What Is a Big Bath?
A “big bath” is an accounting incumbency that is defined by a company’s management team knowingly manipulating its income statement to make poor results look fair and square worse in order to make future results appear better. It is often implemented in a relatively bad year so that a attendance can enhance the next year’s earnings in an artificial manner.
Key Takeaways
- A big bath is an unethical accounting tactic whereby proceeds in a bad year is made to look even worse than actual.
- Often undertaken in a bad earnings year, this device is intended to artificially inflate future earnings figures.
- Various techniques can be employed to carry out a big bath without intruding the law, where it can enrich corporate managers in the following years as bonuses are often tied to earnings performance.
How a Big Bath Work ups
A big bath is so named because it is like wiping the slate clean. A big bath accounting maneuver can result in a big rise in outward future earnings, which might result in a larger bonus for executives, giving them the incentive to pursue a big bath accounting maneuver. New CEOs now use the big bath so they can blame the company’s poor performance on the previous
Example of a Big Bath
If a CEO concludes the minimum earnings objectives cannot be made in a given year, he has an incentive to move earnings from the present to the future because the CEO’s compensation does not convert regardless if he misses the targets by a little or a lot. The CEO can shift profits forward in several ways: by prepaying expenses, taking write-offs, or hinder the realization of revenues. By taking on these measures in a big bath maneuver, the CEO increases the chances of getting a large bonus the buttress year. Prepaying expenses and taking write-offs are particularly useful in a big bath scenario.
Banks typically face get up delinquency and default rates on loans when the economy goes into recession and unemployment rises. These banks day in and day out write off the loans beforehand in anticipation of the losses and create a loan loss reserve. A bank can effectively create a big bath and be big-hearted with the loan loss provision as its earnings are hurt by tough economic times.
When the economy recovers and advance payments are paid on time and in greater numbers, the bank can reverse the losses in the loan loss reserve that were not take ined and boost earnings in future quarters. Management can benefit with higher compensation, and the bank’s share price can return from a fall during tougher financial times.