In the period that covered 1997 through 2000, Xerox Corporation employed improper accounting practices which were approved by the company’s senior management. The management did not disclose its accounting maneuvers as it increased the recognition of the organization’s equipment revenue by more than $3 billion and boosted their income by about $1.5 billion falsely (US Securities and Exchange Commission 1). As a result, Xerox was falsely portrayed as a company meeting its competitive challenges as its executives increased its earnings every quarter throughout the 1997-2000 periods, thus, misleading investors about the quality of the company’s earnings.
Kaplan (6) reports that the scandal was detected when irregularities were realized at Xerox’s subsidiary in Mexico in 2000. Powell (4) states that this forced the company to initiate investigations which resulted in the sacking of 13 managers. The company also announced that it had written off $120 million (Powell 4). However, when James Bingham, Xerox’s assistant treasurer, insisted that there was more to this than was relayed to the public, he was fired. James later sued the company. It is from this lawsuit that the SEC got an idea of the possibility of an accounting scandal at Xerox.
The increasing competition between Xerox and its overseas competitors in the mid-1990s onwards led to intense pressure on Xerox to meet Wall Street’s earnings projections. Companies that failed to meet Wall Street’s expectations experienced significant declines in their stock prices. Besides, Xerox’s executives were compensated for meeting increasing revenues as well as earning targets. As a result, Xerox adopted undisclosed accounting actions to manipulate its financial statements. Xerox began by adding just a penny or two to its quarterly earnings so as to meet Wall Street’s projections (US Securities and Exchange Commission 10). The executives referred to this practice as “closing the gap” between the actual operating results and the projected results (US Securities and Exchange Commission 10). However, the company found it ever more difficult to meet quarterly analyst projections based on how it had traditionally accounted for its revenues. As a result, it started relying more on “one-offs” while reporting its earnings (US Securities and Exchange Commission 10).
The executives used the one-offs to increase Xerox’s first quarterly earnings by 4% in 1997 and followed it by more one-offs of between 17-37% through to the end of 1999 (US Securities and Exchange Commission 12). The undisclosed accounting actions employed by Xerox’s executives resulted in an increase in the company’s pre-tax earnings by 19% in 1997, 29% in 1998, and 1999 in 25% (US Securities and Exchange Commission 12). The US Securities and Exchange Commission reports that had the company reported its revenues as well as earnings consistently with its traditional accounting practices, then it would have failed to meet 11 out of 12 of Wall Street’s estimates during that period (13). The US Securities and Exchange Commission again reports that when Xerox’s engagement partner for the external auditor questioned the several non-Generally Accepted Accounting Principles (GAAP) accounting practices employed by the company, the executives notified the audit firm (KPMG) that they needed a new engagement partner to replace the current one (18). KPMG acted in accordance with their request.
Xerox’s executives employed several accounting tools to enhance the company’s revenues as well as earnings picture. They overstated the company’s earnings using “cookie jar” reserves plus miscellaneous as well as interest incomes tax refunds (US Securities and Exchange Commission 4). They also misrepresented loans as asset sales. The US Securities and Exchange Commission (5) reports that the most significant as well as pervasive accounting practice that the executives improperly employed was pulling forward as well as making immediate recognition of revenues from leases of company equipment, thus, breaching the organization’s traditional accounting practices. Under the organization’s historical accounting practices, the company would have recognized the initial portion while the rest of the payments would have been recognized gradually as the interests were paid over the period of the lease. gradually as well as in future years. This resulted in pulling forward equipment revenue of about $3.1 billion as well as pre-tax earnings of about $717 million in 1997-2000 (US Securities and Exchange Commission 35. During this period, Xerox applied two major accounting actions to manipulate its revenue; return on equity (ROE) as well as margin normalization.
Xerox’s executives assumed a 15% ROE on its financial operations which it used for justifying its reductions on Xerox’s estimate of the fair value of its financing (US Securities and Exchange Commission 39). During this period, they used this figure to determine the finances of the company’s sales-type leases. The company’s executives continually lowered Xerox’s estimation of the fair value financing to raise its reported equipment values. As a result, the company pulled forward $2.2 billion in equipment revenue as well as $301 million in earnings.
Xerox also used margin normalization to reallocate anticipated lease revenues. The executives used an assumed gross margin to reallocate equipment revenues from service. Besides, the company recognized the revenues immediately as opposed to its historical way of allocating equipment revenue from long-term lease revenue. It also made retroactive reallocations to transactions that it had earlier presented in previous financial statements. In 1997 Xerox falsely reported 17% point of gross margin which resulted from its revenue reallocations (US Securities and Exchange Commission 46). This practice resulted in pulling forward $617 million throughout this period.
Xerox’s executives also used price increases as well as extensions of the company’s existing leases to adjust its revenues and earnings prematurely. Between 1997 and 1999, the company pulled forward equipment revenue of around $300 as well as pre-tax earnings of about $200 million (US Securities and Exchange Commission 49). They also increased the estimated residual values of the company’s leased equipment. This resulted in overstatement of the company’s pre-tax earnings by about $43 million during this period (US Securities and Exchange Commission 53). In addition, the executives fraudulently manipulated reserves and other incomes to up Xerox’s earnings by manipulating the cushion reserves, rank reserves as well as tax-related incomes.
The US District Court for the Southern District of New York found Xerox guilty of several accounts of fraud and malpractices of accounting standards, and as a result, the company was fined $10 million civil penalties (Citizen Works 61). The company was also ordered to restate its financial reports for four years and to appoint an independent committee to look into Xerox’s internal accounting controls as well as policies. KPMG which was the audit firm during this period was fired by SEC and six senior executives at Xerox were taken to court by SEC for securities fraud. Those charged were; Paul Allaire, CEO, Richard Thoman, CFO, and Barry Romeril, who were fined $22 million.
Xerox’s accounting scandal remains in the minds of many, including investors and accountants as the question remains, how could have the scandal been avoided. This scandal could have been avoided if the firm (Xerox’s board of directors) could have enforced compulsory audit firm rotation. An audit firm retained by a company for a long time can always collude with the company’s executives to conceal its real economic performance. Mandatory rotation of audit firms would have forced each audit firm to perform a thorough review of Xerox’s financial operations as they seek to avoid the possibility of restatements occurring during their watch.
Works Cited
Citizen Works. The corporate scandal sheet. Citizen Works, 2003. Web.
Kaplan, Karen. KPMG Finds No Fraud at Xerox. Los Angeles Times, 2001. Web.
Powell, Jim. Why do we need the SEC? The Future of Freedom Foundation, 2009. Web.
US Securities and Exchange Commission. US Securities and Exchange Commission, Plaintiff, v. Xerox Corporation, defendant. US Securities and Exchange Commission, 2002. Web.