Off Balance Sheet (OBS)
Off balance sheet refers to the assets, debts or financing activities that are not presented on the balance sheet of an entity.
Off balance sheet financing allows an entity to borrow being without affecting calculations of measures of indebtedness such as debt to equity (D/E) and leverage ratios low. Such financing is usually used when the borrowing of additional debt may break a debt covenant. The benefit of off balance sheet items is that they do not adversely affect the liquidity position of an entity.
Off balance sheet items are in contrast to loans, debt and equity, which do appear on the balance sheet. Most commonly known examples of off-balance-sheet items include research and development partnerships, joint ventures, and operating leases.
Among the above examples, operating leases are the most common examples of off-balance-sheet financing. In the case of operating leases, the asset itself is presented on the balance sheet of the lessor, and the lessee reports in its financial statements only the required rental expense paid against usage of the asset. International Financial Reporting Standards (IFRSs) have set numerous rules for the entities to follow in determining whether a lease should be classified as finance lease or operating lease.
Financial obligations of unconsolidated subsidiaries may also be an example of off-balance sheet financing. Such obligations famously were part of the accounting fraud at Enron. This term came into popular use during the Enron bankruptcy.
The scope for off balance sheet financing has reduced over the years because the accounting standards have closed many of the loopholes that allowed off balance sheet financing. The examples of these loopholes included leasing and borrowing through special-purpose vehicles. At present moment off-balance sheet financing does not appear to be much of a problem but creative new ways to borrow off the balance sheet may be found and exploited in the future. Therefore the investors should always be wary of the risk of off balance sheet items.
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