Corporate Reporting and Balance Sheet Financing - Essay Example

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The Enron failure has given rise to several questions concerning the preparation and presentation of financial statements of accounts including off balance sheet financing resorted to by several corporate entities…
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Corporate Reporting and Balance Sheet Financing
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Download file to see previous pages However there is truth in saying that no one has all relevant information and facts about Enron's failure and hence it cannot be said the OBSF is the lone factor responsible for the Enron debacle. Financial analysts are of the opinion that OBSF may be viewed as a scalpel in a surgeon's hands, which can be put to an effective use if handled properly. This paper presents a discussion on the ways of achieving OBSF. While the paper analyses the effect of the international standards for leasing and financial instruments as avenues of OBSF, it also reflects some views on the regulatory provisions on impairment of the non-current assets of listed companies and the inadequacies of the financial ratios in bringing out the correct financial strength of the companies adopting techniques of OBSF.According to Shiva and Lynda (2003) Off-balance sheet financing (OBSF) is a mode of organizing a financing transaction in such a way that it is not recognized easily as the entity's own liability. There are many distinct advantages of using OBSF under different circumstances. They are:
Arranging for cheaper outside borrowings which are secured by debt contracts that are not backed by collateral securities
The debt-to capitalization ratio can be maintained at such level as may be desired by the firm
Helps in maintaining the credit ratings in the market and thereby enhance the future borrowing capacity and
Providing finance for those projects which could not be approved due to non-availability of own funds.
Although it can be argued that allowing the companies use OBSF method will materially alter the true and fair view of the financial status of the firm as represented by its balance sheet, still the companies may take a chance to use OBSF to look for raising additional funds for rather a risky capital project which is not otherwise available as its own funds. The individual company may attempt a safe play between BSF and OBSF in such a way that it presents useful information for valuing the firm's stock prices and derive the advantage.
2.1 Effective Ways of Using Off Balance Sheet Financing:
While the items like loan, debt and equity appear in the financial statements of a company, the off balance sheet items do not find a place in the balance sheet. Creation of off balance sheet entities, joint ventures, research and development partnerships and operating leases are some of the ways in which the off balance sheet financing method can be employed by a firm.
Creation of off balance sheet entities is one of the usual ways of using the OBSF for the advantage of the firm. These separate legal entities were permissible under Generally Accepted Accounting Principles (GAAP) and tax laws. According to Rick Wayman 2002 'off-balance-sheet' refers to separate legal entities comprising of separate or subsidiary companies where the parent company holds the majority of the shares. It also covers the contingent liabilities of the firm represented by the letters of credit or loans to separate legal entities which are guaranteed by the parent company. While these items are allowed to be excluded from the financial statements of the parent company, GAAP requires them to be shown by way of foot notes attached to the balance sheet and other financial statements. This way the parent company could fianc the new venture without diluting the existing shareholders equity or adding to the external borrowings ...Download file to see next pagesRead More
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