Accounting rate of return

The accounting rate of return (ARR) is average annual accounting profit divided by average investment. It ignores the time value of money and uses profit rather than cash flows, reducing its reliability as an appraisal tool.

ByHoang TruongUpdated July 2, 2026

FrameworkInvestment appraisal

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A machine costing €200,000 with no residual value generates average annual accounting profit of €30,000 over five years. Average investment is (€200,000 + €0) ÷ 2 = €100,000, so ARR = €30,000 ÷ €100,000 = 30%, comfortably above the firm's 20% hurdle — though ARR ignores both cash-flow timing and the time value of money.

Where it fits

TopicCapital Budgeting & Investment AppraisalCoreSubjectCorporate FinanceCore

The formula

LaTeX

\text{ARR} = \frac{\text{Average annual accounting profit}}{\text{Average investment}}

Variables

$A R R$: Accounting rate of return, expressed as a percentage
$A v er a g e ann u a l a cco u n t in g p r o f i t$: Mean annual profit after depreciation over the asset's useful life
$A v er a g e in v es t m e n t$: (Initial cost + Residual value) ÷ 2

Accept the project if ARR exceeds the firm's target return. The method ignores the time value of money and uses accounting profit rather than cash flows, which are significant limitations.

LaTeX

\text{Average investment} = \frac{\text{Initial cost} + \text{Residual value}}{2}

Variables

$I ni t ia l cos t$: Capital outlay at the start of the project
$R es i d u a l v a l u e$: Estimated scrap or resale value at the end of the asset's life (zero if none)

Check yourself

PracticeCORE

A machine costs €120,000, has a residual value of €20,000 at the end of its five-year life, and generates average annual accounting profit after depreciation of €14,000. Using average investment as the denominator, what is the accounting rate of return (ARR)?

Select an answer to check your understanding.