ARR Formula

ACCOUNTING RATE OF RETURN = AVERAGE ANNUAL NET INCOME / INVESTMENT

AND THE SAME FORMULA SHOULD BE USED IN EXAM

average investment = total outlay/2

or

average investment = 1/2( initial cost+installation exp-salvage value)+salvage value+additional working capital

2nd formula is used when all the required items are given in the question

Steps To Calculate ARR:-

1-- Calculate

Avg. earnings after taxes(during project period) = Total expected earnings after taxes but before interest on long term debt / Total project period.

2-- Calculate Avg. investment in project.

 (a) Avg Investment(each year) = (Opening Investment* + closing investment*) / 2

         * includes working capital if any.

(b) Avg. Investment(during project period-n) = ( Step 2(a) for 1st yr +..... step 2(a) for n yrs) / n

                                                     OR

Short cut formula for calculating avg. investment when SLM of Depreciation is used----

     Here, Avg Inv.= 1/2(original cost - salvage value) +salvage value + working capital

3--- At last ,

ARR = STEP 1 result / Avg investment during project period as per step 2(b)

 Follow the above steps for all problems relating to ARR. If you need clarification in the above steps, feel free to ask..

my confusion not yet clarified. Ashay suggest equation as in the ICAI study material. Kanchan and Faiz suggests what I study. which one I should I use? please clarify it.

Dear Sahis,

Your confusion is genuine as the content given in study material is not explained much. There are also no problems on ARR in study material of ICAI.

The above steps of ARR are from a good book by P.C.Tulsian. You can refer that for numericals also. For capital budgeting chapter refer that book for better understanding + do problems from study materials also.