Professional Documents
Culture Documents
Fraud)
SUMMARY:
The intense competition and changing business environment made it difficult for Xerox
to generate increased revenues and earnings in the late 1990s due to foreign
competitors becoming more sophisticated and beat Xerox to the market with advanced
color and digital copying technology. Furthermore, several factors put pressure on
Xerox to report continued revenue and earnings growth during this challenging period.
One, is Wall Street’s high expectation. Two, is to maintain a strong credit rating. And
finally, the compensation system.
In June 2000, the SEC initiated an investigation on Xerox and later revealed that the
company allegedly overstated revenues by $3 billion and pre-taxed earnings by $1.5
billion using a variety of accounting manipulations over the period of 1997 through 2000
to meet Wall Street expectations and disguise its true operating performance. These
accounting manipulations include:
Xerox's accounting manipulations enabled the company to meet Wall Street earnings
expectations during the 1997 through 1999 reporting periods; without it, the company
would have found itself punished with significant declines in stock price. Unfortunately,
Xerox could no longer hide its declining business performance in 2000. There were not
enough revenue inflating adjustments that could be made in 2000 to offset the lost
revenues due to premature recognition.
Xerox's stock dropped from over $60 per share to less than $5 per share in 2000 after
the accounting problems were made public. Xerox reached an agreement to settle its
lawsuit with the SEC in April 2002. In June 2003, six senior executives of Xerox agreed
to pay over $22 million to settle their lawsuit. The executives were found not guilty, so
Xerox agreed to pay all but $3 million of the fines and later they all resigned.
1. Financial information was provided for Xerox for the period 1997 through
2000. Go to the SEC website (www.sec.gov) and obtain financial information for
Hewlett Packard Company for the same reporting periods. How were Xerox and
Hewlett Packard’s businesses similar and dissimilar during the relevant time
periods? Using the financial information, perform some basic ratio analyses for
the two companies. How did the two companies' financial performance compare?
Explain your answers
Xerox Corporation is one of the top brand companies that sells and manufactures digital
prints and provides supplies with digital production as a major operation. On the other
hand, Hewlett-Packard Company also provides comparable products and products that
are not marketed by Xerox, such as personal computers and digital cameras. Both
businesses share the same business environment. However, Xerox Corporation was
getting progressively worse with regards to financial performance from 1997 to 2000
due to its attempt to obtain a Wall Street earnings projection by rushing the recognition
of revenue that should have been recorded in the future year. Xerox Corporation's
liquidity ratio shows that the company had the capability to make a profit during 2000
with a 2.083 current ratio over 1.53 of HP's, which indicates that they had the ability to
pay short-term liabilities. Though both companies have declining net sales, which trails
the profit margin, HP was more likely to keep up its sales than Xerox. Xerox net sales
went down for two consecutive years, hitting an undesirable level. In terms of debt
ratio, Xerox Corporation had higher debt, especially in the year 2000. That went up to
0.829 compared to 0.26 for HP, which means that they will highly face a long-term debt.
Furthermore, HP’s debt ratio has gone up from 1997 to 2000 which also illustrates that
Xerox wasn’t the only one having it worse. From 1997 to 2000, both companies' asset
liquidity increased noticeably, and both used stockholders' equity to generate revenue.
(b) Two main categories of fraud that affect financial reporting are (1) misstatements
arising from fraudulent financial reporting and (2) misstatements arising from
misappropriation of assets. In which, Misstatements arising from fraudulent financial
reporting are intentional misstatements or omissions of amounts or disclosures in
financial statements to deceive financial statement users. Fraudulent financial reporting
may involve acts such as the following: (1) Manipulation, falsification, or alteration of
accounting records or supporting documents from which financial statements are
prepared (2) Misrepresentation in, or intentional omission from, the financial statements
of events, transactions, or other significant information (3) Intentional misapplication of
accounting principles relating to amounts, classification, manner of presentation, or
disclosure. Misstatements arising from misappropriation of assets (sometimes referred
to as defalcation) involve the theft of an entity's assets where the effect of the theft
causes the financial statements not to be presented in conformity with generally
accepted accounting principles. Misappropriation can be accomplished in various ways,
including embezzling receipts, stealing assets, or causing an entity to pay for goods or
services not received. Misappropriation of assets may be accompanied by false or
misleading records or documents and may involve one or more individuals among
management, employees, or third parties.
(c) Auditors should consider the actions, behavior, and how their managers
communicate and treat them, and basically, it is the code of ethics of their managers.
Second, auditors should consider the environment of the business to be able to have an
efficacious corporation. And lastly, auditors should also consider the internal controls of
the business to be able to have an efficient and reliable corporation. These three factors
should be considered when assessing the likelihood of material misstatement due to
fraud.
(d) The factor that existed from 1999 to 2000 in Xerox Company was the competition
towards their competitors, which is basically normal or part of the business industry.
Second, pressure to maintain the company's ratings and expectations of their clients. In
a business industry lapses, and drawbacks are always present, but the only thing that a
business should portray is to keep on fighting and improving. And lastly, it is hard to
maintain the revenue and income growth of the company.
3. Three conditions are often present when fraud exists. First, management or
employees have an incentive or are under pressure, which provides them a
reason to commit the fraud act. Second, circumstances exist – for example,
absent or ineffective internal controls or the ability for management to override
controls – that provide an opportunity for the fraud to be perpetrated. Third, those
involved are able to rationalize the fraud as being consistent with their personal
code of ethics. Some individuals possess an attitude, character, or set of ethical
values that allows them to knowingly commit a fraudulent act. Using hindsight,
identify factors present at Xerox that are indicative of each of the three fraud
conditions: incentives, opportunities, and attitudes.
The Fraud Triangle is visibly present in Xerox company's case. To narrow down the
fraudulent acts inside the company, we decided to generally use the whole company
and summarize the fraud triangle.
Incentive- Xerox's financial needs. The pressure and their aim for the company to meet
wall street expectations is coming up short, thus they see the easiest way possible to
catch up to the intense price competition, is to commit fraud. Ofcourse, any company
that commits fraud basically needs money and for the company to be wealthy. Xerox
was basically pressured into committing fraud, when they saw how vulnerable they were
when their company was slowing down, and other companies inside their market had
better digitized products.
● Instead of recognizing the lease price increases and extensions over the
remaining life of the lease, which is the proper way of doing so, Xerox
immediately recognized it, resulting in the increase of revenue account on the
financial statements, which will also increase the net income for the current
period. The immediate recognition of lease price should have been corrected if
KPMG thoroughly checked the terms of lease contracts that were renegotiated.
Manipulation of Reserves
● Xerox had established reserve accounts where they put unrelated business
expenses, thereby decreasing the operating expenses and increasing the net
income. On the other hand, to check the appropriateness of the practice, KPMG
should have examined Xerox's financial statements to the recorded list of
expenses to see if the figures being reported are accurate or in the correct value.
Additionally, KPMG should have compared the documents of the reserve
account and the portion of retained earnings if they matched.
5. In its complaint, the SEC indicated that Xerox inappropriately used accounting
reserves to inflate earnings. Walter P. Schuetze noted in a 1999 speech:
One of the accounting “hot spots” that we are considering this morning is
accounting for restructuring charges and restructuring reserves. A better title
would be accounting for general reserves, contingency reserves, rainy day
reserves, or cookie jar reserves. Accounting for so-called restructurings has
become an art form. Some companies like the idea so much that they establish
restructuring reserves every year. Why not? Analysts seem to like the idea of
recognizing as a liability today, a budget of expenditures planned for the next
year or next several years in down-sizing, right-sizing, or improving operations,
and portraying that amount as a special, below-the-line charge in the current
period’s income statement. This year’s earnings are happily reported in press
releases as “before charges.” CNBC analysts and commentators talk about
earnings “before charges.” The financial press talks about earnings before
“special charges.” (Funny, no one talks about earnings before credits—only
charges.) It’s as if special charges aren’t real. Out of sight, out of mind (Speech
by SEC Staff: Cookie Jar Reserves, April 22, 1999).
What responsibility do auditors have regarding accounting reserves established
by company management? How should auditors test the reasonableness of
accounting reserves established by company management?
6. In 2002 Andersen was convicted for one felony count of obstructing justice
related to its involvement with the Enron Corporation scandal (this conviction
was later overturned by the United States Supreme Court). (a) Based on your
reading of that case and this case, how was Enron Corporation’s situation similar
or dissimilar to Xerox’s situation? (b) How did the financial and business sectors
react to the two situations when the accounting issues became public? (c) If the
financial or business sectors reacted differently, why did they react differently?
(d) How was KPMG’s situation similar or dissimilar to Andersen’s situation?
(b) When the issues became public both corporation’s share prices dropped. The stock
value of Xerox Corporation dropped from $60 per share to less than $5 per share. While
in Enron’s share prices it jumped down to $10 per share from $100 per share. When all
these accounting manipulation issues became public both corporation’s manipulated
financial statements resulted in multiple lawsuits against their corporations.
(c) Enron Corporation was known to be the biggest company of all time. It was widely
known all over the world and has the high-class reputation that they have maintained
before. Enron Corporation paved the way for energy services. Meanwhile, Xerox
Corporation had the same status before with Enron and Xerox also paved the way for
the technology sector of the economy. But, with their small similarities, financial or
business sectors reacted differently towards their wrongdoings. Enron Corporation left a
big impact in the corporate world because they have created a scheme that was
approved by the SEC. But, Xerox Corporation only engaged in misstatements of
financial statements. As Enron Corporation became a large contributor to the rise of
stock price, it had also largely contributed to the fall of the stock market. Basically,
Enron Corporation created an impact to the economy and this resulted in ceasing their
operations. On the other hand, Xerox Corporation, despite the accounting fraud they’ve
engaged in, they were still able to rise from it and one of the factors of it was because
they were producing products that helped them rebuild their company.
(d) During their time, KPMG’s situation was somehow similar to Andersen LLP because
both auditing companies engaged in fraudulent activities. They tolerated the
misstatements and wrongdoings of their clients. But, if you observe closely, the scandal
that Enron brought to Andersen created such a big effect on Andersen that they had to
cease their operations. They also broke a law which is obstruction of justice that
became a factor in ceasing their operations. On the other hand, in KPMG’s situation,
only four former partners were involved in the fraud and they were able to settle their
lawsuits.