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 off-balance-sheet assets? ›
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 is an example of an off-balance-sheet arrangement? ›
Examples of financial guarantees that create off-balance-sheet credit exposure include financial standby letters of credit and other types of guarantees related to the nonpayment of a financial obligation.
What are the 4 categories of assets on a balance sheet? ›
Assets can be broadly categorized into current (or short-term) assets, fixed assets, financial investments, and intangible assets.
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.
Which of the following is an off-balance sheet? ›
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 on balance sheet and off-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 the types of off balance sheet risk? ›
Off-balance sheet credit risk refers to the credit risk related to off-balance sheet loan commitments, standby letters of credit, certain financial guarantees, and other similar instruments (except for derivative instruments).
What are the types of assets? ›
When we speak about assets in accounting, we're generally referring to six different categories: current assets, fixed assets, tangible assets, intangible assets, operating assets, and non-operating assets.
What are some examples of assets? ›
Examples of Assets
- Cash and cash equivalents.
- Accounts receivable (AR)
- Marketable securities.
- Trademarks.
- Patents.
- Product designs.
- Distribution rights.
- Buildings.
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 are the three major categories on the balance sheet? ›
The balance sheet is broken into three categories and provides summations of the company's assets, liabilities, and shareholders' equity on a specific date. Generally, a comprehensive analysis of the balance sheet can offer several quick views.
What are the major categories of assets and liabilities on a balance sheet? ›
The left side of the balance sheet outlines all of a company's assets. On the right side, the balance sheet outlines the company's liabilities and shareholders' equity. The assets and liabilities are separated into two categories: current asset/liabilities and non-current (long-term) assets/liabilities.
What is off balance sheet spending? ›
Off-balance sheet (OBS) financing is a commonly used method for keeping large expenditures off a company's balance sheet. This may be done to comply with covenants in lending agreements regarding a company's debt (what's owed) to equity (what's owned) ratio.
How does one distinguish between an off balance sheet asset and an off balance sheet liability? ›
An item is classified as an off-balance-sheet asset when the occurrence of the contingent event results in the creation of an on-balance-sheet asset. Similarly, an item is an off-balance-sheet liability when the contingent event creates an on-balance-sheet liability.
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.
What is write-off asset in accounting? ›
A write-off reduces the value of an asset to zero and negates any future value. A write-off is typically a one-time event, entered in a company's books immediately when an asset has lost all usefulness or value, but write-downs can be entered incrementally over time.
