Off-balance-sheet
Encyclopedia
Off-balance sheet usually means an asset
or debt
or financing activity not on the company's balance sheet
.
Some companies may have significant amounts of off-balance sheet assets and liabilities. For example, financial institution
s often offer asset management or brokerage services to their clients. The assets in question (often securities
) usually belong to the individual clients directly or in trust, while the company may provide management, depository
or other services to the client. The company itself has no direct claim to the assets, and usually has some basic fiduciary duties with respect to the client. Financial institutions may report off-balance sheet items in their accounting statements formally, and may also refer to "assets under management
," a figure that may include on and off-balance sheet items.
Under current accounting rules both in the United States (US GAAP) and internationally (IFRS
), operating leases are off-balance-sheet financing. Financial obligations of unconsolidated subsidiaries (because they are not wholly owned by the parent) may also be off-balance sheet. Such obligations were part of the accounting fraud at Enron
.
The formal accounting distinction between on and off-balance sheet items can be quite detailed and will depend to some degree on management judgments, but in general terms, an item should appear on the company's balance sheet if it is an asset or liability that the company owns or is legally responsible for; uncertain assets or liabilities must also meet tests of being probable, measurable and meaningful. 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.
enables banks to remove loans from balance sheets and transfer the credit risk associated with those loans. Therefore, two types of items are of interest: on-balance sheet and off-balance sheet. The former is represented by traditional loans, since banks indicate loans on the asset side of their balance sheets. However, securitized loans are represented off the balance sheet, because securitization involves selling the loans to a third party (the loan originator and the borrower being the first two parties). Banks disclose details of securitized assets only in notes to their financial statements.
As an example UBS has CHF 60,316 Million Undrawn irrevocable credit facilities off its balance sheet in 2008 (USD 60.37 Billion.)
Citibank has USD $960 Billion in off-balance sheet assets in 2010, which amounts to 6% of the GDP of the United States.
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
or debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
or financing activity not on the company's balance sheet
Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...
.
Some companies may have significant amounts of off-balance sheet assets and liabilities. For example, financial institution
Financial institution
In financial economics, a financial institution is an institution that provides financial services for its clients or members. Probably the most important financial service provided by financial institutions is acting as financial intermediaries...
s often offer asset management or brokerage services to their clients. The assets in question (often securities
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...
) usually belong to the individual clients directly or in trust, while the company may provide management, depository
Depository institution
A depository institution is a financial institution in the United States that is legally allowed to accept monetary deposits from consumers...
or other services to the client. The company itself has no direct claim to the assets, and usually has some basic fiduciary duties with respect to the client. Financial institutions may report off-balance sheet items in their accounting statements formally, and may also refer to "assets under management
Assets under management
Assets under management is a financial term used denote the market value of funds being managed by a financial instutition on behalf of its clients, investors, depositors, etc. This metric is a sign of size and success against competition...
," a figure that may include on and off-balance sheet items.
Under current accounting rules both in the United States (US GAAP) and internationally (IFRS
International Financial Reporting Standards
International Financial Reporting Standards are principles-based standards, interpretations and the framework adopted by the International Accounting Standards Board ....
), operating leases are off-balance-sheet financing. Financial obligations of unconsolidated subsidiaries (because they are not wholly owned by the parent) may also be off-balance sheet. Such obligations were part of the accounting fraud at Enron
Enron
Enron Corporation was an American energy, commodities, and services company based in Houston, Texas. Before its bankruptcy on December 2, 2001, Enron employed approximately 22,000 staff and was one of the world's leading electricity, natural gas, communications, and pulp and paper companies, with...
.
The formal accounting distinction between on and off-balance sheet items can be quite detailed and will depend to some degree on management judgments, but in general terms, an item should appear on the company's balance sheet if it is an asset or liability that the company owns or is legally responsible for; uncertain assets or liabilities must also meet tests of being probable, measurable and meaningful. 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.
Confusion between on- and off-balance sheet
Traditionally, banks lend to borrowers under tight lending standards, keep loans on their balance sheets and retain credit risk -- the risk that borrowers will default (be unable to repay interest and principal as specified in the loan contract). In contrast, securitizationSecuritization
Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling said consolidated debt as bonds, pass-through securities, or Collateralized mortgage obligation , to...
enables banks to remove loans from balance sheets and transfer the credit risk associated with those loans. Therefore, two types of items are of interest: on-balance sheet and off-balance sheet. The former is represented by traditional loans, since banks indicate loans on the asset side of their balance sheets. However, securitized loans are represented off the balance sheet, because securitization involves selling the loans to a third party (the loan originator and the borrower being the first two parties). Banks disclose details of securitized assets only in notes to their financial statements.
The Banking Example
A bank may have substantial sums in off-balance sheet accounts, and the distinction between these accounts may not seem obvious. For example, when a bank has a customer who deposits $1 million in a regular bank deposit account, the bank has a $1 million liability. If the customer chooses to transfer the deposit to a money market mutual fund account sponsored by the same bank, the $1 million would not be a liability of the bank, but an amount held in trust for the client (formally as shares or units in a form of collective fund). If the funds are used to purchase stock, the stock is similarly not owned by the bank, and do not appear as an asset or liability of the bank. If the client subsequently sells the stock and deposits the proceeds in a regular bank account, these would now again appear as a liability of the bank.As an example UBS has CHF 60,316 Million Undrawn irrevocable credit facilities off its balance sheet in 2008 (USD 60.37 Billion.)
Citibank has USD $960 Billion in off-balance sheet assets in 2010, which amounts to 6% of the GDP of the United States.