The Off-balance sheet activities (OBS) may also be recognized as the incognito leverage, which usually refer to the asset or liability financing not included in the balance sheet. It is evident that Total return swaps may serve as an excellent example of the off-balance sheet items. However, it encompasses a variety of items that include revolving underwriting facilities, specific loan commitments and letters of credit. In this regard, businesses usually incorporate odd-balance sheet activities as a means of maintaining low debt to equity ratios. For an item to appear on the firm’s balance sheet it should be under formal ownership or a legal responsibility. Therefore, the assets or liabilities that maintain significant uncertainty under tests of being probable, meaningful, and measurable are off-balance sheet. To some extent, the management’s judgment on a balance sheet item will determine its inclusion of exclusion. The following report identifies whether OBS should continue being handled under current accounting standards or changes should be made.
International Accounting Standards Board (IASB)
The IASB is responsible for the generation and modification of internationally recognized standards of accounting as it adjusts and improves the International Financial Reporting Standards (IFRS). The private company was created in 2001 as a replacement for the International Accounting Standards Committee (IASC). Through the development of the organization, the members ensure that the established regulations are feasible and effectively ensure legal accounting practices (Aktan, Chan, Žiković, & Evrim-Mandaci, 2013). The primary aim of these rules is to curb the numerous cases of financial fraud performed by organizations like Enron and auditing firms like Arthur Andersen that enabled the company through the process. Through the set standards of accounting, the national and international corporations can be evaluated based on the practices they employ (Aktan et al., 2013). It is evident that the IASB has made extensive changes to the accounting practices that the corporations should employ. However, oversight firms such as Securities and Exchange Commission (SEC) designate other rules to identify the appropriate practices that corporations should adhere to in the presentation of financial documents.
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Financial Accounting Standards Board
The FASB is also a private non-profit organization that identifies the importance of setting and improving standards for use in accounting practices. The Generally Accepted Accounting Principles (GAAP) are under the oversight of this firm whose use serve the purpose of directing public companies in their recording and reporting of financial standards (Aktan et al., 2013). The organization formed in 1973 came as a replacement for the American Institute of Certified Public Accountants' (AICPA). Since then it has been designated by the SEC for use in financial fraud investigations and evaluation of public corporations. The board serves the numerous companies in the US national market as it aims to establish stiff rules in the accounting processes employed. However, there have been concerns that the FASB fails to live up to the expectations of creating quality standards that will prevent financial fraud (Aktan et al., 2013). Some critics indicate that the modifications made by the non-profit firm could put the US economy in grave danger by accommodating firms with toxic assets and liabilities.
Current Accounting Standards
Under the oversight of the IFRS Foundation, the IASB has full responsibility in undertaking measures for developing and pursuing its technical agenda in discretion following specific consultations with the Trustees and public. It is through this freedom and purposeful guidance that the board issued standard IFRS 10 through to 16 in the recent decade. The firm receives critical praise for its commitment and activity in realizing the appropriate standards that will minimize the instance of financial fraud. The development of the measures that the public corporations should adhere to also takes into consideration the importance of providing investors and shareholders on the financial health of a company (Gordon, Greiner, Kohlbeck, Lin, & Skaife, 2013). Through the practices of OBS, a lot of information is left out of the financial records such that the company appears to be experiencing great financial health. The developments made by the IASB are a direct response to the recent financial crisis, taking place between 2007 and 2009.
The issue of standards modification on IFRS 10 looks into the concepts of control and power as a means of identifying ways of recording financial statements. The board identified these terminologies as the basic determining factor of recognizing the company’s involvement with another. One of basis of incorporating off-balance sheet records is that organizations will identify their lack of or minimal responsibility of the asset or liability (Aktan et al., 2013). Under the new standards, public companies have to take into consideration the factor of control in terms of size of holding and its dispersion (Gordon et al., 2013). In reference to power, investing organizations look into the nature of other shareholders whether they are passive or not and if the investee is controlled based on rights other than voting power. If the above measures do not provide a clear conclusion, the entity is not under the investor’s control.
In alternative cases, public corporations incorporate the use of joint ventures that they participate in as a measure of incorporating off-balance sheet items. The IFRS 11 under joint arrangements attempts to clear up the issue. In this case, practices by corporations should adhere to contracts by two or more parties that share control of an entity (Gordon et al., 2013). The standard requires such firms to identify a single method of recording and reporting financial documents particularly in reference to the jointly controlled entity including assets, liabilities, revenue from output, share of revenue from sale, and share of expenses (Aktan et al., 2013). The IASB sets regulations that are more rigid in the reporting practices of corporations following standards IFRS 10 and 11. The board highlights the importance of disclosures for companies with interests in other entities. In this regard, the information is critical for users to identify risks, nature, financial impact that the entity may have. The OBS is a measure of showing the users of accounting records that the company is uncertain of its assets and liabilities. However, through provision of measures to ascertain the responsibility of a company through IFRS standards, the issue is resolved.
Recommendations
Through significant assessment of the current standards provided by the IASB, the accounting principles effectively handle the issue of off-balance sheet items (Gordon et al., 2013). The standards minimize the ability of corporations to withhold information from the public and its investors. The IFRS 16 provides significant appeal particularly due to its definition and eradication of leases as part of the balance sheet. The standard eliminates the classification of financial or operating leases where the former appears on the balance sheet while the latter is only disclosed as part of the notes (Aktan et al., 2013). The information should be stated clearly on the balance sheet. However, one of the major causes for concern is the distinction between the GAAP and the IFRS. These standards are distinctly different in implementation and adherence to accounting practices. Therefore, international companies have trouble in transforming recording and reporting practices when operating within its jurisdictions.
The SEC indicated its desire to adopt the IFRS standards particularly due to regular improvement of regulations based on changes taking place in the global market. The GAAP framework should take up the responsibility of ensuring the financial health of public corporations as in the current standards it is evident that it lags behind (Gordon et al., 2013). The FASB has come under significant criticism during the financial crisis as its regulations were deemed a result of political pressure and accommodation of companies with toxic assets. The important measure to employ is develop a cohesive relationship between the IASB and the FASB during development and improvement of accounting regulations (Gordon et al., 2013). These boards could help improve the nature of accounting practices in the global community and prevent discrepancies and loopholes that malicious companies wish to exploit.
References
Aktan, B., Chan, S. G., Žiković, S., & Evrim-Mandaci, P. (2013). Off-balance sheet activities impact on commercial banks performance: an emerging market perspective. Economic Research-Ekonomska Istraživanja, 26 (3), 117-132.
Gordon, E. A., Greiner, A., Kohlbeck, M. J., Lin, S., & Skaife, H. (2013). Challenges and opportunities in cross-country accounting research. Accounting Horizons, 27 (1), 141-154.
