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Xerox Accounting Scandal

Xerox Corporation is the world's largest supplier of toner-based photocopier machines and associated supplies.

On April 11, 2002, the Securities and Exchange Commission filed a complaint against Xerox. The complaint alleged Xerox deceived the public between 1997 and 2000 by employing several "accounting maneuvers," the most significant of which was a change in when Xerox recorded revenue from copy machine leases - recognizing a "sale" in the period a lease contract was signed, instead of recognizing revenue ratably over the entire length of the contract.

 

The issue was when the revenue was recognized, not the validity of the revenue. Xerox's restatement only changed what year the revenue was stated.

Prior to 1997, Xerox had recognized revenue from equipment rentals, or leases, as required by U.S. generally accepted accounting principles.

The U.S. GAAP prohibits companies from recognizing the entire proceeds of the sale of equipment unless certain criteria are met, such as transfer of ownership. If none of the criteria are met, the "sale" is considered a lease, and only the rental payments owed to the company in the current period can be treated as revenue in the current period.

 

The SEC charged that the change in how Xerox applied accounting principles not only violated GAAP, but was intentionally designed to fool Wall Street into believing the new management team was working wonders, exceeding Wall Street's expectations nearly every quarter from 1997 through 1999.

The SEC further charged that the accounting irregularities increased fiscal year 1997 pretax earnings by $405 million, 1998 pretax earnings by $655 million, and 1999 pretax earnings by $511 million (in each quarter of each year, earnings were inflated just enough to exceed the Wall Street's First Call Consensus EPS).

The SEC also alleged that Xerox's senior management was aware of, either by directing or approving, the accounting actions that were taken for the purpose of what management called "closing the gap" to meet revenue and profit goals.

When Xerox's auditors, KPMG, questioned the legitimacy of the company's accounting practices, senior management requested that a new partner be assigned to its account. In order to keep the relationship with Xerox that had lasted nearly 40 years, and to protect the $82 million in audit and non-audit fees KPMG would collect from Xerox between 1997 and 2000, KPMG complied with management's request.

Of course the deception employed by Xerox's management soon came to light. The "accounting tricks" employed by Xerox were a double-edged sword: by accelerating future revenues into present periods, it became increasingly difficult for management to meet investors' expectations in future periods, especially as the economy began to worsen in 1999 and later years.

In response to the SEC's complaint, Xerox Corporation agreed to pay a $10 million penalty and to restate its financial results for the years 1997 through 2000. On June 5, 2003, six Xerox senior executives accused of securities fraud, including its former chief executive officer, Paul A. Allaire and G. Richard Thoman, and its former chief financial officer, Barry D. Romeril, agreed to pay $22 million in penalties, disgorgement, and interest.

On January 29, 2003, the SEC filed a complaint against Xerox's auditors, KPMG, alleging four partners in the "Big Five" accounting firm, Michael A. Conway, Joseph T. Boyle, Anthony P. Dolanski, and Ronald A. Safran, permitted Xerox to "cook the books" to fill a $3 billion "gap" in revenue and $1.4 billion "gap" in pre-tax earnings. As noted in the complaint: "There was no watchdog at Xerox. KPMG's bark sounded no warning to investors; its bite was toothless."

In April 2005 KPMG settled with the SEC by paying a $22.48 million fine. As part of the settlement KPMG neither admits nor denies wrongdoing.

Xerox ModiCorp, recently renamed Xerox India , has been investigated for making "improper payments" in order to obtain government orders.

During settlement with the Securities and Exchange Commission, Xerox began to revamp itself once more.

As a symbol of this transformation, the relative size of the word "Xerox" was increased in proportion to "The Document Company" on the corporate signature and the latter was dropped altogether in September 2004, along with the digital X.

However, the digital X and "The Document Company" are still used by Fuji Xerox.

 

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