Learning objectives specific to this case include an increased awareness of the importance of reserves, including when their use is appropriate or inappropriate; better understanding of the role of a concurring partner; improved perception of when departures from GAP are improper; a heightened awareness of the importance of professional skepticism; the identification of audit risk factors; exposure to International Financial Reporting Standards T-Resend identification of illegal acts by a client’s management.
Keywords: Xerox; KEMP; accounting reserves; concurring partner; capital leases; audit quality; professional skepticism. We have determined that certain accounting practices including some that involve complex accounting issues, which we had previously believed to comply with nearly accepted accounting principles Gaping fact, misapplied GAP. In addition, we have made period adjustments to certain previously recorded charges for errors and irregularities resulting from the accounting issues in Mexico.
The impact is a cumulative reduction of common Shareholders’ Equity and Consolidated Tangible Net Worth of $137 and $76 million, respectively. Amendments to revenue in each of the three years 1998-2000, were insignificant. Xerox 2001 an INTRODUCTION he above statement appeared in a letter sent to shareholders along with Xerox Inc. ‘s thereafter referred to as Xerox_2000 Annual Report. In reality, when the dust had finally settled, it was determined that the errors and irregularities encompassed far more than accounting issues in Mexico.
In July 2002, Xerox issued a restatement that resulted in a decrease of revenues of over $3. 8 billion and a decrease in pretax earnings of $1. 2 billion for the period 1997-2000 SEC Iacocca These errors and irregularities ultimately cost Xerox, six Xerox executives, Xerox’s independent auditors, and five partners of the auditing firm nearly SASS million in penalties, interest, and settlement of a class action shareholders’ lawsuit. Edward Spies is an Instructional Assistant Professor at Illinois State University, Sean Kinsfolk is President of Kinsfolk Farms, and Deborah L. Undergo is a Professor at Illinois State University. Editors note: Accepted by Kent SST. Pierre. The material presented in this case was drawn from several SEC accounting and auditing enforcement releases, litigation releases, and administrative proceedings; since some of the information from these sources is overlapping, references provided in the text of this case will be to the primary source where the information was located. Published Online: February 2011 219 220 Spies, Kinsfolk, and Lindbergh MAKING THE NUMBERS LOOK GOOD Xerox is the leading manufacturer of photocopy equipment in the world.
Over the years, Xerox developed many new products and became known for its high-quality products. In its 2000 Annual Report, Xerox reported annual sales of $18. 7 billion. Xerox was ranked 87th in the Fortune 500 and had 92,500 employees worldwide Commoner. Com exerciser, like many technology companies, faced significant competition from overseas, especially in Japan, in the late sass. They faced competition in the copy machine business from the likes of Canon, Monomial, and Ricoh.
Because of the increased competition, Xerox was confronted with declining revenues, which should have led to lower than expected earnings SEC cliffhanging to meet the investment community expectations can have a dramatic negative impact on the price of the company’s stock. It appears that Xerox’s senior management was obsessed with meeting quarterly earnings expectations SEC coordinating to complaints filed by the SEC in 2000, Paul Allure and G. Richard Thomas Each Of whom were the CEO during portions Of the period investigated by the Sealant Barry Roomier, the SCOFF, set a negative “tone at the top” SEC added
This tone measured the success of Xerox by the company’s ability to meet analysts’ expectations. This meant meeting quarterly earnings targets estimated by stock analysts and reported by First Call, a service that reports a consensus earnings projection based on estimates prepared by various analysts SEC AAA::] Xerox, as shown in Figure 1, met or exceeded First Calla’s estimated quarterly earnings in every quarter for the period 1997-?1999. As is also shown in the chart, if Xerox had not resorted to various accounting devices El. , manipulation schemes]the company would have missed the quarterly estimates in 11 of the 12 quarters.
Senior management knew about these schemes, and kept track of each of these manipulations to quantify their impact on the corporate financial results. The manipulation schemes initially added only a penny or two to the quarterly earnings per share. At their worst, however, these schemes added 30 cents per share to the fourth quarter of 1998 earnings per share, and 61 cents to the 1998 annual earnings per share. In the fourth quarter of 1998, 36 percent of the earnings per share came from the accounting devices. Management referred to the process of manipulating the quarterly earnings per share as “closing the gap” SEC added
Cookie Jar Reserves Over the years, Xerox developed a “cookie jar” of financial reserves that were released into income, as needed, to meet quarterly expectations. During the period 1997-1999, Roomier, Philip Fishcake, Xerox’s corporate Controller, and Daniel Marching, the Assistant Controller who reported to Fishcake, released $41 5 million of reserves held in the cookie jar to “close the gap” between actual results and analysts’ expectations SEC clangorously Taller, who served in various capacities of Xerox management during this time, participated in the release of $100 million of these reserves.