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

Which of the following statements about the accounting rate of return method of investment appraisal is correct?

ARR uses accounting profit after depreciation, so the depreciation policy chosen changes the result. It does not discount cash flows, does not give an absolute dollar increase in wealth like NPV, and is expressed as a percentage rather than as a time period.

  1. AIt is based on discounted cash flows, so it reflects the time value of money
  2. BIt is affected by the depreciation policy adopted because it uses accounting profitCorrect
  3. CIt measures the absolute increase in shareholder wealth in dollar terms
  4. DIt is expressed as a payback period in years

Explanation

ARR is calculated from accounting profit after depreciation, so different depreciation methods change the result. It does not discount cash flows, it gives a percentage rather than a dollar wealth increase, and it is not a period in years.

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