Question2 LLM Advance Co. is a new high tech start up in the artificial intelligence (AI) business sector. The shareholders recruited an experienced high tech start up executive as their CEO to drive business growth through competitive innovation and sales. The CEO is entitled to a predefined executive bonus if the net profit (before tax) will be at least $10 million in this financial year compared to the $2 million net losses (before tax) in the prior year. The amount of bonus paid will be a percentage of the net profit (before tax) achieved. At the same time LLM Advance Co. is benefiting from the Australian government a start up R&D tax subsidy. The subsidy will be terminated when the company reaches a net profit before tax of $15 million or above, Two weeks before the 30 June 2023 financial year-end the CEO realises from the CFO forecast that the company net profit (before tax) will be exceptionally good, forecasting to reach $18 million. In terms of Positive Accounting Theory, the CEO would select accounting policies to maximise their bonus and to minimise political costs, would: Select one alternative: Keep and maximise profit before tax at $18 million without any constraints to maximise the CEO bonus. Reduce profit before tax to exactly $10 million. Reduce profit before tax to be just below $10 million. Reduce profit before tax to exactly $15 million. Reduce profit before tax to be just below $15 million. ResetMaximum marks: 2

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BlackTom AI · Accepted Answer

We start by restating the scenario to ensure clarity: LLM Advance Co. is a startup in AI seeking a CEO bonus tied to net profit before tax (PBT), with a government R&D subsidy that will be terminated when PBT reaches 15 million or more. The Positive Accounting Theory lens suggests the CEO will choose accounting policies to maximize personal benefits (the bonus) while minimizing political costs (negative consequences like subsidy termination).

Option 1: Keep and maximise profit before tax at $18 million without any constraints to maximise the CEO bonus.
- Why this is unlikely: Although a higher PBT would increase the percentage-based bonus, reaching $18 million would trigger the subsidy termination (the government subsidy ends once PBT hits $15 million). Under Positive Accounting Theory, the CEO weighs both personal gain and political costs; terminating the subsidy would create political costs or negative signaling, which would undermine long-run value. This option ignores the subsidy constraint and thus is not aligned with minimizing political costs while maximizing the bonus in a restrained setting.

Option 2: Reduce profit before tax to exactly $10 million.
- Why this is unlikely: Dropping PBT to $10 million would still qualify for the bonus since the threshold is at least $10 million, but it does not maximize the personal payoff relative to higher PBT scenarios (e.g., near $15–18 million). It also deliberately foregoes potential higher bonuses that could be earned with higher PBT, and it does not address the subsidy constraint beyond meeting the minimum threshold. In the TA framework, this move sacrifices potential personal gain without a compensating reduction in political costs beyond the minimum, making it suboptimal for maximizing the CEO’s utility.

Option 3: Reduce profit before tax to be just below $10 million.
- Why this is unlikely: If PBT is just below $10 million, the CEO would lose eligibility for the bonus entirely (the condition is PBT at least $10 million). This clearly fails the objective of maximizing the CEO’s personal benefit, and there is no benefit in terms of political costs since the subsidy issue remains as a separate constraint not mitigated by staying under the threshold. It is the opposite of the desired outcome under the specified theory.

Option 4: Reduce profit before tax to exactly $15 million.
- Why this is unlikely: Reaching exactly $15 million would terminate the subsidy (the trigger is “15 million or above” for termination), creating political costs. While this still provides a bonus (since it meets the $10 million threshold), it sacrifices the subsidy and incurs political costs, which the CEO would typically want to avoid when pursuing a strategy to maximize overall utility. The marginal difference from slightly below 15m versus exactly 15m highlights the political-cost concern embedded in the question.

Option 5: Reduce profit before tax to be just below $15 million.
- Why this is the most aligned with the theory: Keeping PBT just under the termination threshold preserves the subsidy while still delivering a PBT well above the $10 million bonus threshold. This configuration allows the CEO to maximize the personal bonus (relative to keeping PBT low) and simultaneously minimize political costs by avoiding subsidy termination. In short, it achieves a balance—high enough PBT to secure a substantial bonus, but not high enough to lose the subsidy, aligning with Positive Accounting Theory's emphasis on personal gain while controlling political costs.

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