Big bath

A big bath is the concentration of unpleasant accounting decisions in a single reporting period that was already weak without them. Instead of recognising impairments, provisions and write-offs gradually, as they come due, management takes them all at once, while the market is already braced for bad news and one more expense line does not change the overall picture of the year.

What makes the practice possible

The opportunity arises wherever the size of an expense depends on an estimate rather than on the fact of a payment. An impairment test compares an asset's carrying amount with its calculated recoverable amount, which in turn rests on a cash flow forecast and a discount rate, that is, on the company's own assumptions. The more balance sheet items are valued this way, the more room there is for the practice: goodwill from past acquisitions, intangible assets, long-stalled construction projects, slow-moving inventories, doubtful receivables. An asset that has been written off no longer weighs on future periods: the impaired value is no longer amortised, and a provision once created can later be partly released. The effect is therefore twofold: the practice makes one year worse and several following years easier. Impairments are sometimes accompanied by revised estimates and a change in accounting policy, which under the rules is disclosed separately.

How it shows up in the data

The telltale sign is a divergence between profit and cash. Profit sags or turns negative, while operating cash flow stays where it was, because a write-off is not a payment. For Nornickel the comparison reads as follows: net income is no data, operating cash flow is no data. A persistent gap in favour of cash means that part of the year's expenses are estimates, and they should be examined through the notes rather than the bottom line. The same logic underlies the concept of earnings quality.

Where the term stops working

A big bath is neither a violation nor a separate accounting method. Standards require assets to be impaired when their recoverable amount has fallen; the only question is in which period this is recognised and whether items that took longer to come due have been gathered into one year. The term is therefore meaningless when applied to a single write-off with a clear external cause: a lost asset, an exit from a region, a discontinued operation.

The second limitation is what is being observed. The practice is worth discussing at group level, that is, on the basis of consolidated financial statements, where all acquired assets are brought together. The accounts of a separate legal entity may contain no large estimated items at all, and the same year will show nothing.