Off Balance Sheet By: Associate Professor Dr. GholamReza Zandi

Balance Sheet A balance sheet or statement of financial position is a summary of the economic resources, obligations and the net difference resources and obligations. – Value of all assets, liabilities and shareholders’ equity controlled by an entity or business organisation at a specific date of time. The balance sheet provides brief information about the company’ financial position. 2

Usefulness of Balance Sheet Provides information on what a company owns as well as what it owes. Provides a basis for computing rates of return and evaluating the capital structure and financial performance of the company. Helps enterprise risk and future cash flows. Helps to analyse entity liquidity, solvency, profitability, efficiency and financial flexibility. Provides stakeholders information useful in making a range of business decisions. 3

Limitations of Balance Sheet Relevance of accounting information – Assets and liabilities are stated at historical cost. Judgements and estimates are used in determining many items in balance sheet. 4

Classifications Current assets – It is expected to be realised in, or is intended for sale or consumption in, the entity’s normal operating cycle. – Held primarily for the purpose of being traded. – Expected to be realised within 12 months after the balance sheet date. – Cash or cash equivalent. 5

Classifications Non current assets – Include tangible, intangible, and financial assets of a long term nature. – Property, plant and equipment (PPE), intangible assets, investments, biological assets. 6

Classifications Liabilities known as a probable future obligation of economic benefit arising from a present obligation to transfer assets or provide services to other entities in the future as a result of past transactions. – Current liabilities – Non current liabilities 7

Off Balance Sheet Finance It is a about financing arrangements where strict recognition of the legal aspects of the individual contract results in the exclusion of liabilities and associated assets from the balance sheet. – Usually refers to asset or liability or financing activity that is not presented on the company’s balance sheet. – Example, leases. 8

Off Balance Sheet Finance Example – A company undertakes the long term hire of a machine by payment of annual rentals, the rental is recorded in the profit and loss account, but the machine, because it is not owned by the hirer, will not be shown in the hire’s balance sheet. 9

Off Balance Sheet Finance Off balance sheet financing, sometimes also called : – Asset monetisation – Financial engineering It is a technique that allows a corporation to move the value of an asset off its balance sheet, thereby freeing up the capital previously locked up in the asset 10

Examples Structures REIT Sale/leaseback transaction Leases-operating Contribution agreements Public or private joint ventures or partnerships 11

Example Enron: – Hide billions of dollars of debt in order to borrow large amount of capital to be a giant energy trader. – Shifting debt through special purpose entities and other unconsolidated affiliates. – Hidden liabilities allowed Enron to maintain the appearance of a rapidly growing stable company. 12

REIT Financing real estate development projects – Transfers ownership of a real estate to a 3 rd party, while retaining sufficient control over use of the asset. – Example: sale and leaseback, joint venture or partnering structures. 13

Synthetic Lease A method of financing used to be built real estate projects A SPV created to facilitate the financing of a real estate project Qualifies as operating lease Assets and financing are moved off the balance sheet improving return on assets and capitalisation of ratios Similar to sale and lease back but shorter term (5- 10 years) 14

Sale and Leaseback A property sold to a financial intermediary, and then leases the property back to the seller under a 15 – 20 years operating lease Seller/lessee retains the right of first refusal to repurchase the property Seller/lessee remains responsible for properties associated taxes, insurance, routine and non routine capital expenditure, and rental payment 15

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