In the recent years, there has been a change in the business world in the way the risks and the returns are assessed. In the old days, it was done through the use of the traditional balance sheet. However, over the years, this has been replaced by the now upcoming off balance sheet. What this means is that a debt, asset or a financial activity which is not found on the balance sheet of the company. This could involve a lease or even a separate subsidiary or a contingent liability such as a credit letter.
Off balance sheet also involves loan commitments, forwards, features and other derivatives apart from the derivative which pertain to equity securities, phantom stock, and ESOP which must be held as reserves in the long term section which is found on the Balance Sheet. However, there has been a problem over the years. There has been the use of the off balance sheet by majority of the financial analyst. In the past decade, there has been a strong a fair environment in the United Kingdom concerning the issue of the regulatory environment.
However, there has been a conflict in the recent past where the companies in the United Kingdom are now being forced by the European Commission to adopt international accounting standards. To say this is not to be anti-European or be jingoistic or even critical of the international accounting standards. It simply means what is best for the United Kingdom quoted companies at the present and at the same time ensuring that the international capital market is preserved over the long run. (Karl E. & Fair, 1999)
Some companies are known to have a significant amount of liabilities and off balance sheet. For instance, financial institutions usually offer brokerage services or assets management to their clients. The assets which are in question usually will belong directly or in trust to the individual clients while at the same time the company may provide depository, management or other services. The problem with the off-balance sheet is that the company which is under management happens to have no direct claims to the assets.
In addition, it has some basic fiduciary duties which are with respect to the clients. The difference with the normal or the on-balance sheet and this off-balance sheet is that items can be quite detailed and therefore will depend on some degree of management judgment. However, an item should always appear in the company’s balance sheet it happens to be a liability or an asset which is formally owned by or it is legally responsible for; uncertain liabilities and assets should also meet tests of being measurable, probable and meaningful.
For example, a company that is being sued for having some damages is likely not to include the potential liabilities which are legal on its balance sheet until a judgment which is legal against it. This is likely to happen and at the same time, it is possible to estimate the amount of judgment that will be arrived at. It happens that if the amount of risk is small, it is difficult for it to appear in the account of the company until a judgment is rendered. (Beaney, 2005)
What at off balance sheet means is that money is raised in a way that does not appear on the financial statement as cash flow or loan. Among the most widely spread or widely used ways of achieving that is going by joint ventures, R&D partnership and leases. The lesser used methods are passing tax benefits to investors and receivables securitization. This type of balance sheet has got some problems. It is these problems that make the standard setting bodies in the United Kingdom and also those in the international level to act on business organizations or rather to impose some standards.
Among the disadvantages of the off balance sheet is that if the company that is using the off balance sheet decides to form a partnership with another party which is ready to provide funds, it means that the company using the off balance sheet has to part with the technical knowhow. This will mean that the other company which is providing the funds will have to use the knowledge or the technology of other company. At some cases, it will benefit on the business which it is illegally involved. Due to this issue, there is need for the standard setting bodies to ensure that such case does not happen.
To do so, the standard setting bodies are known to impose some conditions to the involved organizations. These conditions would ensure that the parties which are involved are not taking advantages of each other. The standard setting bodies therefore requires that the parties which are involved do so in a merger. This would mean that none of the parties which are involved are taking advantage of the other. In a merger, it would require that the two parties which are involved are contributing towards the success of the merger.
This further means that management of the organization is done in one office as compared to the previous time when each part of the organization was managed individually. (Baye, 1999) There is a tendency that the organization is likely to pass the tax benefits to the investors. What this means is there is an effect and a serious effect for that matter to the cash flow. It may be difficult for the organization to prevent this. What this means is that if the organization keeps doing this, it will retard the growth of the organization as there is a low cash flow due to the tax benefits passage to investors.
Since the organization cannot be able prevent this from happening, it is therefore the duty of the standard setting body in the region to interfere so that it can be able to set the standards for the organization. In this case, the body sets that standards that will be necessary such that if the organization wants to use the off balance sheet, it will have to meet the set standards and this way, it will not be able suffer the losses or the retardation as a result of the tax benefit passage to the investors.
(Ross, 1999) There is another disadvantage that comes along with the off balance sheet usage. This is that with the use of this method, it is difficult for the organization to engage in the trade receivable securities. The reason is that the company usually does not have a lot of cash flow or rather the company does not have a steady cash flow. This further means that the company has been limited in the way the company can be able to conduct its businesses.
Therefore the organization requires that for organization to engage in the use of this type of balance sheet, it must therefore ensure that there is the full and steady cash flow. (McLaney, 2009) The international accounting standards board refers to an independent standards setting board which is appointed and also overseen by a geographically and also professionally diverse group of Trustees who happens to be accountable for the public interest. They also have some stated goals that are to provide the world which have an integrating capital markets with a common language for financial reporting.
They do so by setting the financial and accounting report standards through the use of a thorough open and also transparent process through engaging with investors, business leaders, regulators and the global accountancy profession at every stage of the process and also collaborating with the entire world standard setting community. This body is equivalent of the United Kingdom’s Accounting Standard Board. (Karl E. & Fair, 1999) This body is known to issue the International Financial Reporting Standards.
These are the standards which are the ones which guide the financial analyst and all the parties who are ready to do or rather conduct business within the region. These standards are the one which guide the financial analyst on what they are supposed to do. In the business world, there are chances that there will be change in the way the business will be conducted from time to time. This body is the one which is responsible in ensuring that there is a constant update on the International Standards Setting.
For example, with the emergency of the use of the off balance sheet by the financial analyst, there was a chance that the international accounting standards would be distorted. This meant that they would not be used and therefore there was a need for this body to come up with some modification so that they can still cover this part. They do this by the use of a code of practice which is attached to the local authority. (Beaney, 2005) The reason as to why it has to be attached to the local authority is that some of the standards that are set will require the organization to strain a little.
This means that these organizations may not be willing to meet the standard requirement. Therefore, there has to be law enforcement so that incase an organization or a financial analyst decides not to meet the requirement of the standard setting body, the law will deal with such type of human being. The financial analysts are also checked by the International Financial Reporting Interpretation Committee. This is an IASB’s interpretive committee. It however fulfils the same duty as the previous body or the IFRS. This is a body that is similar to the Urgent Issues Force which is found in the United Kingdom.
The body is the one which reviews the accounting issues which are likely to receive unacceptable or divergent treatment in the authoritative guidance absence. Unlike in most of the organizations which have a similar duty which are known to take a long period of time before they solve an issue, this body is known to solve out the issues in a timely manner or urgently. Among the issues that are dealt with by this body are the issues which involve the financial analyst and the documents that they use in their analysis. (www. cipfa.
org. uk, 2009) These bodies are also known to work closely with other similar national committees in the region that they may be operating in so that they can have a far reaching consensus on the appropriate accounting guidance that is given by the respective committees in the region or the country. While in the process of developing interpretations, these organizations are known deal with serious issues. By serious issues, we mean that they deal with those major issues that are known to affect a large part of the society.
They do not in most cases deal with those issues which affect smaller part of the society or the business entity. And since the issue of the business use of off balance sheet and the issue of the financial analyst failing to use the normal on balance sheet is an issue of wide spread practice in business world, it is an issue that will be addressed by this body. (Ross, 1999) This is the body that will issue the interpretation of some of the standard settings and requirements. It is the one that will be used so as to ensure that there is clear and concise understanding of what is supposed to be done.
In the same line this body works closely together with the Standing Interpretation Committee. This is the body that was earlier used before the emergency of the IFRIC. The interpretations that are arrived at by these two bodies are then incorporated in the code of Practice which is found on the Local Authority Accounting. Then there is the use of the International Public Sector Accounting Standard Board. This is the one which is abbreviated as IPSASB. It constitutes an independent board of standard setting which is found within the International Federation of Accounting or IFAC.
This body focuses on the financial reporting and the accounting needs of regional, national and local governments which are related to governmental agencies and also all those constituencies that they serve. (Smith, 2007) Among the duties that this board serves is that it addresses the needs of accounting by issuing and also promoting benchmark guidance. In addition, it facilitates the information exchange among the accountants and also all the other financial analysts. The same information exchange is done among all the other personnel who work in the public sector or those who rely on the work of the public sector.
(Smith, 2007) Through this mechanism, the standard setting organization or the board is able to control the problem that is brought about by the financial analyst together with the use of the off balance sheet. The reason is that for a financial analyst to fit in the career, they must adhere to the requirement of the standard setting board. In this case the board for example may require the financial analyst to provide the information which is from the on balance sheet such as the capital of the organization and therefore the analyst will have to use the on balance sheet over the off balance sheet. (Beaney, 2005)
In addition, the standard setting bodies are known to set the use of the ratios and all the other assessment methods to use the data that is found on the on balance sheet. Even if the financial analyst will use the off balance sheet, they still have to use the on balance sheet because some of the calculations that are required can only be found in the on balance sheet. This way, they have been able to control the problem that is brought about by the use of the off balance sheet. It is clear that with the emergency of the use of the off balance sheet, there have been a lot of problems or disadvantages that come along with it.
Among them is the illegal sharing of the organization knowhow and also failure of the organization to grow or to develop as a result of the shared tax benefits and also failure to have a lot of cash flow. This means that when this method is used by the financial analysts, the results that are arrived at are not true or rather; they are not a true reflection of the organization that is being analyzed. In conclusion, the Standard Setting Boards in the United Kingdom and also all over the world to take part in the regulation of the way the financial analysts conducts their analysis.
To do this, these bodies have come up with the code of practice and also some requirements which the analysts needs to meet so that they can be able to conduct their business. In addition, they have also attached themselves to the local authority so that their codes of practice and these requirements may be enforced. This has been successful and as time goes on, they the standard setting body has been able to deal with this issue of the financial analyst use of off balance sheet. Even though they have not been able to fully control it, it is manageable. References Baye, M. (1999). Managerial Economics & Business Strategy.
London: Sage Publication. Beaney, S. (2005, April). Defining corporate finance in the UK. The Institute of Chartered Accountants . Karl E. & Fair, R. C. (1999). Principles of Economics . Chicago: Prentice-Hall. McLaney, E. (2009). Business Finance, 8th Edition. Irwin: McGraw Hill Publishers. Ross, S. (1999). Essentials of Corporate Finance. Washington: MacMillan Publishers. Smith, C. (2007). International Trade & Globalisation. Stocksfield: Anforme Publishers. www. cipfa. org. uk. (2009, April 26). International Standard Setting Bodies. Retrieved May 19, 2009, from http://www. cipfa. org. uk/pt/cipfalasaac/ifrs_bodies. cfm