Economic and accounting rates of return

The rate of return on invested capital is a central concept in financial analysis. The purpose of calculating the rate of return on investment in general is to measure the financial performance, to assess the desirability of a project and to make decisions on the valuation of firms. Financial statement users make regular use of the accounting rate of return (ARR) rather than the economic rate of return (IRR) to assess the performance of corporations and public-sector enterprises, to evaluate capital investment projects, and to price financial claims such as shares. Since ARR measures are based on published accounting statements, there has been a long and sometimes heated debate as to whether such measures have any economic significance. This paper aims to provide a summary of the economic and accounting rates of return discussions in the literature. We analyze the concepts of ARR and IRR and explore possible relationships between them. We extend the previous studies in this line to provide more specific relations of IRR and ARR.