What is big bath’
Big bath is an Accounting term defined by the strategy steering group manipulation of the report on profits and losses of the company, poor results look even worse to make future results better. It is often implemented in a bad year for the company to increase revenues in the next year in an artificial form.
Breaking down the ‘big bath’
Big bath is so named because like starting with a clean sheet. Big bath Accounting maneuver could lead to a large increase in profits, which can lead to an increase in the bonus for managers, giving them an incentive to achieve big bath Accounting maneuver. New CEOs sometimes use the big bath so they can blame poor performance on the company’s previous CEO and take credit for repairs next year.
Because stocks trade on earnings, unfavorable earnings report can lead to a significant depreciation in stock a few cents less profit per share (EPS); large bath does not affect the stock price as much. When the profit was positively affected by a large bath in the future, the stock price may recover and trade higher than it otherwise would be without the manipulation of accounting. Big bath is not necessarily illegal, but may be within the boundaries of the accounting regulations.
An example of a large bath
If the Director General finds the minimum target profit can not be produced in a given year, he has an incentive to move earnings from the present to the future, as the compensation of the CEO is not going to change no matter if he misses the goal a little or a lot. The Director-General may move profits forward in several ways: prepaid expenses, taking write-offs and/or delaying the realization of revenues. By adopting these measures in a large maneuver tub, CEO increases the chances of receiving a large bonus next year. Prepaid expenses and taking write-offs are particularly useful in a large tub situation.
Banks, as a rule, faced with rising arrears and defaults on loans when the economy goes into recession and unemployment growth. These banks often write off loans in advance in anticipation of losses and provisions for possible loan losses. The Bank can effectively create a large bath and a liberal provision for loan losses, as its earnings are not painful difficult economic times. When the economy recovers and loan payments paid on time and in greater numbers, the Bank can reverse the loss in provision for possible losses on loans, which were not implemented and increase revenue in subsequent quarters. Management can benefit from higher compensation, and stock price of the Bank may recover from falling on hard financial times.