Big bath accounting is when a company makes profits appear less than they are in a particular year to inflate earnings for the following year. It can be used to mislead investors or to attribute financial struggles to a previous CEO. It can be difficult to determine when it crosses the line into fraud.
Big bath is an accounting term that refers to a company’s practice of making profits appear less than they actually are in a particular year. By doing this in a year in which the company missed earnings expectations anyway, the company can inflate earnings for the following year. To do this, the company picks up on expenses, understates profits, and makes numerous write-offs of revenue. Although large bathroom accounting can be legitimately accomplished, it is often used as an attempt to mislead the public and investors about a company’s true financial situation.
It’s somewhat of a contradiction to assume that a company would ever want to present itself in anything other than the best financial health for those outside the company. However, there are instances where a business does exactly that, and that’s when big bathroom bookkeeping comes into play. By deferring revenue from one year to the next, it allows the company to appear to be recovering from a bad period or regaining strength in the face of a downtrend.
There are several reasons why this type of accounting practice might take place. One of them could be the fact that the company has no chance of reaching its revenue targets. In such a case, it might be to the company’s advantage to take a big dip that year, thereby increasing its chances of exceeding expectations in the coming year. This can be particularly beneficial to company leaders who will receive large bonuses for exceeding those expectations.
In the event of a regime change at a company, the big bookkeeping in the bathroom can come into play. The new CEO of a company might want to attribute the company’s current struggles to the old boss. Accumulating the losses in the year the former CEO was in power would make it seem as if the deceased leadership was to blame for the financial struggles. It would also improve the financial outlook for the first year the new CEO was in power.
Determining where large bathroom accounting crosses the line from clever to fraudulent is a difficult task. Large one-time expenses being added to the books could be a sign that the company is overstating its losses for the year in question. While those charges might be legitimate, they would be even more suspicious if they appeared on a company’s books every two years, suggesting that the company was increasing profits in the intervening years. For that reason, it’s important to study a company’s books over a period of several years to get a better idea of whether the accounting is up to par.
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