Off balance sheet finance

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Off balance sheet finance as a financial reporting practice is unethical

Overall off balance sheet finance as a financial reporting practice is unethical. The reason for this is that while the purpose of financial statements is to disclose the financial situation of the company to its stakeholders, the off balance sheet finance actually hides the real situation of the company. A company apparently taps into extra sources of financing and reducing liability risks by using off balance sheet finance. The extra financing in most cases occurs because the company uses these methods to hide the real position. further it uses methods that avoids showing liability risks. From the deontological ethical perspective, it is the duty of the firm to disclose all its liabilities on its balance sheet. The purpose of reporting is to clarify to the stakeholders the real position. This means that when a firm uses off balance sheet finance it does not carry out its duty to disclose.
Reasons and justifications for the extensive use of Off-Balance-Sheet Financing in financial reporting;
The legitimate purposes of off balance sheet finance are that off balance sheet finance provides additional sources of financing. What are these sources? One of the most common ones is operating lease. When a firm takes a loan to finance the purchase of machinery, the liability shows on the balance sheet but if a firm takes an operating lease, the annual lease payment is an expense and no liability shows up on the balance sheet of the company. So, operating lease is used to keep the balance sheet free of large liabilities. Another method of reducing balance sheet liability is synthetic leases. A bank or a lender purchases the property and rents it to the company. The company avoids showing the increased liability but still gets benefits like tax deduction of interest payment and depreciation of property.
Finally, we discuss the most controversial of off balance sheet finance methods the use of SPEs. Consider a bank that holds receivables, say from credit cards. There is tremendous risk associated with these entities. The bank creates a special purpose entity and sells these assets to the special purpose entity for bonds that are backed by these very receivables. The special purpose entity normally repays the bonds from the money received from ...