Off Balance Sheet (OBS)

What is an ‘Off Balance Sheet – OBS’

Off balance sheet (OBS) items refer to assets or liabilities that do not appear on a company’s balance sheet but that are nonetheless effectively assets or liabilities of the company. Assets or liabilities designated off balance sheet are typically ones that a company is not the recognized legal owner of, or in the case of a liability, does not have direct legal responsibility for. As an example, although loans issued by a bank are ordinarily kept on the bank’s balance sheet, when some loans are securitized and sold off as investments, that securitized debt will be kept off the bank’s books, and an operating lease is one of the most common off-balance items.

Explaining ‘Off Balance Sheet – OBS’

Off balance sheet items are an important concern for investors in regard to assessing a company’s financial health. Off balance sheet items are often difficult to identify and track within a company’s financial statements because they usually only appear in the accompanying notes. Another concern is that some off balance sheet items have the potential to become hidden liabilities. For example, collateralized debt obligations (CDO), where assets that make up the CDO are debt obligations, can become toxic assets — ones that can suddenly become almost completely illiquid — before investors are aware of the company’s financial exposure, because the CDOs are off balance sheet items.

How Off Balance Sheet Financing Works

An operating lease, used in off balance sheet financing, is a good example of a common off balance sheet item. Assume that a company has an established line of credit with a bank and that a financial covenant condition for the bank extending credit is that the company must maintain its debt-to-assets ratio below a specified level. Taking on additional debt to finance the purchase of new computer hardware would violate the line of credit covenant by raising the debt-to-assets ratio above the maximum specified level.

Off Balance Sheet (obs) FAQ

What is an off balance sheet transaction?

Off-balance sheet transactions are assets or liabilities that are deferred and absent from the balance sheet. They allow a party to have the benefit of an asset while transferring its liabilities to another party.

What are the off balance sheet items?

Off-balance sheet (OBS) items is used to describe assets or liabilities that are not on a company’s balance sheet even though they are still assets and liabilities of the company. They are not owned by the company or a direct obligation.

Is off balance sheet financing legal?

Off-balance sheet financing is legal and it’s recognized by Generally Accepted Accounting Principles, or GAAP, as long as GAAP classification methods are followed. This form of financing is almost always debt financing, so the debt is not recorded as a liability on the balance sheet.

What is the off balance sheet risk?

Off-balance sheet risks represent differences in an organization’s reported and actual assets and liabilities. OBSRs are mostly seen in undisclosed liabilities, such as operating leases.

Where are off balance sheet items reported?

Off-balance sheet (OBS) items is used to describe assets or liabilities that are not on a company’s balance sheet even though they are still assets and liabilities of the company.

What are the disadvantages of balance sheet?

Disadvantages can be because of discrepancies in values, making it hard to know the real value of assets within a balance sheet, which in turn, can give unreliable ratios. A bigger disadvantage is its transparency.

Further Reading

  • An analysis of the relevance of off-balance sheet items in explaining productivity change in European banking – [PDF]
  • Scale economies and cost complementarities in commercial banks: On-and off-balance-sheet activities – [PDF]
  • The effect of bank capital requirements on bank off-balance sheet financial innovations – [PDF]
  • Off-balance sheet activities and cost inefficiency in Taiwan's banks – [PDF]
  • The impact of off-balance-sheet activities on banks returns: An application of the ARCH-M to Canadian data – [PDF]
  • Commercial bank net interest margins, default risk, interest-rate risk, and off-balance sheet banking – [PDF]
  • Capital structure and the changing role of off-balance-sheet lease financing – [PDF]
  • Off-balance-sheet credit risk of the top 20 Japanese banks – [PDF]
  • Determinants of off-balance sheet activities: An empirical analysis of public sector banks – [PDF]