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Taking on additional debt to finance the purchase of new computer hardware would violate the line of credit covenant by raising the debt-to-assets ratio above the maximum specified level.The company solves its financing problem by using a subsidiary or special purpose entity (SPE), which purchases the hardware and then leases it to the company through an operating lease while legal ownership is retained by the separate entity.
Accounts receivable (AR) represents a considerable liability for many companies.
This asset category is reserved for funds that have not yet been received from customers, so the possibility of default is high.
The Enron scandal was one of the first developments to bring the use of off-balance-sheet entities to the public's attention.
In Enron's case, the company would build an asset such as a power plant and immediately claim the projected profit on its books even though it hadn't made one dime from it.
Therefore, Company XYZ needs to find another way to obtain a the machine.
To solve the problem, Company XYZ creates a separate entity that will purchase the equipment and then lease it to Company XYZ via an , joint ventures, or research and development activities.
Off-balance sheet items are typically those not owned by or are a direct obligation of the company.
For example, when loans are securitized and sold off as investments, the secured debt is often kept off the bank's books.
Often, companies set up special-purpose vehicles (SPVs) or special-purpose entities (SPEs) that have their own balance sheets, and companies then place the assets or liabilities in question on the SPEs' balance sheets.
Off-balance-sheet financing is most often used in order to comply with financial .