What is a Big Bath?

A big bath is a very large one-time write-off taken by a company. This write-off is structured as a reserve, so that charges taken in the future can be offset against the reserve. The intent behind the use of a big bath is to take a large hit to earnings in the current period, so that future periods will look more profitable. This approach can be valid, but has a reputation for being used too much to manipulate the amount of reported earnings. An investor should be particularly suspicious when a firm has a history of repeatedly taking a big bath, followed by unusually strong earnings in subsequent periods. Several reasons for taking a big bath write-off are as follows:

Already reporting poor results. A big bath is most commonly taken when an organization is already reporting poor results in a year, on the theory that an even larger loss will not bother investors excessively. The general concept is to hit investors with all possible losses all at once.
Assist with future bonuses. A big bath may also be used when management wants to earn bonuses in future periods. They take a big bath in a losing year, when they will not be earning bonuses anyways, thereby improving the odds that they can earn bonuses in later years, when profits are more likely. This approach tends to result in gyrating earnings from year to year, as big baths are continually taken every few years in order to earn bonuses in the other years.
Write off inflated values. A big bath may also be taken when a management team wants to write off assets that have over-inflated or fraudulent values. For example, managers could have created false sales, which require that corresponding accounts receivable also be stated on the books. A big bath can be employed to write off these receivables.

The big bath approach is more commonly taken by public companies, which are more focused on presenting the most favorable earnings information to investors.

Related AccountingTools Courses

Fraud Examination

Fraud Schemes

The Interpretation of Financial Statements

Example of a Big Bath

A tech company is going through a tough year with declining sales and profitability. The CEO decides to take a "big bath" in its accounting by taking the following steps:

Write off selected assets. The company writes off $200 million worth of outdated or unused equipment and inventory that might otherwise have been written off gradually over several years.
Restructuring charges. The company records a $100 million restructuring charge for closing several facilities, laying off employees, and consolidating operations.
Goodwill impairment. The company writes down $150 million of goodwill from a prior acquisition, claiming that the acquired company is now worth less than its original purchase price.

These large expenses significantly reduce the company's net income or result in a substantial loss for the current year. In subsequent years, when the company doesn't have to account for these one-time losses, it can report improved financial results, giving the impression of a successful turnaround. This strategy is controversial and can mislead stakeholders. While not illegal if done within accounting standards, it can raise ethical concerns and attract regulatory scrutiny.