Bath Accounting Taking a Bath

Bath Accounting

Taking a bath

The dirty accounting trick of taking a 'bath'

In an accounting context, what is a definition of 'taking a bath?'

The representatives of a company, including its accountants, have a responsibility to make the company look as good as possible to increase its perceived market value and to enhance shareholder value. To do so, accountants must strive, within the guidelines of the law and generally accepted accounting practices, to present a sunny financial picture to the world. However the degree to which certain practices are acceptable remain controversial. For example, "taking a bath" is defined as writing off expenses or "pre-booking" expenses during bad or transitional economic times (Kothari 2004). Write-offs are accelerated and revenues are deferred to a later date when a company 'takes a bath.' Taking a bath means writing off assets to make a company look as if it is performing less well than it actually is performing.

Thus, taking a 'bath' means that when a company is doing particularly poorly, its accountants will often write-off as many expenses and assets as possible. This can occur in a number of scenarios: for example, a new management team may want to make the previous or present year look as bad as possible, so their leadership looks particularly strong by comparison with the previous administration. "Taking a bath" makes future expenses seem significantly reduced and thus future projected earnings also increase in a way that favors a change of regime. "In other words, the company is taking a bath in the worst year so it can wipe its slate clean. This almost always guarantees record-breaking earnings in subsequent years," and thus justifies record-breaking bonuses for the CEO and leadership team (Yuan 2008).

Additionally, poorly-performing companies with deep structural problems and a fundamentally unsound business model may also decide to 'take a bath' during a year that is economically difficult for the entire market, such as during the credit crisis of today. Thus, the company can blame a particularly bad year on forces that are unavoidable and affecting every organization and make subsequent years look better by virtue of comparison.

Question 2: How is this practice explained using agency theory?

It is arguable that accountants are not behaving unethically when they act in such a fashion: after all, by boosting the perception of a company's financial status, they encourage investors to buy more shares and thus boost the value of the company over the short-term. They are acting as agents of the company, and have a duty to improve company performance. Theoretically, 'taking a bath' can even buy a good company time, prevent a financial panic during a particularly bad year, and give the company time to reconfigure itself. But ultimately, boosting the value of a company is 'good' only if the accountant's primary responsibility is to shareholders and other individuals with short-term interests in the company.

In contrast, from a normative ethical standpoint, this practice of 'taking a big bath' creates an inaccurate portrait of the company's real economic status, and can hurt individual investors and employees over the long-term. The company's poor performance will eventually be revealed, innocent people will invest in a company that is structurally unsound, and employees will have to be let go when the full extent of the company's failure is revealed to the world.

Question 3: How can the agency costs of this practice be minimized?