This is the year of “lost by a hundred, lost by a thousand”. It is a very bad year for many businesses. It is a year in which bad results are immediately justified. It is a year in which managers do not even have to give many explanations. Everyone already knows it's bad. The market already knows it will be bad. So bad, that showing losses of 100 or 1000 matters little, as it is a lost year anyway.
In these years, what could be the temptation of managers? If the year is lost and it is, if we are going to have such bad results already, then why not show even worse?
And why this motivation of managers? Because, the worse the results this year, the greater the probability that the company will be able to show better results for the year, indicating recovery and growth to the market. This is done at the expense of “cleaning” the assets and / or pressure on the liabilities.
In Anglo-Saxon terminology the expression used is “big bath accounting”. In Portuguese I have adopted “lost by a hundred, lost by a thousand”.
The cleaning in a given year in the asset, carried out mainly at the expense of impairments, translates into superior results in future years. Constituting impairments on tangible fixed assets, intangible assets or financial investments implies, in that year, recognizing expenses. If they are excessive, they revert to the year, giving rise to the recognition of income and, simultaneously, an illusion of recovery.
If they are excessive impairments no goodwill, whose reversion is prohibited, in the following year there are lower amortizations (when the company uses SNC) or, at least, the probability of recognizing additional impairment is lower (if the company uses international accounting standards). Excessive amortization, less amortization for the year. Excessive impairments on credits, or even bad debts, for the year the credits are received and income is realized. Excessive write-downs of fixed assets for the year are less amortization.
In fact, any decrease or derecognition of assets in a given year, originates either directly in the future (via cancellation or reversal) or, at least, lower expenses. Either way, with greater or lesser effect, translates into greater results than what would appear in the absence of this practice.
The increase in liabilities is also susceptible to “big bath accounting”, using mainly the provisions item. Excessive provisions in a year give rise to expenses in that year, it is true, but yields in the year in which they are reversed. And here we see that 2020 is a year to be very attentive to the accounts. It is a year in which the reading of the balance sheet has to be closely monitored by the analysis of the annex and the careful interpretation of trends and ratios. It is a year in which there is no excuse (never should be excused ...) a careful reading of the legal certification of the accounts.
A full understanding of the 2020 accounts, and especially the estimates that are intrinsic to it, allows us to assess the share of the 2021 results that will effectively translate recovery and growth.