On the Use of the Accounting Rate of Return in Empirical Research

Accountants are acutely aware that, despite the proliferation of Accounting Standards, published financial statements contain a good deal of subjective judgment and variety of practice, which make them not strictly comparable between the same company for different years (time series analysis) or between different companies for the same year (cross-sectional analysis). Furthermore, the recent debate on accounting in a period of rapid inflation has served to emphasise that accounting measures of value and income are very different from those of the economist, and a series of academic papers, Harcourt [1965] and Solomon [1966] being seminal works, has demonstrated that there can be important divergences between the Accounting Rate of Return (ARR) ¹ and the Internal Rate of Return (IRR) on investment, the latter being the more relevant return for the appraisal of economic performance. In these circumstances, it is not surprising that many accountants are sceptical of the value of using the ARR, calculated from published accounts, in empirical research, particularly in economics, ² but also in the area of accounting and finance.