to calculate and simple to understand like pay back period. It considers the total profits or savings over the entire period of economic life of the project.

2. This method recognizes the concept of net earnings i.e. earnings after tax and depreciation. This is a vital factor in the appraisal of a investment proposal.

3. This method facilitates the comparison of new product project with that of cost reducing project or other projects of competitive nature.

4. This method gives a clear picture of the profitability of a project.

5. This method alone considers the accounting concept of profit for calculating rate of return. Moreover, the accounting profit can be readily calculated from the accounting records.

6. This method satisfies the interest of the owners since they are much interested in return on investment.

7. This method is useful to measure current performance of the firm.

Disadvantages or Weakness or Limitations of Accounting Rate of Return Method

This method has some disadvantages or limitations also. They are briefly explained below.

1. The results are different if one calculates ROI and others calculate ARR. It creates problem in making decisions.

2. This method ignores time factor. The primary weakness of the average return method of selecting alternative uses of funds is that the time value of funds is ignored.

3. A fair rate of return can not be determined on the basis of ARR. It is the discretion of the management.

4. This method does not consider the external factors which are also affecting the profitability of the project.

5. It does not taken into the consideration of cash inflows which are more important than the accounting profits.

6. It ignores the period in which the profits are earned as a 20% rate of return in 10 years may be considered to be better than 18% rate of return for 6 years. This is not proper because longer the term of the project, greater is the risk involved.

7. This method cannot be applied in a situation when investment in a project to be made in parts.

8. This method does not consider the life period of the various investments. But average earnings is calculated by taking life period of the investment. As a result, average investment or initial investment may remain the same whether investment has a life period of 4 years or 6 years.

9. It is not useful to evaluate the projects where investment is made in two or more installments at different times.

Leave a Reply

Recent Posts


Related pages

disadvantages of eposmanagement accounting marginal costingarrear calculatorimportances of managementdefine venture capitalistmergers and acquisitions examplesgatt wikiinductive and deductive method of teaching sciencemeaning of depositoriesroles and responsibilities of strategic managertypes of organisational structures and their advantages and disadvantagesexample of fdi in indiahow to vouch salesseniority promotionfeatures of capital budgeting decisiondifferentiate between centralization and decentralizationvalid void and voidable contractstandard costing systemmeaning of budget and budgetary controlexample of a vertical mergerdemerits of advertisingdifference between multistage and multiphase samplingfunctions of primary market and secondary marketproforma of fund flow statementfeature of capitalismwhat is irr in accountinghow to calculate direct labor ratehow to prepare fund flow statement from balance sheetdecentralisation definitiondefinition amalgamationlimitations of budgetary controlcif stands for in shippingleadership autocraticconsumer advantages of e commercemixed economic system advantages and disadvantagesadvantages of audit programmebonds and debentures differencecomputerised auditingfunctions of regional rural banks in indiareceivables turnover ratio definitiondefinition of prospectus in company lawwhat is the profitability indexautocratic leader characteristicsamalgamationsperpetual inventory management systemwhat is the definition of impersonalbudgeting wikipediamethods of economics inductive and deductivemultistage cluster sampling definitionbailment casesadvantages and disadvantages of division of labortypes of partnership firmcaveat definition in a sentencemeaning of vouchedamalgamation and mergertypes of financial companiesindian contract 1872autocratic leadership pptexamples of quota samplingcost apportionment methodabsolute assignment of life insurance policyamalgamation meaning in hindiadvantages and disadvantages of social auditultra vires definitiondumping examples economicsspeculative transactionswhat are the benefits of fdidso days sales outstanding formulapromissory note payeeimportances of budgetingdefine competitive parityformula for stock turnoverwhat is the difference between job costing and process costingadvantages of pricing strategieshorizontal merger examplecalculating payback periodcif or fobadvantages and disadvantages of retained profitdebentures as a source of financedrawer drawee and payee in chequemeaning of forfeiting