How to Determine an Accounting Rate of Return

Step-by-Step Guide

1. 1

   Step 1: Determine the Annual Profit.

   This method of determining the Accounting Rate of Return uses the basic formula ARR = Average Annual Profit / Initial Investment.
   
   To begin, you’ll need to find the Annual Profit.
   
   This number is based on accruals, not on cash, and it reflects the costs of amortization and depreciation.
2. 2

   Step 2: Identify the depreciation value.

   Assuming the investment involves the purchase of a fixed asset (such as equipment or machinery), you’ll need to calculate a depreciation value.
   
   This is a two-part process:
   First, subtract the scrap value of the asset – the value of its separate components when no longer operational – from the asset’s initial value.
   
   If, for example, a given piece of machinery was originally valued at $1000, and its scrap value is $500, you’ll subtract to get $500.
   
   Second, divide the resulting amount by the asset’s useful life – the number of years the asset is expected to perform productively.
   
   If, in our example, the piece of machinery is expected to perform well for five more years, then you’ll divide $500 by 5 to get $100. , Deduct the amount of depreciation from the Annual Profit of the project; you will be left with the Average Annual Profit.
   
   This number will be the numerator in the ARR equation above. , Divide your Average Annual Profit by the amount of your initial investment (the combined value of the fixed asset investment and any change in the working capital as a result of that investment).
   
   The result, expressed as a percentage, is your ARR.
3. 3

   Step 3: Find the Average Annual Profit.

4. 4

   Step 4: Divide to get the ARR.

Detailed Guide

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