Everything about Off-balance-sheet totally explained
Off balance sheet (OBS) usually means an
asset or
debt or financing activity not on the company's
balance sheet. It could involve a lease or a separate
subsidiary or a contingent liability such as a
letter of credit. It also involves
loan commitments, futures, forwards and other derivatives, when-issued securities (famous in the US) and loans sold.
Some companies may have significant amounts of off-balance sheet assets and liabilities. For example, financial institutions 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.
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's an asset or liability formally owned by or legally responsible for; uncertain assets or liabilities must also meet tests of being
probable,
measurable and
meaningful. For example, a company that's being sued for damages wouldn't include the potential legal liability on its balance sheet until a legal judgment against it's 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.
Example: banking
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 wouldn't 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 don't 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 (although the same funds held in a brokerage account may or may not be off-balance sheet).
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