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ACCA Applied Knowledge · Management Accounting · Asset budgeting and investment appraisal

Which of the following is a recognised limitation of the accounting rate of return as an investment appraisal method?

A key limitation of ARR is that it ignores the timing of profits and therefore the time value of money. Profits earned early are treated the same as those earned late because nothing is discounted. ARR is also based on accounting profits, not cash flows.

  1. AIt ignores depreciation charges
  2. BIt ignores the timing of profits and so the time value of moneyCorrect
  3. CIt is based on cash flows, which can be manipulated
  4. DIt cannot be compared with a target percentage return

Explanation

ARR uses average accounting profit, so profits arising early and late are treated alike and no discounting is applied. It does include depreciation and is based on profits, not cash flows. It is expressed as a percentage and is compared with a target return.

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