We said in the lecture on asset definition that valuable intangible assets such as brands and talents do not appear in the assets of the report because they are difficult to quantify and do not meet the recognition requirements of accounting standards. . These assets are called off-balance sheet assets. Similarly, some corporate debts do not appear in the liabilities of the statement because they do not meet the recognition requirements of accounting standards. We call them off-balance sheet liabilities. These off-balance sheet liabilities are like the part of the iceberg hidden underwater. They are calm on weekdays, but once they explode, they are like the Titanic's misfortune, which will have a devastating blow to the enterprise. For example, in the Enron incident we mentioned, small and medium-sized shareholders suffered huge losses because of hidden debts.
Therefore, if you want to recognize the true situation of a company, it is very important to understand its off-balance sheet liabilities. However, off-balance sheet liabilities are complex and hidden, and even many professionals cannot understand them. Survey data shows that only 10.5% of accountants have a good understanding of off-balance sheet liabilities, and as many as 23.3% have no idea at all. ?
In this lecture, we will talk about what common off-balance sheet liabilities companies have, so that we can give you a comprehensive understanding of a company's debt risks. Let’s first look at the circumstances under which off-balance sheet liabilities will be formed. There are usually three situations: 1. Hidden liabilities that naturally arise during operations; 2. Deliberately hidden liabilities; 3. Off-balance sheet financing liabilities.
Let’s talk about them one by one.
The first type is the implicit liability arising from the operating characteristics of the enterprise. For example, if a chemical enterprise has soil contamination due to the leakage of harmful chemical substances during its operations, the enterprise needs to bear the obligation to purify it. This kind of environmental liability is the largest type of hidden liability for chemical companies. This kind of liability is different from the liability arising from corporate financing activities (such as bank loans). Liabilities arising from financing activities usually have clear repayment time and amounts, but implicit liabilities arising from operations are like a "bomb". It is uncertain at what point in time it will explode in the future, and how powerful it will be once it explodes. , so it cannot be measured and recognized in accounting, so it can only be placed off the balance sheet.
When financial experts evaluate a company's liabilities, they not only look at the liabilities caused by the company's financing activities, but also pay special attention to the hidden liabilities that may be contained in the company's actual operations.
If hidden liabilities are serious, they can even bring down a company. For example, ABB is a well-known electrical appliance company in Europe. At its peak, it had more than 200,000 employees and once ranked 68th among the world's top 500 companies. ABB has invented dozens of major technologies that have changed mankind, such as the world's first high-voltage direct current transmission line and the world's first industrial robots.
What did ABB rely on to grow rapidly? Relying on a large number of merger and acquisition activities. The company itself was formed in 1988 through the merger of a Swedish company and a Swiss company. The two companies complemented each other and developed rapidly after the merger. After tasting the benefits of the merger, the new company continued to expand its territory everywhere. At that time, the company's morale was high, and every employee and investor was looking forward to greater development of ABB. Until December 1989, ABB acquired a company called American Combustion Engineering, which mainly manufactured boilers for refineries and petrochemical companies. No one expected that what was originally an ordinary acquisition would bring the biggest disaster in ABB's development history, putting it on the verge of bankruptcy.
What happened?
It turns out that when ABB did due diligence before the acquisition, it only did financial due diligence, but failed to discover that there was an important hidden danger in the company's operations, that is, the company's boiler products used chemicals containing Carcinogen-causing asbestos acts as thermal insulation. Later, employees and customers who had been exposed to this type of boiler experienced adverse physical reactions, so they filed a class action lawsuit against ABB, with as many as 100,000 plaintiffs. ABB paid US$865 million in compensation, but the lawsuit did not end with compensation.
Although ABB sold American Combustion Engineering to Alstom at a low price in 2000, it still retained relevant liability for compensation. The sky-high compensation fees involved in this lawsuit caused ABB to suffer a huge loss of US$691 million in the second year, and was in danger of bankruptcy. Later, ABB promised to establish a trust fund of US$1.2 billion as a compensation guarantee, and in exchange for the plaintiff agreeing to the bankruptcy of American Combustion Engineering, the lawsuit was finally settled.
You see, when a company is acquired, if the implicit liabilities of the target company are ignored, how much risk will it bring to the buyer's company.
This type of implicit liabilities is usually related to the operating characteristics of the company. For example, the biggest hidden liability of airlines is lawsuits and compensation caused by air crashes. The largest hidden liability in the chemical, coal, materials, and mining industries is environmental liability. An implicit liability that China Shenhua Co., Ltd. has voluntarily disclosed in its financial statements is the "land reclamation obligation." That is to say, after completing mining activities, the company must repair the damaged land. However, since the environment and conditions of each piece of land are different, it is difficult to estimate in advance how long it will take and how much it will cost to repair. Financially, it is impossible to include this future expenditure in the report. Therefore, when investors evaluate China Shenhua's debt level, they must estimate its hidden debt based on the company's operating characteristics.
If one type of off-balance sheet liabilities are hidden liabilities that naturally arise in operating activities, then there is another type of hidden liabilities that are deliberately hidden in the financial statements by companies in order to make the debt ratio on the financial statements look lower. outside. We call it, deliberately hiding debt.
In April 2019, Seazen Holdings received a letter of inquiry from the Shanghai Stock Exchange. The company was questioned for deliberately hiding high debts off the balance sheet. Real estate companies have large project capital needs and need to spread risks, so they usually have a large number of joint ventures (associates). According to the accounting standards, if Seazen Holdings holds more than 50% of the shares of a joint venture (associate), it actually has actual control over the company, and accounting requirements require consolidated financial statements, that is to say, the company will be consolidated. The company's assets and liabilities are included in Xincheng Holdings' statements.
However, Seazen Holdings found a reason and did not conduct consolidated statements. Seazen Holdings' argument is that the company decides whether to consolidate based on its articles of association rather than the provisions of accounting standards. This explanation is obviously unconvincing. Why is Seazen Holdings unwilling to include the financial conditions of these 24 companies in its own statements? If you take a closer look at the situation of these 24 companies (as shown in the table below), you will find that most of these companies are loss-making companies, and the asset-liability ratio is also very high. Among them, the asset-liability ratio of Yongqing County Xincheng Real Estate Development Co., Ltd. even reached 399.54%.
As of the end of December 2018, Seazen Holdings' own asset-liability ratio has reached as high as 84.57%. If these 24 high-debt companies are consolidated, Seazen Holdings' asset-liability ratio will obviously continue to rise. Seazen Holdings' cash flow has been very tight in recent years and it is highly dependent on bank loans. If the asset-liability ratio continues to rise, it will obviously cause banks to worry, so they will find ways to transfer liabilities that should be on the balance sheet off the balance sheet. Deliberately hiding liabilities off the balance sheet, this wave of operations deliberately deceived investors and violated accounting standards.
The third type of off-balance sheet liabilities is caused by innovative financing methods.
Suppose you open a private school. It has developed rapidly in the past few years and needs to be expanded, and you are in urgent need of funds. It takes a long time to find investors, and you don’t want to sell your company shares and dilute your control over the company, so you want to find a bank loan. Obtaining bank loans usually requires mortgages and guarantees, but the education industry has a special feature, that is, according to my country's current laws, real estate and educational facilities used for education cannot be used as mortgages. So getting a loan is also difficult.
Loans and equity financing are not possible, so are there any other methods? In fact, there is another method, which is a new financing method that has become very popular in recent years, called asset securitization, or ABS for short.
What is asset securitization? Simply put, you have something that will continue to bring you cash in the future, and you can accurately predict the amount and frequency of that money. At this time, you can cooperate with financial institutions to issue securities based on this stable future cash flow and obtain a financing. So how do people who buy securities rely on their income to be paid? Just use the cash generated by this thing in the future to pay for it. The essence of this operation is to advance money in the future. The school has the obligation to pay a sum of money regularly in the future, so it is essentially a liability of the enterprise. The school's most stable future cash flow comes from tuition and accommodation fees. Therefore, schools can package and sell these future revenues in exchange for current financing.
In 2017, Beijing 21st World International School issued 300 million ABS, and Xiamen Yingcai School also issued 800 million ABS.
Various tourist attractions and theme parks also use this innovative financing method. What is the most stable cash flow in these places? The ticket to enter the park is the basic asset of ABS.
Have you discovered it? As long as it is an asset that can stably generate cash, it can be used to make ABS. However, the success of asset securitization is very dependent on the quality of the assets. After the school securitizes future tuition and living expenses income, the securities sold will rely on students' regular future tuition and living expenses payments. If these students interrupt their payments on a large scale, it will cause a thunderstorm for ABS.
Can I see off-balance sheet liabilities?
Having said so many ways and risks of off-balance sheet liabilities, is there any way to control it? The U.S. Securities and Exchange Commission (SEC) formally passed the Fair Information Disclosure Act in 2000, requiring U.S. listed companies to proactively disclose off-balance sheet transactions, arrangements and debts, and a series of off-balance sheet matters that may have a significant impact on the company's finances. information.
Especially after the Enron incident broke out in 2002, the U.S. Securities and Exchange Commission once again made strict regulations on off-balance sheet disclosure by promulgating the Sarbanes-Oxley Act, of which Section 401 clearly requires listed companies to All major off-balance sheet businesses, contracts or debts involving the company are disclosed in the annual and quarterly reports.
Unfortunately, my country’s accounting standards have not yet formulated unified disclosure requirements and standards. Some conscientious companies will disclose it in their financial statements, but some companies deliberately conceal their off-balance sheet liabilities without making any form of disclosure. How to standardize disclosure requirements is an important issue being studied by the Ministry of Finance. What we can do now is to judge the hidden liabilities that may exist in corporate operations through industry analysis. Combined with analyst reports and other information channels, we can understand whether the company deliberately hides liabilities.
What are the hidden liabilities in your work or life? You are welcome to leave me a message and we will see you in the next class.
Answer: Hidden liabilities at work or in life include: (1) If you and your family members become seriously ill if you do not have enough critical illness insurance, the family will fall back into poverty; If that person had not purchased life insurance and accident insurance, an accident would bring the family back into poverty; (2) When working in a factory, he was most afraid of disasters and floods, because a fire could wipe out millions of dollars in inventory; When recruiting employees, especially those who operate machines, we will look for employees who are steady and do not drink during the day or when necessary, because such employees will basically not be involved in work-related accidents. In our industry, fires occur in factories every year, and there are even more work-related injuries. If an accident occurs intentionally, the factory may lose tens of thousands or one hundred thousand yuan, or it may lose hundreds of thousands or millions... These are all hidden Liabilities.