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Understanding Average Accounting Return: A Legal Perspective
Definition & Meaning
The average accounting return (AAR) is a financial metric used to evaluate the profitability of an investment. It is calculated by taking the average earnings generated by a project after accounting for taxes and depreciation, and then dividing that figure by the average book value of the investment over its lifespan. Essentially, AAR measures the return on investment over a specified period, helping investors assess the effectiveness of their financial decisions.
Table of content
Legal Use & context
The average accounting return is often utilized in financial and investment contexts, particularly in corporate finance and accounting. It is relevant in assessing the viability of business projects and investments, which may be subject to legal scrutiny in areas such as corporate governance and compliance. Users can manage their investment evaluations with tools like US Legal Forms, which provide templates for financial analysis and investment agreements.
Key legal elements
Real-world examples
Here are a couple of examples of abatement:
Example 1: A company invests $100,000 in a project that generates $20,000 in earnings annually for five years. The average book value of the investment might decrease due to depreciation. If the average earnings after taxes and depreciation are $15,000, the AAR would be calculated as follows:
AAR = Average Earnings / Average Book Value = $15,000 / $100,000 = 0.15 or 15%.
(Hypothetical example)
Comparison with related terms
Term
Definition
Key Differences
Return on Investment (ROI)
A measure of the profitability of an investment.
ROI considers total gains relative to total costs, while AAR focuses on average earnings relative to book value.
Internal Rate of Return (IRR)
The discount rate that makes the net present value of an investment zero.
IRR is a time-sensitive measure, whereas AAR is a straightforward average over the investment's lifespan.
Common misunderstandings
What to do if this term applies to you
If you are evaluating an investment and need to calculate the average accounting return, gather your project's financial data, including earnings, taxes, and depreciation. You can use financial templates available through US Legal Forms to assist in this process. If the calculations seem complex or if you're making significant financial decisions, consider consulting a financial advisor or legal professional for tailored guidance.
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