The Role of the Accounting Rate of Return in Financial Statement Analysis

Abstract

In Brief and Lawson there is an error involving one of the assumptions. The error does not, however, lead to basic changes in the analysis or the conclusions. Brief and Lawson state that the relationships they derive are based on Peasnell who shows that r can be expressed as a weighted average of the accounting rates of return plus an error term. When Brief and Lawson simplified the error term by assuming a constant growth of book value, they were actually assuming that At* grows at a constant rate. The change in the assumption may, or may not, affect the estimate of the growth rate of book value, g, and, therefore, the estimate of the error, E. If g is estimated using the terminal points method of estimating growth. However, if growth is estimated using the method of least squares, then the new assumption would affect the estimate of E.

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