Big Bath

Big Bath is a kind of manipulative accounting in the books of accounts. The company manipulates the income in a bad year by degrading the income further, thereby reporting even more loss than what it is so that the upcoming period or year looks better and makes it possible for future results to look attractive.

• "Big Bath" is a type of deceptive accounting practice in which a company manipulates its financial records to make the following quarter or year appear better by intentionally degrading the income and reporting even greater losses than what occurred. 
• It is common for accountants to manipulate the books by understating income or overstating losses in the current year to make the year appear worse, boost future earnings, and present a better picture subsequently.
• Using accounting tricks to intentionally make the current year appear worse than it is to inflate future earning potential is considered unethical.

• It is a typical scenario of manipulating books of accounts where accountants understate the current year's income or loss to make the year look even worse to enhance the future earnings and show a better picture. It is an unethical accounting technique to make the current year look worse than it is. This strategy is applied to blow up future income potential artificially.
• There can be several techniques to apply a big bath strategy without coming into legal trouble. This process can enrich the managerial performance as a bonus is often looked at in tandem with the company performance. When they show a picture where the company is in bad shape, the bonus level gets impacted, which in some form or the other is the right amount of savings for the company. This name means to wipe a slate clean. On the other hand, this strategy may lead to substantial future earnings for the company, leading to high bonus amounts for the executives.

• The main intention of this strategy is to take a more significant blow to the earnings in the current period. In the future, the earnings can be made to dress more attractive or shown in the books as accounts to be more pleasing and of higher magnitude.
• This approach is legal and has the reputation of the business involved in the form of the magnitude of the company manipulating the books of accounts and to what extent or value of the income statement is getting financially dressed. An investor should stay aware of a company or be a little suspicious about companies who have repeatedly applied the big bath strategy and thus shown better earnings reports in the consecutive period.
• This strategy is usually taken when the firm is aware of the financial condition that it is going through a loss-making phase and, thus, based on the belief that a more substantial loss in the future should not affect the investors to a great extent. A big bath at times is also implemented when the firm wants to write off their assets that are over-inflated or have suspicious values that are not correct.
• It may also be applied when the business wants to distribute or earn an excessive bonus in the upcoming period. They will implement this strategy in the initial year and provide no bonus stating the earnings are low. Next year, they will report excessive income and distribute bonuses accordingly.

• A business provides no bonus to its employees, stating they are a loss-making unit. The next year, they will report higher earnings and provide the bonus accordingly.
• The business may create false sales records, which demand that there should be a matching account receivable that should also be tagged to it. A big bath may be applied to write off these expected receivables.
• Top-level executives in a firm, if they feel that the target cannot be achieved in a current year, top-level executives can shift the little profit they expect to earn in several ways, like making write-offs or prepaying expenses, writing receivables, etc. Thus, they show an inflated profit in the next year, stating that they have done exceptionally well and bag the bonus to a greater magnitude.

• A big bath is generally brought into practice when there is a loss reported in a particular event or a fall in the sales level due to some uncontrollable factors.
• It is generally done for a balance sheet cleansing, and firms typically wait for a loss-making year to apply this strategy.
• This strategy is applied to settle all losses in one shot so that the future looks attractive.
• This strategy, at times, is applied to pull the interest of creditors or investors by portraying an attractive future.
• This strategy is generally seen to be in practice either before the management is changed or immediately after the management has been changed.

• It generally reduces the optimization level of the resources available in the market.
• Too much adherence to this practice may impact the business's reputation, as investors tend to become more suspicious of the business unit.
• The business using earning manipulation may tend to show an enhanced profit every following year, and if this doesn’t show the expected result, investors may back out from the firm.
• When the profit is manipulated to a higher degree, it may end up the business losing its reliability and relevance due to too much financial dressing of its data.
• It is tough to apply this technique because companies have to work under the guidelines of GAAP, and any significant change which is not under GAAP guidelines may lead the firm to practice fraudulent activity.

Some of the advantages are as follows:

• A big bath is a source to earn more bonuses and profit in the successive year.
• They may be used to attract investors and creditors based on the story of an attractive profit-earning capacity shortly.
• It is a proactive strategy to settle for all losses in one go.
• Big Bath is a technique to clean the balance sheet, and firms typically wait for a loss-making year to do this.

A big bath though a manipulative accounting technique is legal if applied to a limited magnitude. Though it attracts a lot of criticism, the management with a fixed expectation in mind may use it. On the other hand, the different expectations may attract the practice of this strategy, and the business has to keep in mind to manipulate their numbers only to a certain extent.

This has been a guide to what Big Bath is and its definition. Here we discuss how Big Bath works with examples, assumptions, and criticisms. You may learn more about financing from the following articles –

• Window Dressing
• Quarterly Report
• Quality of Earnings
• Pro-Forma Earnings