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An off-balance sheet is a way of keeping track of an asset or debt without including it in the main accounting system. Most companies have two methods of managing assets and debts, known as on- and off-balance sheets, and sometimes referred to as on- and off-book accounting. On-balance assets and debts are standard transactions that the company owns and is directly responsible for, while off-balance sheet transactions are for circumstances when the company does not have direct ownership of the money. This term is also a common way of describing illicit accounting practices.
The biggest difference between an on- and an off-balance sheet assets or debts is ownership. When an asset or debt belongs to a company, the company can do pretty much anything it wants with the money such as liquidate assets and spend the money, reinvest into its own company, or sell off debts to other institutions. If the money doesn’t belong to the company, it can’t do anything without the owner’s approval.
Most companies use an on-book system nearly exclusively. Places like retail stores and restaurants have no common need for off-book accounting; the only places where the practice is common is in financial institutions and brokerages. These companies often hold money and assets for other parties, and while these assets are in the company’s system, they do not actually belong to the company.
While many banks use the off-balance sheet system, it is not required for every bank transaction. For example, when a person gives money to a bank, it is part of a contract he entered into when he opened an account. The money the bank holds actually belongs to the person, and he can use it as he pleases. When the person gets money at the bank, he is actually getting his own money given back to him, which means the transaction is actually considered as part of the on-book system. As a result, the majority of institution accounting is done with the on-balance sheet.
A transaction is only listed on an off-balance sheet if the institution holding the money has no control outside of direct contractual benefit. This situation actually comes up in only a few cases, and most of them involve holding money in trust. For example, if a brokerage house is holding a small amount of an investor’s money as collateral against a stock market dip, that money doesn’t actually belong to the company until it takes it out to cover a loss. Until that point, the money is in the brokerage house’s accounts, but the company is unable to use it.
The off-balance sheet is also a common method of describing transactions that are illegal. These transactions take place off the official books for the company. Regardless of its origin, any money that comes in or goes out needs to be accounted for. In the past, this led to the practice of using two accounting ledgers, one official and one not, creating an on- and off-book system.