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 (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 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 entity? ›
Common Off Balance Sheet Item Examples
These are leases where the asset doesn't meet the definition of being owned by the company, but are leased for a specific period of time. Examples: Lawsuits, warranty obligations, or environmental cleanup obligations.
What are the major categories of off balance sheet activities? ›
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.
Which of the following is an off balance sheet? ›
Operating lease: An operating lease doesn't show up as an asset or a liability on a balance sheet. Instead, operating lease expenses are treated as operating expenses. Therefore, they are considered an off-balance sheet source of finance.
What are examples of off-balance-sheet commitments? ›
Off-balance sheet activities include items such as loan commitments, letters of credit, and revolving underwriting facilities. Institutions are required to report off-balance sheet items in conformance with Call Report Instructions.
How do you write-off assets on a balance sheet? ›
Write-offs usually involve a debit to an expense account and a credit to the associated asset account. Expenses are also reported on the income statement, and deducted from revenues. This leads to a lower profit and lower taxable income.
What is an example of off balance? ›
A gust of wind knocked him off balance and he fell face down in the mud. She was trying to behave as if his visit hadn't thrown her off balance. He tried to use his own weight to push his attacker off but he was off balance.
What is an example of an off-balance-sheet arrangement? ›
Examples. Common forms of off-balance-sheet financing include operating leases and partnerships. Operating leases have been widely used, although accounting rules have been tightened to lessen the use.
What are the example of balance sheet assets? ›
The balance sheet includes information about a company's assets and liabilities. Depending on the company, this might include short-term assets, such as cash and accounts receivable, or long-term assets such as property, plant, and equipment (PP&E).
Off-balance sheet items are typically those not owned by or are a direct obligation of the company. For example, when loans are securitized and sold off as investments, the secured debt is often kept off the bank's books.
What do off-balance-sheet activities consist of issuing? ›
Question: Off-balance-sheet activities consist of issuing financial instruments such as various types of guarantees and engaging in derivative trading to generate additional revenue.
What accounts don't appear on a 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 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.
What is the difference between on balance sheet and off-balance-sheet assets? ›
(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 some forms of off-balance-sheet financing? ›
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.
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.
What are on balance sheet assets? ›
The balance sheet includes information about a company's assets and liabilities. Depending on the company, this might include short-term assets, such as cash and accounts receivable, or long-term assets such as property, plant, and equipment (PP&E).
What are off ledger assets? ›
Definition: Off-ledger items are not commonly defined in traditional accounting but generally refer to funds or transactions that are not recorded in the primary ledgers of an entity. These might be used internally or externally but are not part of the formal accounting records.
How do I remove assets from my balance sheet? ›
How to record disposal of assets
- Calculate the asset's depreciation amount. The first step is to ensure you have the accurate value of the asset recorded at the time of its disposal. ...
- Record the sale amount of the asset. ...
- Credit the asset. ...
- Remove all instances of the asset from other books. ...
- Confirm the accuracy of your work.
