XEROX

CORPORATION
EVALUATING RISK OF FINANCIAL STATEMENT
FRAUD
INSERT SUMARY OF XEROX
XEROX COMPANY VS. HEWLETT
PACKARD
 (a) What responsibility does an auditor have to detect material misstatements due to errors

2
and fraud?

 Obtain reasonable assurance that the financial statements are not materially
misstated whether due to fraud or error.

(b) What two main categories of fraud affect financial reporting?

 The two main categories of fraud are fraudulent financial reporting and
misappropriation of assets.

(c) What types of factors should auditors consider when assessing the likelihood of
material misstatements due to fraud?

 In assessing the likelihood of material misstatements due to fraud, there are

two things that auditors should look at which are the inherent risks of the
company and the control risks of the company.
2
(d) Which factors existed during the 1997 through 2000 audits of Xerox that created an
environment conducive for fraud?

 Industry transition/ changing business environment 

 Intense price competition from overseas rivals
 Compliance to Wallstreet earning’s projection 
 Pressure to maintain its strong credit rating
 Xerox’s compensation system put pressure on management to report revenue
and earnings growth
3. Identify factors present at Xerox that are indicative of each of the three fraud
conditions: incentives, opportunities, and attitudes.

INCENTIVES OPPORTUNITIES ATTITUDE

Compensation of Senior Senior management

senior management management’s considers their
linked to Xerox’s authority over accounting
reported earnings. financial reporting.  manipulation as
✨accounting
opportunities✨. 

Ability to request the Senior management

auditing firm to grant felt pressure to keep
a change in strong credit rating to
engagement partner. continue gaining
access to the
necessary credit
markets (wall street)
4. Several questionable accounting manipulations were identified by the SEC. (a) For each accounting
manipulation identified, indicate the financial statement accounts affected. (b) For each accounting
manipulation identified, indicate one audit procedure the auditor could have used to assess the
appropriateness of the practice.
Accounting manipulations (A) Financial Statement (B) Audit Procedure
Accounts Affected

Acceleration of Lease Revenue, Expenses, Net

Revenue Recognition from income, common
Bundled Leases shareholder’s equity

Acceleration of Lease Revenue, Receivables, 

Revenue from Lease Price
Increases and Extensions

Increases in the Residual Cost of sales

Values of Leased Equipment

Acceleration of Revenues None? 

from Portfolio Asset Strategy
Transactions

Manipulation of Reserves Expense accounts,

Accounting reserves, Net
income

Manipulation of Other Interest income, Net income

Incomes

Failure to Disclose Factoring None? (Notes to the financial

Transactions statement is lacking)
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?

Auditors have the responsibility to check if the company followed

the standard of GAAP in establishing reserves, and make sure that
they performed the accounting correctly. Auditors also have the
responsibility to apply the concept of materiality appropriately in
planning and performing the audit. Determining materiality involves
the exercise of professional judgment. A percentage is often
applied to a chosen benchmark as a starting point in determining
materiality for the financial statements as a whole.

In determining materiality and identifying the appropriate

benchmark, several factors are considered and one of these is the
nature of the entity, where the entity is in its life cycle, and the
industry and economic environment in which the entity operates.
After determining materiality and identifying the appropriate
benchmark, the auditor should be able to test the reasonableness
of the accounting reserves established by company management.
XEROX VS ENRON

(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?