Management Accounting Assignment Example | Topics and Well Written Essays - 2750 words

Management Accounting - Assignment Example Each of the method has a different approach to evaluating the worth of an investment or project for an organization. Whereas the last three techniques focus on cash flow, the first technique (the accounting rate of return (ARR) also called return on investment (ROI) uses accounting profit during its appraisal calculation, offering a view of the general profitability of the investment project. 1. The accounting rate of return The accounting rate of return also referred to as the return on investment method calculates the estimated general profit or loss concerning an investment project and connects that profit or loss to the amount of capital injected in the project as well as the period for which that investment is required to go. The profit referred to in the appraisal process here is the one that is directly linked to the investment project and, therefore, costs or revenues made elsewhere in the business are not included. There is a minimum rate of return required for any investmen t that a business wants to undertake. This is connected to the business’s cost of capital. ... r the years of life of the investment project and dividing the total life of the investment project in years and the average investment is found by adding the investment in the first year to the remaining value at the end of life of the project and dividing by two. With these two values, we can comfortably calculate the ARR. This calculation gives the uniqueness of product as well as its drawbacks as we can see in the subsequent discussions and comparisons. The main advantages of accounting rate of return are: Accounting rate of return considers the general profitability of the investment project. The method is simple to understand as well as easy to use. The method’s end outcome is expressed in form of a percentage, permitting projects of varying sizes to be compared. The major drawback is: The method is based on the accounting profits and not the cash flows. Calculation of profit as well as capital employed is based on expenditure items, which are treated as revenue (those a ppearing on the profit & loss account) and as capital (appearing on the balance sheet). Even though there are guidelines relating to this area, this practice can be quite subjective. Various accounting policies, for instance, relating to depreciation can generate different figures of profit and capital employed, therefore permitting the profit as well as balance sheet numbers to be manipulated in some way. This is why capital projects are also appraised in terms of cash flows. Accounting rate of return method does not consider the timing of cash flows of the project. For instance, we may have two projects M, and N. Project M may result in an accounting rate of return of 19 percent whereas project N may have ARR of 17 percent. Nevertheless, investment M may be a six year investment whilst