Question

South Korea- based consumer electronics giant Samsung was accused by analysts of aggressively writing off some assets in the first quarter of 2019 to minimize its profits. Korea News Plus reported that the company engaged in "big bath" accounting (taking a large loss in an already-down time period). The company denied overstating the losses. Interestingly, in 2008 analysts accused the company of the same practice. In that year, the Korea Times reported that Samsung posted an operating loss much larger than was expected.

INSTRUCTIONS:
What future advantage might a company seek by booking even larger losses in an already weak quarter? How might readers of financial statements react when a company has been accused of "big bath" accounting more than once? How would a large asset write-off immediately affect the income statement, balance sheet and statement of cash flows?

Answer 1

1.
The future advantage  a company might seek by booking even larger losses in an already weak quarter is to reduce its future tax liability . It reduces its future tax liability because losses can be used as a deduction from ordinary income in the following years. This reduces the corporation's net taxable income. Moreover, the larger the loss, the larger the tax deduction. In strong quarters, companies are more likely to show higher profits, which increases the amount of corporate income tax and decreases the net tax deduction available for future years.

2.Readers of financial statements might react when a company has been accused of "big bath" accounting more than once by becoming more skeptical of the reported financial results. Before they fully trust reported profits, they ask what other accounting practices might affect the reported figures?
Before they fully trust reported profits, readers of financial statements ask whether a company has been accused of "big bath" accounting more than once by other analysts or by the Securities and Exchange Commission itself. Analysts sometimes accuse companies of reporting overly-optimistic or otherwise false net income in future quarters to artificially inflate their stock prices. In addition, many analysts claim that companies alter bookings to inflate their quarterly results and reduce future tax liabilities .

3.A large asset write-off would immediately affect the income statement, balance sheet and statement of cash flows by reducing the company's net income by the amount of the write-off. Overall, a large write-off would reduce the company's net income (bad) and cash flow (good). Moreover, a large asset write-off would not immediately affect the income statement, balance sheet and statement of cash flows if it was used for purposes other than increasing future tax deductions. For example, if a company recorded a large loss as an operating expense in past quarters to generate future tax deductions for depreciation for new equipment, that loss might not be used as a current operating expense.

 For example, if a company recorded a large loss as an operating expense in past quarters to generate future tax deductions for depreciation for new equipment, that loss might not be used as a current operating expense.