Association for Financial Professionals (AFP) Practice Exam

Which of the following is considered a type of off-balance-sheet financing?

1. Banker's acceptance

2. Commercial paper

3. Capital lease

4. Operating lease

The correct answer is: Operating lease

Off-balance-sheet financing refers to a financial arrangement that does not appear on a company's balance sheet, yet still allows the entity to utilize assets or financing without incurring traditional debt. This can help organizations manage their leverage ratios and appear more financially stable than they might actually be. An operating lease is a prime example of off-balance-sheet financing. In this arrangement, the company leases an asset for a specific period without taking on the full financial responsibility associated with ownership, meaning the asset and the associated liability do not appear on the balance sheet. As a result, the firm can benefit from the use of the asset while keeping its debt obligations lower compared to capital leases, which are treated as both an asset and a liability on the balance sheet. In contrast, banker's acceptances and commercial paper are forms of short-term financing transactions that do involve liabilities on the balance sheet, as they represent debt obligations. A capital lease, meanwhile, is considered a form of on-balance-sheet financing because it effectively transfers ownership and the associated liabilities of the asset to the lessee, making it essential for the asset and liability to be recorded on the balance sheet. Understanding the nature of the operating lease and its ability to provide financing without impacting the balance sheet directly is crucial