The Accounting Rate of Return as a Framework for Analysis

Research on the accounting rate of return (ARR) began with Harcourt (1965), Solomon (1966) and Vatter (1966) and continued with Kay (1976, 1978), Peasnell (1982), Franks and Hodges (1984), Kay and Edwards (1986), Edwards, Kay and Mayer (1987), Brief and Lawson (1992), Brief (1996) and others. The basic framework was provided by an economic model and the ARR was interpreted in terms of that model. In contrast, this paper focuses on an accounting model that defines the ARR as a constant over a multi-period horizon. Twenty-six properties of the accounting model are discussed. More than half relate to the constant ARR. Property 15 defines two economic models as special cases. The remaining properties concern the relationship between the ARR and IRR, the residual income valuation model and the direct comparison of the accounting and economic models. Some of these properties were previously derived by others and some are discussed for the first time. Taken together, the twenty-six properties can viewed as a framework for analysis. First, many of the relationships that are derived hold for a finite time horizon and mimic steady state conditons. Consequently, the analytical results have more generality than those that assume an infinite time horizon or steady state. Second, the accounting model is structured as a present value model and, therefore, mimics economic models. This makes many of the relationships between the accounting and economic models transparent. Third, this work could be extended to compare two accounting policies or to compare the accounting process