Off-Balance Sheet OBS Activities: Types and Examples

If the company chooses an operating lease, the company records only the rental expense for the equipment and does not include the asset on the balance sheet. If the company buys the equipment or building, the company records the asset (the equipment) and the liability (the purchase price). By using the operating lease, the company records only the rental expense, which is significantly less than the entire purchase price and results in a cleaner balance sheet. Disgraced energy giant Enron used a form of off-balance sheet financing known as SPVs to hide mountains of debt and toxic assets from investors and creditors. The company traded its quickly rising stock for cash or notes from the SPV. There are rules and regulations in place to ensure that corporate accounting is fair and accurate.

  1. SPEs are created by corporations for the sole purpose of carrying out specific financial transactions or isolating financial risks.
  2. However, if it is used manipulatively or without disclosure, it can lead to misguided decision making by stakeholders and may even result in legal and reputational damage.
  3. Off-balance sheet financing is a form of financial, non-recourse debt that companies use to raise more capital.
  4. Operating leases have been widely used, although accounting rules have been tightened to lessen the use.

Companies might try to use this type of financing for disingenuous reasons such as hiding losses or debts from their balance sheets. These companies have been caught using off-balance sheet financing to hide their true financial conditions. Notably, off-balance sheet financing affects more than just the balance sheet and income statement. Other reports, such as the statement of cash flows, where cash from operating activities is reported, may also be influenced. Here, off-balance sheet arrangements could lead to cash outflows for lease payments or other obligations not appearing as financing activities; they may instead appear as operating expenses. Operating leases are contracts that allow a company to use an asset for a specific period without owning it.

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For example, accounting for an R&D partnership allows the company to add minimal liability to its balance sheet while conducting the research. This is beneficial because, during the research process, there is no high-value asset to help offset the large liability. This is particularly true in the pharmaceutical industry where R&D for new drugs takes many years to complete. Joint ventures and R&D partnerships are also commonly used in this type of accounting practice.

The company may choose this form if it wants to improve liquidity or manage credit risk. However, it should be noted that securitization can introduce other types of risk, for example, if the underlying assets default. In both cases, a company will eventually own the equipment or building.

Off-Balance Sheet Financing Reporting Requirements

Off-balance sheet financing is also known as “off-balance sheet items”. Other names include “non-recourse financing” and “external financing.” In off-balance sheet financing, a company projects cash flows from future operations to make their financial position look strong. This type of financing has no impact on the company’s financial statements. Off-balance sheet items are not inherently intended to be deceptive or misleading, although they can be misused by bad actors to be deceptive. Certain businesses routinely keep substantial off-balance sheet items.

What Is Accounts Receivable Financing?

They offer several financing options related to accounts receivable including asset sales. The company can connect to multiple accounting software programs including QuickBooks, Xero, and Freshbooks. For asset sales, they pay approximately 90% of a receivables value and will pay the rest minus fees once an invoice has been paid in full. Depending on the terms, a financier may pay up to 90% of the value of outstanding invoices. This type of financing may also be done by linking accounts receivable records with an accounts receivable financier.

In February 2016, the Financial Accounting Standards Board (FASB), changed the rules for lease accounting. It took action after establishing that public companies in the United States with operating leases carried over $1.25 trillion in OBSF for leasing obligations. Off-balance sheet financing is the use of debt or equity instruments to raise funds.

Factoring Receivables Uses Your Invoices as Collateral

Investors will benefit from having a better grasp of OBS if they want to know how much a company has offset on its balance sheet. They will also understand how the set-off rights impact the obligations and rights of the company. Overall, there are a few broad types of accounts receivable financing structures. A company’s commitment to CSR implies an intrinsic awareness of the impact their decisions and operations have not just on shareholders, but on a broader range of stakeholders.

OBS risks include derivative instruments, contingent assets, and contingent liabilities. OBS items are essential to investors since they help them comprehend the company’s financial situation. For instance, if the company can settle its off-balance sheet liabilities. The term remote is used here, consistent with its use in Topic 450, to mean that the likelihood is slight that a loan commitment will be exercised before its expiration.

Most factoring company platforms are compatible with popular small business bookkeeping systems such as Quickbooks. Linking through technology helps to create convenience for a business, allowing them to potentially sell individual invoices as they are booked, receiving immediate capital from a factoring platform. Another example is when businesses move liabilities off their balance sheets via special purpose entities (SPEs). Another example of this is when companies transfer business risks through special-purpose entities (SPEs). They would be responsible for servicing it and repaying any interest or principal amount.

Reasons they’ll be excluded from a balance sheet include a lack of direct ownership or direct obligation. While the practice is legal, companies still must address these OBS items in notes on their balance off balance sheet receivables finance sheets. A business tries to keep certain assets and liabilities off its balance sheet in order to present to the investment community a cleaner balance sheet than would otherwise be the case.

As such, the business of accounts receivable financing is rapidly evolving because of these liquidity and business issues. Accounts receivable (AR) financing is a type of financing arrangement in which a company receives financing capital related to a portion of its accounts receivable. Accounts receivable financing agreements can be structured in multiple ways usually with the basis as either an asset sale or a loan. Another drawback is that the company may have more liabilities than expected.


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