Off-balance sheet items simply refer to assets or liabilities that are left off of a company’s financial statements. Off-balance sheet financing arrangements, transactions and obligations should be carefully scrutinized by public companies, as they are subject of disclosure under certain securities laws and regulations. Such obligations can also impact the overall financial health of a company, even though they are not visible on the company’s financial statements.

The Securities and Exchange Commission (SEC) sets forth various reporting requirements for public companies under Regulation S-K. Under Item 303 of Regulation S-K, public companies are required to provide a description of any material off-balance sheet financing arrangements, transactions and obligations in certain periodic and other public filings with the SEC. This disclosure goes into the Management’s Discussion and Analysis (MD&A) section of SEC filings. This requirement came into place in connection with the Sarbanes Oxley Act of 2002.

The disclosure of off-balance sheet liabilities must also be made in accordance with the Accounting Standards Codification (ASC), a framework of accounting standards and principles developed by the Financial Accounting Standards Board (FASB). The ASC is recognized as an authoritative source of information on U.S. Generally Accepted Accounting Principles (GAAP).

Examples of off-balance sheet financing arrangements include letters of credit, guarantee arrangements, commitments to originate loans, certain derivative instruments, and contingent liabilities that are not fully reflected in a company’s financial statements. An obligation is deemed to not be “fully reflected” if the amount recognized in the company’s financial statements is less than the reasonable possible maximum exposure to loss under the obligation.

ASC 815 requires derivative instruments, such as futures, swaps and options, to be recognized on a company’s balance sheet. Derivative instruments must be disclosed as off-balance sheet arrangements if the fair value is not fully reflected as a liability or asset in the company’s financial statements. For example, periodic changes in fair value of derivative instruments that are classified as equity and indexed to a company’s own stock may not be recognized on the balance sheet.

Historically, most operating leases were considered off-balance sheet arrangements. However, accounting rules for leases under ASC 842 changed a few years ago. Under the new lease accounting rules, only operating leases with a term of less than 12 months are allowed to be classified as an off-balance sheet arrangement. In this case, the lease payment is just recorded as an expense on the company’s income statement and is not listed as am asset or liability on the company’s balance sheet. Leases with terms of more than 12 months must be recorded as a lease liability and an asset right-of-use on the company’s balance sheet.

Many companies do not maintain material off-balance sheet financing arrangements. They will include a statement to this effect in the MD&A section of their periodic reports and other applicable SEC filings. An example of such disclosure is the following: “As of the date of this filing, we do not have any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our results of operation or financial condition.”