Big bath

The strategy of manipulating a company's income statement to make poor results look even worse. The big bath is often implemented in a bad year to enhance artificially next year's earnings. The big rise in earnings might result in a larger bonus for executives. New CEOs sometimes use the big bath so they can blame the company's poor performance on the previous CEO and take credit for the next year's improvements.

Investopedia Says:
For example, if a CEO concludes that the minimum earnings targets can't be made in a given year, he/she will have an incentive to move earnings from the present to the future since the CEO's compensation doesn't change regardless if he/she misses the targets by a little or a lot. By shifting profits forward - by prepaying expenses, taking write-offs and/or delaying the realization of revenues - the CEO increases the chances of getting a large bonus the following year.

Related Links:
To spot the signs of earnings manipulation, you need to know the different ways companies can inflate their figures. Cooking The Books 101
Learn what it means to do your homework on a company's performance and reporting practices before investing. Advanced Financial Statement Analysis
Use these key attributes to uncover top-level investments. Find Investment Quality In The Income Statement
Search for the "bloody" fingerprints in accounting crimes. Common Clues Of Financial Statement Manipulation
These income statement red flags may not spell a company's downfall. Learn why here. The One-Time Expense Warning

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Big Bath accounting is the process where publicly traded corporations write-off or write-down certain assets from their balance sheets in a single year. The write-off removes or reduces the asset from the financial books and results in lower net income for that year. The objective is to ‘take one big bath’ in a single year so future years will show increased net income. This technique is often employed in a year when sales are down from other external factors and the company would report a loss in any event. For example, inventory valued on the books at $100 per item is written down to $50 per item resulting in a net loss of $50 per item in the current year. Note there is no cash impact to this write-down. When that same inventory is sold in later years for $75 per item, the company reports an income of $25 per item in the future period. This process takes an inventory loss and turns it into a ‘profit’. Corporations will often wait until a bad year to employ this ‘big bath’ technique to ‘clean up’ the balance sheet. Although the process is discouraged by auditors, it is still used. In recent times, General Motors and other US Corporations have taken huge write downs on balance sheet assets resulting in massive losses. The same result can be achieved by recording in one year the future cash costs of expected plant closing or employee layoffs. The objective is to take these loses all at once, so future periods can show positive net income.

References

• Investopedia.com

External links

• GM Writeoffs
• Ford Writeoffs
• Motley Fool website

Accountancy
Key concepts
Accountant Bookkeeping Trial balance General ledger Debits and credits Cost of goods sold Double-entry system Standard practices Cash and accrual basis GAAP / IFRS
Financial statements
Balance sheet Income statement Cash flow statement Ownership equity Retained earnings
Auditing
Financial audit GAAS Internal audit Sarbanes-Oxley Act Big Four auditors
Fields of accounting
Cost • Financial • Forensic Fund • Management • Tax
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