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Able Ltd Accounting Rate of Return Question.

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA MA – FIA FMA › Able Ltd Accounting Rate of Return Question.

  • This topic has 3 replies, 2 voices, and was last updated 10 months ago by John Moffat.
Viewing 4 posts - 1 through 4 (of 4 total)
  • Author
    Posts
  • April 6, 2022 at 1:42 pm #652787
    Convery
    Member
    • Topics: 1
    • Replies: 1
    • ☆

    Hi,
    In the mock exam there is the following question,

    Calculate the Accounting Rate of Return for the project with;

    Initial Cost – $300,000
    Expected Life – 5 years
    Estimated Scrap Value – $20,000
    Additional revenue from the project per year – $120,000
    Incremental costs of the project – $30,000 per year
    Cost of Capital – 10%

    The answer is saying 21% but I don’t understand how they’re getting to that figure.

    Thanks!

    April 6, 2022 at 3:20 pm #652794
    John Moffat
    Keymaster
    • Topics: 56
    • Replies: 51583
    • ☆☆☆☆☆

    The total profit before depreciation over the 5 years is 5 x (120,000 – 30,000) = 450,000.
    The total depreciation over the 5 years is 300,000 – 20,000 = 280,000.
    Therefore the total accounting profit is 450,000 – 280,000 = 170,000, and the average annual profit is 170,000/5 = 34,000 per year.

    The average amount invested is (300,000 + 20,000) / 2 = 160,000.

    Therefore the ARR is 34,000 / 160,000 = 21.25%

    April 6, 2022 at 3:34 pm #652797
    Convery
    Member
    • Topics: 1
    • Replies: 1
    • ☆

    Thank you for this,
    but why is the average amount invested $160,000? I don’t understand why $20,000 is considered an investment?

    April 7, 2022 at 10:30 am #652823
    John Moffat
    Keymaster
    • Topics: 56
    • Replies: 51583
    • ☆☆☆☆☆

    At the start of the investment there is $300,000 invested and this is what will appear on the Statement of Financial Position (Balance Sheet). This will be depreciated over the life of the project and so the value on the Statement will fall each year. At the end of the investment it will appear as having a value of only $20,000. So the average over the 5 year period will be half way between the two at $160,000.

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