CASE STUDY:

Xerox’s
Accounting
Manipulation Case

SUBMITTED BY:

Baliza, Mariel Ursal

Baltazar, Khen Lenard Agustin
Flores, Michaela Mia
Hernandez, Bea Angeli Abrea
Malabanan, April Dianne Cajayon
Monteron, Shara Mae Tablo
Pardales, Louisa May Baniaga

BSMA 2- 2

SUBMITTED TO:

Mr. John Christopher R. Retardo

I. COMPANY BACKGROUND

Xerox is an American corporation that pioneers office technology, notably being the first
to manufacture xerographic plain-paper copiers. The product brought so much success and
name recognition that the company has waged a continuing campaign to prevent
the trademark Xerox from becoming a generic term. It was founded in the year 1906 by Joseph
C. Wilson and now headquarters in Norwalk, Connecticut, USA and operates in over 180
countries worldwide. It now has more than 30,000 employees consisting of 7500 sales
professionals, 12,800 management service employees, and 12,900 technical service employees.
Xerox takes its lead in document technology by providing digital document products and
services. The company's main offerings encompass three main areas: Managed Document
Services, Workplace Solutions, and Graphic Communication. Its Managed Document Services
offerings help customers optimize their printing and related document workflow and business
processes, ranging from small businesses to global enterprises. Xerox’s Controlled Paper
Management involves the distribution business of information, as well as contact and marketing
solutions. Its Workplace Software and Graphic Design products and technologies help its
customers' work processes by supplying them with the printing and communications
infrastructures. Xerox now derives more than 20 percent of its revenues from color printers,
copiers, digital presses, and related services and supplies. Approximately 45 percent of
revenues are generated by the company's numerous overseas offices, subsidiaries, and joint
ventures. The company is regarded by Fortune magazine's annual reputation survey as one of
the most admired companies in the computer industry.
II. CASE BACKGROUND

Behind such recognition, some improper disclosure and misstatements on its corporate
financial statements come about which then is known as, “The Xerox Scandal”. A well-known
case of premature revenue recognition is the Xerox scandal of 2002. On April 12th, 2002, the
Securities and Exchange Commission (SEC) filed a civil fraud complaint against Xerox
Corporation for alleging that they intentionally deceived the public, from 1997 to 2000, by
prematurely recognizing revenues from copier machine leases on the signing date rather than
over the life of the lease, as payment would become due. It was at the same time when major
fraud scandals- WorldCom’s and Enron Corporation’s broke out. The charges were filed after a
two-year investigation into the company’s accounting practices. The SEC alleged that Xerox’s
management accelerated the revenue recognition of leasing equipment by upwards of $3 billion
over a four-year period and overstated the company’s pre-tax earnings by $1.5 billion to
alleviate pressure from Wall Street and to hide the company’s true performance. Also, using the
cookie jar method, the corporation violated the generally accepted accounting principles (GAAP).
Xerox’s revenues were assigned to time periods in which they were not yet received and then
releasing the stored funds at strategic times in order to boost the lagging earnings for a
particular quarter. This gives the impression that the company’s consistently achieving its
earning goals and meeting its investors’ expectations.
It was reported that Xerox’s management was aware of, and even approved of, these
accounting methods; This is irrefutably considered as fraud. The acts made by the Xerox
Corporation to defraud its investors have a number of potential reasons that can be rooted in
the fraud triangle.

A. PRESSURE OR INCENTIVE (ALSO CALLED AS MOTIVE)- With hopes of

acquiring such great deals, Xerox committed the fraud for the investors to remain
unaware about the company’s inability to achieve earning goals and to satisfy the
latter’s expectations. The company’s need to push sales to meet Wall Street’s
expectations impelled Xerox to commit the fraudulent actions. Xerox’s motive was to
maintain the financial position of the company by using accounting maneuvers that
could compromise future results. It wanted to maintain its good operational
performance by keeping up short-term earnings in order to maintain high share values.
As a result, they were compelled to manipulate earnings to align expectations with
actual results. Pressures in the form of performance-based rewards such as bonuses
 or stock options may also have originated from expectations for personal
gain. Additionally, there was an intense overseas competition from Japanese
manufacturers such as Canon and Ricoh which then have started to gain a reputation
for good quality low-cost copiers. This led Xerox to lose a considerable portion of its
core small copier business to desktop printers and millions of dollars in their revenues,
driving them to falsify earnings, in an attempt to prevent commercial failure. Xerox’s
senior management was desperate to achieve profitable revenue growth and world-
class productivity despite the knowledge that this would not be attainable given the
current competitive environment condition. Hence, they resorted using techniques to
boost incomes such as accelerating revenue and cookie-jar reserves.

B. OPPORTUNITY- In order to alleviate the company from losing its reputation, Xerox
used the accounting function to maneuver its financial condition and make the investors
perceive the company as one that could meet its stockholders’ expectations. With
direct access and information that controls the company’s assets, Xerox’s accounting
manipulated its financial statements to establish shareholder value which violated the
generally accepted accounting principles (GAAP). By falsely driving up stock prices,
Xerox defrauded its investors into believing that the company’s financial position was
considerably superior than it actually was. The fraudulent actions improved Xerox’s
earnings, revenues and margins in each quarter from 1997 through 2000, and allowed
the company to exceed Wall Street’s expectations in each reporting period from 1997
through 1999.

III. FRAUD DISCOVERY

James Bingham, a fifteen-year veteran and assistant treasurer at Xerox was the one
who blew the whistle about the fraudulent activities made by Xerox Corporation. As an assistant
treasurer, he identified the corrupt accounting practices and corporate culture of his employer.
In his desire to ameliorate Xerox’s business operation, he sent an e-mail to his boss, then
Treasurer Eunice Filter which consisted of criticisms on the company’s accounting practices and
corporate culture. He concluded that there was a high probability that the company has issued
misleading financial statements and disclosures. However, two days later, he was fired which
provoked him to expose the corporation’s fraud publicly. Bingham filed a lawsuit against Xerox,
accusing the latter of dismissing him for his objection to the corporation’s "accounting fraud."
The filing of the lawsuit brought Mr. Bingham to the attention of the SEC where he became a
star witness on the investigations against his former employer.
The Securities and Exchange Commission (SEC) began investigating the accounting
practices at Xerox in 2000. The SEC alleged that the executives had engaged in the scheme
from 1997-2000 that misled investors about Xerox's earnings to polish its reputation on Wall
Street and to boost the company's stock price. Because of the accounting manipulations, the
top Xerox executives were able to cash in on stock options valued at an estimate of $35 million.
Xerox stock rose to a peak of $60 a share in mid-1999, when the company was carrying out the
accounting fraud. It had since declined sharply and reached $7 immediately.
On the 29th of January 2003, the SEC also filed a lawsuit against KPMG, which was
Xerox’s auditor for forty years. Alleging one of the Big Four accounting organizations, KPMG
allowed Xerox to "cook the books" to fill a sales void of $3 billion and a "loss" of $1.4 billion in
pre-tax earnings. KPMG and Xerox Corporation have neither confirmed nor denied misconduct
in response to the SEC's lawsuit. KPMG settled with the SEC in April 2005 by charging a fine of
$22.48 million. Meanwhile, because of Xerox’s lack of cooperation with SEC investigators, the
company received a stiff criminal penalty amounting to $10 million and was enforced to restate
its financial statements for the years 1997 through 2000. The $10 million fine was the largest
fine administered by the SEC in a financial fraud case at that time. Following the settlement
with the SEC, Xerox began its transformation, led by CEO Anne Mulcahy. In 2008, the company
got approval to settle the securities lawsuit.
In addition, during Xerox’s post-scandal transformation, Sarbanes-Oxley came into effect
to improve financial and accounting compliance. Today, Xerox has turned its practices around
and secured a spot on several lists of the most ethical companies. This set off Xerox to regain
consumer confidence and improve the ethical culture of the company.

IV. CONTROLS

The turn of the century was marked with a number of accounting and ethics scandals
that would significantly convey the importance of a proper system of internal controls. Xerox
could have deterred any possible fraudulent acts from happening through; but not limited to:
1. Corporate Governance. This facilitates effective, entrepreneurial and prudent
management that can deliver the long-term success of the company. It also encompasses
ethical framework and creation of organization’s value which could have helped Xerox to
establish a management that promotes commitment to laws and ensures the protection of
stakeholders' interests and rights.

2. Segregation of duties. This incorporates systematic organizational structure within the

organization. Xerox should have had a clear distinction between the roles of the board of
directors and the management. The company’s directors must have overlooked the actions
taken by its management that caused the business to face the consequences of its
fraudulent activities. Segregation of principles in an organization also could have helped
Xerox to have a division of authorization concerning function, documentation, custody of
assets and reconciliation or audit. This is an essential tool which guarantees that key
processes are performed by more than one person to prevent fraud, financial misstatement
in the company by mitigating risks of manipulation of accounting processes.
i.e Establishing an audit committee to collaborate with the company’s internal
audit department would help facilitate fraud detection within the organization. The
primary purpose of a company's audit committee is to provide oversight of the
financial reporting process, the audit process, the company's system
of internal controls and compliance with laws and regulations.

3. Frequent fraud risk assessment. Xerox should have a fraud risk assessment team that
evaluates risks related to reputation risk, regulatory and legal misconduct and risks
concerning information technology. Data collected through fraud risk assessment provide
guidance on how the management of an organization should establish anti-fraud policies
and systems (Wells, 2005). It helps to connect internal control systems with various fraud
risks in response to system vulnerabilities.

4. Independent internal verification. This involves the review, comparison, and

reconciliation of data prepared by employees. Verification should be made periodically or on
a surprise basis. Verification should be done by an employee independent of the personnel
responsible for the information.