Off-balance sheet (OBS) refers to assets or liabilities that do not appear on a company's balance sheet. Although the OBS accounting method can be used in a number of scenarios, this accounting practice is especially useful for sheltering a company's financial statements from the impact of asset ownership and its corresponding liability.
Key Takeaways
- Off-balance sheet (OBS) assets are assets that don’t appear on the balance sheet.
- OBS assets can be used to shelter financial statements from asset ownership and related debt.
- Common OBS assets include accounts receivable, leaseback agreements, and operating leases.
Large asset purchases are often funded with debt financing, but too much debt can make a company less desirable to investors and lenders. Using the off-balance-sheet method for these types of assets can help businesses maintain appealing leverage ratios. Some of the most common OBS assets are operating leases, leaseback agreements, and accounts receivable.
Operating Lease
An OBS operating lease is one in which the lessor retains the leased asset on its balance sheet. The company leasing the asset only accounts for the monthly rental payments and other fees associated with the rental rather than listing the asset and corresponding liability on its own balance sheet.
At the end of the lease term, the lessee generally has the opportunity to purchase the asset at a drastically reduced price.
Leaseback Agreements
Under a leaseback agreement, a company can sell an asset, such as a piece of property, to another entity. They may then lease that same property back from the new owner. Like an operating lease, the company only lists the rental expenses on its balance sheet, while the asset itself is listed on the balance sheet of the owning business.
Accounts Receivable
Accounts receivable (AR) represents a considerable liability for many companies. This asset category is reserved for funds that have not yet been received from customers, so the possibility of default is high.
Instead of listing this risk-laden asset on its own balance sheet, companies can essentially sell this asset to another company, called a factor, which then acquires the risk associated with the asset. The factor pays the company a percentage of the total value of all AR upfront and takes care of the collection. Once customers have paid up, the factor pays the company the balance due minus a fee for services rendered. In this way, a business can collect what is owed while outsourcing the risk of default.
Examples of Off-Balance Sheet Assets
OBS assets allow companies to keep assets and liabilities off the balance sheet. This helps improve their accounting ratios or avoid breaking covenants. Banks can move assets off its balance sheet through securitization. On balance sheet assets for banks are loans.
Some companies create special purpose entities (SPEs) to keep assets off the balance sheet. It’s worth noting that OBS items tend to show up in the footnotes to financial statements. As well, the accounting profession has made efforts to limit OBS assets, such as with the Sarbanes-Oxley Act (SOX).
FAQs
Off-balance-sheet items are contingent assets or liabilities such as unused commitments, letters of credit, and derivatives. These items may expose institutions to credit risk, liquidity risk, or counterparty risk, which is not reflected on the sector's balance sheet reported on table L.
What are examples of off-balance sheet items? ›
There are a few different items that are used in off balance sheet financing, such as:
- Letters of credit.
- Loan commitments.
- Revolving underwriting facilities, i.e., types of funding methods if borrowers are unable to raise funds elsewhere.
Off-balance sheet (OBS) assets are assets that don't appear on the balance sheet. OBS assets can be used to shelter financial statements from asset ownership and related debt. Common OBS assets include accounts receivable, leaseback agreements, and operating leases.
What are the types of off-balance sheet debt? ›
Methods of off-balance-sheet financing include selling receivables under certain conditions, providing guarantees or letters of credit, participating in joint ventures, research and development partnerships and operating leases.
What are the four main categories of off-balance sheet business? ›
Off-balance-sheet business is usually divided into four major categories: A. Direct credit substitutes, trade and performance-related items, commitments and trade guarantees.
What are off and on balance sheet items? ›
(On) Balance sheet items are considered assets or liabilities of a company, and can affect the financial overview of the business. Off-balance sheet items, however, are not considered assets or liabilities as they are owned or claimed by an external source, and do not affect the financial position of the business.
What are off-balance-sheet entities? ›
Off-balance-sheet entities are assets or debts that do not appear on a company's balance sheet. Investors use balance sheets to understand a company's assets and liabilities and to evaluate its financial health.
Why keep assets off-balance-sheet? ›
Off-balance sheet financing is an accounting practice where companies keep certain assets and liabilities from being reported on balance sheets. This practice helps companies keep debt-to-equity and leverage ratios low, resulting in cheaper borrowing and the prevention of covenants from being breached.
How do you write-off assets on a balance sheet? ›
In a balance sheet, write-offs include a credit to the associated asset account and a debit to an expense account. Expenses will also be entered in the income statement after deducting from the revenues already reported.
What are off-balance-sheet assets and off-balance-sheet liabilities? ›
In accounting, "off-balance-sheet" (OBS), or incognito leverage, usually describes an asset, debt, or financing activity not on the company's balance sheet. Total return swaps are an example of an off-balance-sheet item. Some companies may have significant amounts of off-balance-sheet assets and liabilities.
The OBS activities that we discuss in this report are grouped into three broad categories: commitments, guarantees, and market-related transactions. Guarantees are activities in which a bank guarantees the obligations of a customer to a third party and include standby letters of credit.
What is the difference between on balance sheet and off-balance-sheet? ›
The difference between off–balance-sheet financing and on-balance-sheet financing is quite simple: Off–balance-sheet financing means a company leaves an asset or liability off their financial statement (although still giving mention of it in the notes), and on-balance-sheet financing means a company accounts for an ...
What is bad debt write-off balance sheet? ›
When debts are written off, they are removed as assets from the balance sheet because the company does not expect to recover payment. In contrast, when a bad debt is written down, some of the bad debt value remains as an asset because the company expects to recover it.
What are the 3 balance sheets? ›
The income statement, balance sheet, and statement of cash flows are required financial statements. These three statements are informative tools that traders can use to analyze a company's financial strength and provide a quick picture of a company's financial health and underlying value.
What is an example of off balance? ›
Examples of off balance
Unpredictable rainfall in terms of quantity and timing throws farmers off balance and affects yields. So the central concept of the book throws it off balance. The guerrillas held their ground and by the fourth day the drive lost its impetus, the assailants thrown off balance.
What is off-balance-sheet risk example? ›
For example, a company that is being sued for damages would not include the potential legal liability on its balance sheet until a legal judgment against it is likely and the amount of the judgment can be estimated; if the amount at risk is small, it may not appear on the company's accounts until a judgment is rendered ...
What are off-balance-sheet activities risk? ›
Off Balance Sheet Activities are financial commitments or obligations that are not directly recorded on a company's balance sheet. These activities might not be visible in the financial statements, but they can materially affect a company's financial position and risk exposure.
Which of the following items is not listed on the balance sheet? ›
While dividends are often shown on the statement of changes in equity, they are not included on the balance sheet because they are not considered to be assets, liabilities, or equity. Instead, they are a distribution of earnings to shareholders and do not affect the company's financial position or performance.
