what is off balance sheet financing obsf 
the term off balance sheet obsf financing refers to an accounting practice that involves recording corporate assets or liabilities in such a way that doesn t make them appear on a company s balance sheet the practice is used to keep debt to equity d e and leverage ratios low especially if the inclusion of a large expenditure would break negative debt covenants off balance sheet financing is a legal practice as long as companies follow accounting rules and regulations it becomes illegal if corporate heads use it to hide assets or liabilities from investors and financial regulators 1understanding off balance sheet financing obsf companies with mountains of debt often do whatever they can to ensure that their leverage ratios do not lead their agreements with lenders otherwise known as covenants to be breached by the same token a healthier looking balance sheet is likely to attract more investors to meet these goals they may need to turn to certain accounting strategies like obsf off balance sheet financing is an accounting practice that allows companies to keep certain assets and liabilities off their balance sheets although they may not be present on the sheet they still belong to the business obsf is commonly used by businesses that are highly leveraged especially when taking on more debt means a higher debt to equity ratio the more debt a company has the higher the risk of default for the lender this means charging the company a higher interest rate 1this practice involves omitting certain capital expenditures or assets from the balance sheet this means shifting ownership to other entities like partners or subsidiaries in which the company secures a minority claim as such examples may include joint ventures jv research and development r d partnerships and operating leases some corporations use special purpose vehicles spvs with their own balance sheets to which they transfer these assets and liabilities 1although it sounds sketchy off balance sheet financing is a legitimate and very legal practice as long as companies abide by established accounting rules and regulations companies in the united states are required to abide by generally accepted accounting principles gaap 3 the strategy becomes illegal when it is used to hide financial irregularities as was the case with enron 4although certain transactions may not appear on a company s balance sheet they often show up in accompanying financial statements as an investor it s important to read between the lines as this information may often be buried in other financial forms special considerationsthere are rules and regulations in place to ensure that corporate accounting is fair and accurate as such regulators frown upon obsf as an accounting method and are making it harder for companies to use it demand to make off balance sheet financing more transparent is growing the aim is to help investors make better and more well informed decisions about where to invest their money despite the push companies may still find ways to pretty up their balance sheets going forward 1the key to identifying red flags in obsf is to read financial statements in full as an investor you should keep an eye out for words like partnerships rental or lease expenses and cast a critical eye over them you may also want to contact company management to clarify if obsf agreements are being used and to determine how much they really affect liabilities off balance sheet financing obsf reporting requirementscompanies must follow securities and exchange commission sec and gaap requirements by disclosing obsf in the notes of their financial statements 5 investors can study these notes and use them to decipher the depth of potential financial issues although this isn t always as straightforward as it seems over the years regulators have been seeking to clamp down further on questionable financial reporting of this kind 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 26 according to the international accounting standards ias board roughly 85 of leases were not reported on balance sheets making it difficult for investors to determine leasing activities and companies ability to repay their debts 7the accounting standards update 2016 02 asc 842 came into effect in 2019 right of use assets and liabilities resulting from leases are now to be recorded on balance sheets 2enhanced disclosures in qualitative and quantitative reporting in footnotes of financial statements are also now required additionally obsf for sale and leaseback transactions are available 2types of off balance sheet financing obsf as noted above there are a number of tools companies have at their disposal when it comes to off balance sheet financing operating leases are some of the most popular ways to overcome these issues here s how this process works rather than buying equipment outright a company rents or leases it and then purchases it at a minimal price when the lease period ends choosing this option enabled a company to record only the rental cost for the equipment booking it as an operating expense on the income statement results in lower liabilities on its balance sheet joint ventures and r d partnerships are also commonly used in this type of accounting practice when a company creates a jv or other type of partnership it does not have to show the partnership s liabilities on its balance sheet even if it has a controlling interest in that entity 1example of off balance sheet financing obsf 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 the spv used the stock for hedging assets on enron s balance sheet 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