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1974•Journal of Business Finance &amp AccountingRequires access

Accounting Rate of Return vs. Economic Rate of Return

Lawrence A. Gordon

Open publisher page 38 citations

Abstract

The accounting rate of return (ARR) has traditionally been used as a surrogate for the economic rate of return (IRR) in evaluating the effectiveness of managements’ capital investment decisions. Over the years, some question has been raised as to the validity of using the ARR as an approximation of the IRR. Several papers have recently come to grips with this question with varying degrees of success. This paper is intended to expose the conceptual differences between these rates of return, with the goal of clearly pointing out just how useful the ARR can be to management.

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What this paper is about

The accounting rate of return (ARR) has traditionally been used as a surrogate for the economic rate of return (IRR) in evaluating the effectiveness of managements’ capital investment decisions. Over the years, some question has been raised as to the validity of using the ARR as an approximation of the IRR. Several papers have recently come to grips with this question with varying degrees of success. This paper is intended to expose the conceptual differences between these rates of return, with the goal of clearly pointing out just how useful the ARR can be to management.

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Available abstract

The accounting rate of return (ARR) has traditionally been used as a surrogate for the economic rate of return (IRR) in evaluating the effectiveness of managements’ capital investment decisions. Over the years, some question has been raised as to the validity of using the ARR as an approximation of the IRR. Several papers have recently come to grips with this question with varying degrees of success. This paper is intended to expose the conceptual differences between these rates of return, with the goal of clearly pointing out just how useful the ARR can be to management.

Key concepts: Rate of return, Internal rate of return, Time-weighted return, Return on investment, Modified internal rate of return, Economics, Investment performance, Return of capital

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