## What Is the Accounting Rate of Return – ARR?

The accounting rate of return (ARR) is the percentage rate of return expected on investment or asset as compared to the initial investment cost. ARR divides the average revenue from an asset by the company's initial investment to derive the ratio or return that can be expected over the lifetime of the asset or related project. ARR does not consider the time value of money or cash flows, which can be an integral part of maintaining a business.

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## The Formula for ARR

﻿$ARR = \frac{Average\, Annual\, Profit}{Initial\, Investment}$﻿

## How to Calculate the Accounting Rate of Return – ARR

1. Calculate the annual net profit from the investment, which could include revenue minus any annual costs or expenses of implementing the project or investment.
2. If the investment is a fixed asset such as property, plant, or equipment, subtract any depreciation expense from the annual revenue to achieve the annual net profit.
3. Divide the annual net profit by the initial cost of the asset, or investment. The result of the calculation will yield a decimal. Multiply the result by 100 to show the percentage return as a whole number.

## What Does ARR Tell You?

The accounting rate of return is a capital budgeting metric useful for a quick calculation of an investment's profitability. ARR is used mainly as a general comparison between multiple projects to determine the expected rate of return from each project.

ARR can be used when deciding on an investment or an acquisition. It factors in any possible annual expenses or depreciation expense that's associated with the project. Depreciation is an accounting process whereby the cost of a fixed asset is spread out, or expensed, annually during the useful life of the asset.

Depreciation is a helpful accounting convention that allows companies not to have to expense the entire cost of a large purchase in year one, thus allowing the company to earn a profit from the asset right away, even in its first year of service. In the ARR calculation, depreciation expense and any annual costs must be subtracted from annual revenue to yield the net annual profit.

### Key Takeaways

• ARR is helpful in determining the annual percentage rate of return of a project.
• ARR can be used when considering multiple projects since it provides the expected rate of return from each project.
• However, ARR does not differentiate between investments that yield different cash flows over the lifetime of the project.

## Example of How to Use the Accounting Rate of Return – ARR

A project is being considered that has an initial investment of $250,000 and it's forecasted to generate revenue for the next five years. Below are the details: • initial investment:$250,000