Off-balance sheet risks: What are they and why is their disclosure important?

General Motors (GM) has broken a record. The Big-Three automaker posted a phenomenal $23.5 billion loss for fiscal year 1992 (White, 1993, p. A3). Paradoxically, this world-record loss accompanied reports that GM generated income of $92 million from operations in 1992 (Dubrowski, 1993). The accounting data seem contradictory: How could GM incur a record loss when its operations are improving? The answer: GM recorded a “one-time hit.” Company executives recognized the cumulative effect of previously undisclosed liabilities for postretirement benefits -namely, a $20.8 billion obligation for retiree medical benefits. Prior to issuance of GM’s 1992 financial statements, these liabilities were off-balance sheet. That is, they existed outside the realm of financial reporting. GM is not alone. Many companies maintain off-balance sheet assets and liabilities. This essay explores some of the critical issues surrounding off-balance sheet risks (O&S&), namely, (1) the nature of OBSR, (2) managerial motivation to pursue off-balance sheet activities, (3) the importance of disclosing these activities, and (4) the Financial Accounting Standards Board (FASB) crusade to control OBSR.