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.
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.
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 collection.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.The company solves its financing problem by using a subsidiary or special purpose entity (SPE), which purchases the hardware and then leases it to the company through an operating lease while legal ownership is retained by the separate entity.An operating lease, used in off-balance sheet financing (OBSF), is a good example of a common off-balance sheet item.Assume that a company has an established line of credit with a bank whose financial covenant condition stipulates that the company must maintain its debt-to-assets ratio below a specified level.Often, companies set up special-purpose vehicles (SPVs) or special-purpose entities (SPEs) that have their own balance sheets, and companies then place the assets or liabilities in question on the SPEs' balance sheets.Off-balance-sheet financing is most often used in order to comply with financial .Companies must follow Securities and Exchange Commission (SEC) and generally accepted accounting principles (GAAP) requirements by disclosing off-balance sheet financing (OBSF) in the notes of its financial statements.Investors can study these notes and use them to decipher the depth of potential financial issues, although as the Enron case showed, this is not always as straightforward as it seems.Off-balance sheet items are often difficult to identify and track within a company's financial statements because they often only appear in the accompanying notes.Also, of concern is some off-balance sheet items have the potential to become hidden liabilities.