In an earlier post, I had written about how hedge accounting drives certain business transactions. But, this is not unique to only hedge accounting. Other areas of accounting also drive it-including the innocuous revenue recognition norms. To drive home the point that this(structuring transactions to manage earnings) prevailed way before hedge accounting/Repo 105, I detail the (in)famous Xerox accounting scandal as explained in the SEC lawsuit available here. There have been umpteen posts/books/articles written on other facets of the scandal but little on the Enron type securitization. So I thought to cover it here
Xerox committed many financial reporting sins while managing its earnings during 1997-2000. But the transaction detailed in paras 56-57(of the lawsuit) is most relevant here.
In 1999, Xerox Brazil changed its business model from its traditional sales-type lease model to one based on rental contracts. Because, under GAAP, the revenue from rental contracts cannot be recognized immediately, Xerox entered into PAS transactions(selling to investors the revenue streams from portfolios of its leases that otherwise would not have allowed for immediate revenue recognition) to allow such immediate revenue recognition
Essentially, Xerox securitized its rental revenues so that it could account for them upfront. While accounting rules(NOT principles but rules..) permitted this, these transactions had no business rationale other than earnings management.
Moral:- History repeats itself so our only recourse is to be vigilant,