Lecture 4 OBSF - LectureNotesNo.4 Dr.ElGazzar OFF-BALANCE...

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    Lecture Notes No. 4 Dr. El-Gazzar OFF-BALANCE SHEET FINANCING (OBSF)
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OBSF Definition Corporate Motivations Forms Implications for Financial Reporting OBS Financial Risk
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OBSF Definition OBSF can be defined as any financial arrangement under which the firm is able to acquire assets or services without recognizing the rights and the corresponding obligations as assets and liabilities in the balance sheet. So, the key point here is acquisition of assets (or even rights to use /utilize) without reporting about the assets or the associated obligations. Is this practice represent a financial fraud? No, it is done in a legal way and by exploiting the latitude allowed by Generally Accepted Accounting Principles. Management uses the gaps in GAAP in practicing the OBSF.
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OBSF CORPORATE MOTIVATIONS: Firms act rationally. That is to maximize own utility. In the case of OBSF, management can be motivated by any of the following factors: Cash Flows Savings When the firm obtains an asset (or right) and uses it in operations without worrying about financing it, this act relives the firm from significant cash outflows, which can be of great value when the firm can’t raise additional capital.
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. Motivations continued Enhancement of reported accounting-based performance measures . Through OBSF, assets are used in operations without being reported in the firm’s assets. In addition, no increase in the balance sheet’s equity or liabilities resulted from the arrangement. Therefore, we have an increase in the firm’s revenues and profits while both assets and equity are not increased. Holding other factors constant, this act produces higher: return on assets; assets turnover; return on equity. All of these ratios are appreciated by management and the business community.
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Lecture 4 OBSF - LectureNotesNo.4 Dr.ElGazzar OFF-BALANCE...

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