What Are Some Types of Off-Balance Sheet Assets?

Off-balance sheet assets are assets used in off-balance sheet financing, the practice of leaving certain financial arrangements off the balance sheet. Some examples are guarantees, retained or contingent interests, some derivative instruments, and variable instruments.

Off-Balance Sheet Asset Disclosures

Guidelines passed by the Securities and Exchange Commission and Federal Accounting Standards Board now have stricter definitions than those of the past for allowable off-balance sheet arrangements.

Companies must disclose any off-balance sheet financial arrangements in their Management’s Discussion and Analysis of Financial Position and Results of Operations (MD&A) within their financial reports.

Types of Off-Balance Sheet Arrangements

Several arrangements can be excluded from a balance sheet, some of which are:

• Letters of credit: Letters of credit are financial instruments used in international trade, where a foreign buyer’s bank pays an exporter once products are shipped. These monetary commitments are often used by companies entering new markets when developing trustful relationships with trade partners in those markets.
• Guarantee arrangements: A guarantee arrangement is an agreement between two parties where a third party agrees to pay a liability if the liable party cannot make good on its part of the agreement. For example, if a young business applied for a loan, it might have someone willing to pay the loan act as the guarantor if it were not able to pay some time in the future.
• Commitments to originate loans: A loan commitment is an agreement from a bank to a business to lend that business a specific amount of money.
• Certain derivative instruments: A credit derivative is a contract between two parties, such as futures, options, or swaps. However, they are only required to be on the balance sheet if their fair value can be reflected as a liability or asset.
• Certain contingent liabilities: If certain conditions are met, a business might need to account for contingent liabilities, such as being sued. If proceedings lasted for more than a reportable annual or quarterly period, it would have to disclose the lawsuit and potential liabilities in its MD&A.

Explain Off-Balance Sheet Assets Like I’m 5

Companies are required by standards boards and regulatory authorities to report all of their assets and liabilities, which can include many types of financial transactions, physical property, investments, and more.

In the past, businesses were allowed to not record certain financial arrangements on their balance sheets. These omissions gave them an opportunity to disguise some transactions to make themselves seem more profitable, efficient, or otherwise more attractive to investors than they might have been if the arrangements were included on the balance sheet.

Specific assets are still allowed not to be included on balance sheets, but they must be disclosed in the Management’s Discussion and Analysis section of the required financial reports.

The Bottom Line

Companies are allowed to omit certain assets from their balance sheets. These assets are called off-balance sheet items; however, off-balance sheet assets must be disclosed in the Management’s Discussion and Analysis section of the financial report.