Implications of off-balance-sheet financing and inferences for the future

1. Implications of off-balance-sheet
financing and inferences for the future
THE NEED FOR
TRANSPARENCY IN
FINANCIAL
REPORTING

2. MAIN ISSUES
• Misuse of accounting rules by companies to obscure
their shady transactions(mainly off Balance sheet
Items).
• Regulators should ensure more transparency,
accountability and create ethical awareness and
implement principal based accounting by disclosing
the economic motivation of the practices.
• Off balance sheet item gives a wrong signal to the
risk averse investor since it hides the true debt
obligation of the company. Moreover it helps the firm
for income smoothing, hide the volatile nature and
increase borrowing capacity.

3. TYPES OF OFF-BALANCE-SHEET
ARRANGEMENTS AND THEIR
IMPLICATIONS1. Investments in the equity of other entities
To escape the (SFAS)No.94 rule to consolidate the subsidiaries debt
obligation in the parent co. B/S, firms sometimes forgo the voting
right(less than 50%) but still maintains the option to cash onto the
entity’s debt obligation. Therefore new law has been issued FIN No.46
which made firm disclose the billion dollar debt obligation.
2. Transfers of financial assets
Companies often makes use of it through the SPE to take the
advantage of financial market, enhance liquidity, manage risk and obtain
low cost funding. On the other hand obligation to the investors is borne
by the SPE not the parent co.
3. Retirement arrangements
Companies create legal entities to manage pension fund but the
obligation of risk remains on the employee if it underperforms. FIN
NO.46 allows the co. not to consolidate an employee benefit plan so a

4. CON’T
4. Leases
Firms have an incentive to avoid capital lease because it increases
the long term liabilities.
5. Contingent obligations and guarantees
Contingent liabilities and guarantees are uncertain or potential
obligations that my give rise to liabilities but the timing and amount
are not sure. In this article, two main approaches are described to
disclosure the contingency on the balance sheet.
For SFAS NO. 5, “Accounting for contingencies” approach
If a loss is deemed “probable” and estimable, the loss amount with
the highest probability of occurrence must be recognized on the
balance sheet.
If the potential loss is “probable” but not estimable, or if the loss is
deemed “reasonably possible” but not “probable,” the existence of
the potential loss must be disclosed but no liability is recorded on
the balance sheet.
If the loss is deemed “remote,” no disclosure or recognition of a

5. DISCUSSION
1. Standards-setters
2. Accounting professionals
3. Boards of directors
4. Investors
Article states that the financial statement of a company is one of
the key factors investors should look into in making investment
decisions. Therefore, an investor need a minimum of skepticism
in order to have deep checking on what is presented as final
balance sheet by the company since companies may be involved
in what is called “off-balance sheet”.
5. Regulators
• Any bill that goes through Congress with that sort of vote
cannot be good.” The Act applies to all issuers of securities
that are registered or have filed a registration statement with
the SEC

6. RECOMMENDATION
1. Adopt international accounting Standard
2. Uniform disclosure framework
3. Education and awareness to UG accounting, finance
and business course
4. Auditor’s independence
5. Making FASB independent