How to Calculate the Accounting Rate of Return

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Accounting Rate of Return (ARR) Calculator

Calculation Results:

Average Annual Profit:

Average Investment:

Accounting Rate of Return: %

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How to Calculate the Accounting Rate of Return (ARR)

The Accounting Rate of Return (ARR) is a financial ratio used in capital budgeting to assess the profitability of an investment or project. Unlike Net Present Value (NPV) or Internal Rate of Return (IRR), ARR focuses on accounting profits rather than cash flows and does not take the time value of money into account.

The ARR Formula

To calculate the ARR, you need to divide the average annual accounting profit by the average investment cost. The formula is expressed as:

ARR = (Average Annual Profit / Average Investment) × 100

Step-by-Step Calculation Components

  • Average Annual Profit: This is the total net profit expected over the life of the asset divided by the number of years.
    Formula: Total Profit / Useful Life
  • Average Investment: This represents the average book value of the asset over its life.
    Formula: (Initial Cost + Salvage Value) / 2

Practical Example

Suppose a company wants to purchase a new machine for $100,000. The machine is expected to last 5 years and have a salvage value of $20,000 at the end of that period. Total profits over the 5 years are projected to be $50,000.

  1. Average Annual Profit: $50,000 / 5 years = $10,000
  2. Average Investment: ($100,000 + $20,000) / 2 = $60,000
  3. ARR: ($10,000 / $60,000) × 100 = 16.67%

Why Use ARR?

ARR is favored by managers because it uses accounting data that is readily available from financial statements. It provides a quick percentage-based snapshot of performance, making it easy to compare multiple projects against a company's required "hurdle rate." However, because it ignores the time value of money, it should be used alongside other metrics like NPV for a more comprehensive analysis.

function calculateARR() { var initial = parseFloat(document.getElementById('initialInvestment').value); var salvage = parseFloat(document.getElementById('salvageValue').value); var totalProfit = parseFloat(document.getElementById('totalProfit').value); var years = parseFloat(document.getElementById('usefulLife').value); var resultBox = document.getElementById('arrResultBox'); var errorBox = document.getElementById('errorBox'); // Validation if (isNaN(initial) || isNaN(salvage) || isNaN(totalProfit) || isNaN(years) || years <= 0) { errorBox.style.display = 'block'; resultBox.style.display = 'none'; return; } errorBox.style.display = 'none'; // 1. Calculate Average Annual Profit var avgAnnualProfit = totalProfit / years; // 2. Calculate Average Investment var avgInvestment = (initial + salvage) / 2; // 3. Calculate ARR var arrValue = 0; if (avgInvestment !== 0) { arrValue = (avgAnnualProfit / avgInvestment) * 100; } // Display Results document.getElementById('avgProfitDisplay').innerText = '$' + avgAnnualProfit.toLocaleString(undefined, {minimumFractionDigits: 2, maximumFractionDigits: 2}); document.getElementById('avgInvestmentDisplay').innerText = '$' + avgInvestment.toLocaleString(undefined, {minimumFractionDigits: 2, maximumFractionDigits: 2}); document.getElementById('finalARRDisplay').innerText = arrValue.toFixed(2); resultBox.style.display = 'block'; }

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