On-balance & Off-balance Sheet Financing

On-balance sheet financing and off-balance sheet financing are similar in that both forms of financing generate funds for the parent company. The differences between the two forms of financing lie in (a) the ability of the parent company to shield its borrowing activity from some creditors by using off-balance sheet financing and (b) the ability to shield parent company assets from lenders by using off-balance sheet financing.

Technically, the parent company engaging in off-balance sheet financing is not borrowing funds. Rather, the parent company in such a scenario sells an asset to a special purpose entity (SPE), which may be anything of value that has an income stream, but which usually is an interest-bearing financial asset. The SPE buys the asset from the parent company. The parent is the dominant shareholder in the SPE, so the transaction is somewhat like selling an interest bearing asset to oneself. In turn, the SPE pledges the asset to a lender in return for a loan in an amount equal to most of the value of the financial asset.

The SPE must repay the loan and the interest. The SPE (in theory) is able to fund repayment with money from the parent company in the form of (a) interest payments and (b) asset repurchase (in installments). Under such an arrangement, the lender has recourse only to the SPE, which has nothing but an interest bearing asset that the parent company is under no legal obligation to redeem, but is under an obligation to pay the s

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e corporation without providing any additional risk premium) (c) employees (earnings management compromises their future earnings; places at risk corporate-sponsored pensions and insurance; and places at risk any savings plans that involve corporate participation or management) (d) government (earnings management places at risk future tax collections; increases the potential that government will have to fund corporate pension obligations, unemployment claims, and health and welfare claims) (d) public (earnings management may lead to instability in local, regional, or national economies that will adverse all members of the public regardless of their inclusions in any of the groups identified above) Question 3 Comprehensive income is the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Comprehensive income includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. Comprehensive income, thus, is any positive in the level of business equity that occurs during a period. A reduction in the level of business equity during a period, presumably would be either a comprehensive loss or c

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