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Question :- A project costs Rs.5,00,000 and has a scrap value of Rs. 1,00,000. Its stream of income before depreciation and taxes during first year through five years is Rs. 1,00,000, Rs.1,20,000, Rs. 1,40,000, Rs. 1,60,000 and Rs. 2,00,000. Assume a 50 per cent tax rate and depreciation on straight-line basis. Calculate the accounting rate for the project. Also explain the advantages and disadvantages of ARR. Answer:- Cost of Project – Scrap Value = Investment to be considered for depreciation Cost of the project =500000 Scrap Value =100000 Investment of project =400000 No. of years =5years Depreciation =80000 (Straigh line method of Depreciation = Investment / No. of years) Now, Profit Before Depreciation & Tax (PBDT) - Depreciation = PBT Years PBDT Depreciation Straight PBT 1 st 100000 80000 20000 2 nd 120000 80000 40000 3 rd 140000 80000 60000 4 th 160000 80000 80000 5 th 200000 80000 120000 Profit Total 320000 Average Profit 64000 Accounting Rate of Return (ARR) = (Average Profit / Total Investment) x 100 ARR - 64000 x 100 /500000 ARR - 6400000 /500000

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Accounting Rate of Return ARR example. Advantages of considering ARR ratio for new Investments.

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Page 1: Accounting Rate of Return ARR example

Question :- A project costs Rs.5,00,000 and has a scrap value of Rs. 1,00,000. Its stream of income before depreciation and taxes during first year through five years is Rs. 1,00,000, Rs.1,20,000, Rs. 1,40,000, Rs. 1,60,000 and Rs. 2,00,000. Assume a 50 per cent tax rate and depreciation on straight-line basis. Calculate the accounting rate for the project. Also explain the advantages and disadvantages of ARR.

Answer:-

Cost of Project – Scrap Value = Investment to be considered for depreciationCost of the project =500000Scrap Value =100000 Investment of project =400000No. of years =5years Depreciation =80000(Straigh line method of Depreciation = Investment / No. of years)

Now,Profit Before Depreciation & Tax (PBDT) - Depreciation = PBT

Years PBDT Depreciation Straight PBT

1st 100000 80000 20000

2nd 120000 80000 40000

3rd 140000 80000 60000

4th 160000 80000 80000

5th 200000 80000 120000

Profit Total 320000

Average Profit 64000

Accounting Rate of Return (ARR) = (Average Profit / Total Investment) x 100

ARR - 64000 x 100 /500000

ARR - 6400000 /500000

ARR - 12.8%

For Advantages & Disadvantages refer below given links;www.accountingformanagement.org/accounting-rate-of-return-method/

http://accountingexplained.com/managerial/capital-budgeting/arr

http://accountlearning.blogspot.in/2011/07/advantages-and-disadvantages-of.html

http://wiki.answers.com/Q/What_are_the_advantages_and_disadvantages_of_Average_Rate_of_Return

http://principlesofaccounting.blogspot.in/2009/06/accounting-rate-of-returnarr-method-of.html

http://principlesofaccounting.blogspot.in/2009/06/accounting-rate-of-returnarr-method-of.html
http://wiki.answers.com/Q/What_are_the_advantages_and_disadvantages_of_Average_Rate_of_Return
http://accountlearning.blogspot.in/2011/07/advantages-and-disadvantages-of.html
http://accountingexplained.com/managerial/capital-budgeting/arr
http://www.accountingformanagement.org/accounting-rate-of-return-method/

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