Average accounting returns are a calculation that demonstrates the measure or rate of return on an investment within a specified period of time. There are several factors that go into arriving at an average accounting return, which in turn make the calculation helpful in several different applications.
In order to process an average accounting return on investments, it is important to consider the expenses associated with the investment. For example, a number of financial experts choose to include depreciation of the asset as part of the calculation. The depreciation will impact the average book value that is currently associated with the investment, and form the foundation for the application of other factors to the equation.
After the book value and depreciation have been accounted for, the next factor to apply to calculating the average accounting return is to look at the total earnings that have been generated by the asset during the time period under consideration. Subtract any taxes that may have been incurred on the income generated by the asset. Applying the total of earnings minus taxes will make it possible to get an idea of how much, if any return is actually being realized from the investment strategy.
Once the average accounting return has progressed to the point that the average projected earnings minus the taxes has been calculated, it is necessary to divide figure by the average book value that was determined earlier. Keep in mind that the book value may have been impacted by the rate of depreciation that was applied to the asset.
There are several reasons why calculating the average accounting return can be helpful to the investor. One major advantage of knowing the average accounting return is that understanding the real value of the asset will help the investor know whether to hang on to the asset or cut the losses and use the money from the sale to find a more lucrative investment. However, calculating the average accounting return on one period and making decision is usually not the best approach. Tracking the average accounting return over two to four periods can also shed some light on whether conditions have improved since acquiring the asset. It is not unusual for a slow beginning to build into a respectable amount of return the longer that the ownership of the asset is maintained.
Understanding the average accounting return for the last few months can also come in handy if the owner decides to sell the asset. Providing information about the current rate of return can be utilized as an incentive for prospective buyers who may be comfortable with the current level of performance.