Question3 General Farming has been enjoying government subsidies and concessional income tax rate under an agricultural industry start up incentive scheme. To be eligible for the subsidies and concessions, General Farming Ltd’s net profit margin (ratio of net profit to revenue) must not exceed 5%. For the first time in 8 years, General Farming Ltd interim profit before audit was $12 million with a total revenue of $190 million. In terms of Positive Accounting Theory, General Farming Ltd might select accounting policies that will: Select one or more alternatives: reverse impairment losses recognised in prior years Change depreciation method from straight line to reducing balance for a new asset. increase impairment losses recognised in current year Change depreciation method from reducing balance to straight line for a new asset. ResetMaximum marks: 2

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BlackTom AI · Accepted Answer

The scenario describes General Farming Ltd aiming to keep its net profit margin (net profit / revenue) at or below 5% to qualify for subsidies and a concessional tax rate under the agricultural start-up incentive scheme. Given interim figures: profit before audit = $12 million, revenue = $190 million, the margin is 12/190 ≈ 6.32%, which is above the 5% threshold. Under Positive Accounting Theory (PAT), managers may select accounting policies to influence reported earnings and financial metrics in order to achieve favorable outcomes like eligibility for incentives. Now evaluate each option in turn:

Option 1: reverse impairment losses recognised in prior years.
- Reversing impairment losses would increase reported profit (since losses are added back), thereby raising the net profit and the margin. This moves away from the objective of staying at or below 5%, making it unlikely to be chosen under PAT for this goal. Therefore, this option is inconsistent with the aim to reduce the margin and is unlikely to be selected.

Option 2: Change depreciation method from straight line to reducing balance for a new asset.
- Switching from straight-line to a more accelerated method (reducing balance) increases depreciation expense in the early years of an asset. This reduces current period net profit, which would lower the reported profit margin toward or below 5%. Since PAT allows managers to select policies to influence reported earnings, this change directly serves the objective of reducing the margin to meet subsidy eligibility. Hence, this option is a plausible choice.

Option 3: increase impairment losses recognised in current year.
- Recognising higher impairment losses in the current year reduces net profit, thus lowering the margin. This is another instrument for achieving the required threshold, aligning with PAT’s notion that managers may adjust earnings through accounting choices to influence incentives. Therefore, this option is also a plausible choice.

Option 4: Change depreciation method from reducing balance to straight line for a new asset.
- Moving from an accelerated method (reducing balance) to straight-line reduces depreciation expense in early years, which would increase current period net profit and raise the margin. This would push the company away from the target of ≤5%, making it a counterproductive choice for achieving subsidy eligibility. Thus, this option is unlikely to be selected for this objective.

In summary, options 2 and 3 are consistent with the objective of reducing reported net profit to meet the 5% margin requirement under PAT, while options 1 and 4 would tend to increase profitability and are inconsistent with that objective.

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