Big bath
Encyclopedia
Big Bath in accounting is an earnings management technique whereby a one-time charge is taken against income in order to reduce asset
s, which results in lower expenses in the future. 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.
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
s, which results in lower expenses in the future. The write-off removes or reduces the asset from the financial books and results in lower net income
Net income
Net income is the residual income of a firm after adding total revenue and gains and subtracting all expenses and losses for the reporting period. Net income can be distributed among holders of common stock as a dividend or held by the firm as an addition to retained earnings...
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
Inventory
Inventory means a list compiled for some formal purpose, such as the details of an estate going to probate, or the contents of a house let furnished. This remains the prime meaning in British English...
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.