Big Bath

What is Big Bath?

Big Bath is a kind of manipulative accounting in the books of accounts where the company manipulate the income in a bad year by degrading the income further thereby reporting even more loss than what it actually is so that the upcoming period or year looks better and make future results look attractive.

Explanation

Big Bath

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For eg:
Source: Big Bath (wallstreetmojo.com)

How Does it Work?

Big Bath Examples

Assumptions of Big Bath

Criticism of Big Bath

  • It generally reduces the optimization level of the resources available in the market.
  • Too much adherence to this practice may impact the reputation of the business, also, 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 on 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 of fraudulent activity.

Advantages

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 at one go.
  • Big bath is a technique to clean the balance sheet, and firms typically wait for a loss-making year to do this.

Conclusion

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

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