Essay, Pages 4 (823 words)
The objective of the assignment was to do an analysis of a company’s financial statement and identify areas in where financial fraud may be occurring or has occurred. The company I chose for the assignment was Xerox Corporation (“Xerox”). In my opinion based on the analysis of Xerox financial statements from 1998 to 2000, a review of outside sources such as Securities Exchange Commission (“SEC”) filings, and other periodical resources, I believe that red flags existed prior to the fraudulent schemes being uncovered.
The senior management of the Xerox Corporation misled investors about earnings to meet Wall Street expectations and to boost the company’s stock price which in turn resulted in higher compensation and higher prices for personal sales of stock for the parties involved. One of the main fraudulent schemes that the company used was manipulation of income. Xerox Corporation is publicly traded company. It’s incorporated in New York which manufactures sells and leases document imaging products, services and supplies in the United States and 130 other countries.
In 2000, Xerox employed approximately 92,500 people worldwide, 50,000 of them in the United States. For the year ended December 31, 2000, Xerox reported total revenues of $18. 7 billion and a net loss of $273 million. In order to see if fraud had occurred, a fraud examiner would have to gain an understanding of management and what factors motivate them. This area is just as important as understanding the financial statements information.
As a fraud examiner some of the key questions that should be covered are: Is management under pressure from Wall Street investors and analysts to meet earning expectations? Is management’s compensation primarily performance based, such as bonuses, stock options? Does management set unduly aggressive financial targets? What is the “tone at the top”? In addition, the fraud examiner should compare the volume of sales and selling price of the industry.
The primary comparatives of Xerox were Kodak, IBM, and Canon.
The key question would be how do these companies match to Xerox’s performance and are the accounting practices in line with each company? In regards to the control environment Xerox created “tone at the top” which equated business success with meeting short-term earnings targets. Since management had the ability to implement new policies which could affect the recording of revenues such as accounting for income practices to either spread across periods or accelerated recognition of revenue.
For example, when revenues started to drop management changed its accounting practices to accelerating recognition of revenue on leases without disclosing the practice. As a fraud examiner by directing attention to management at an early stage of an analysis could a lot of valuable information regarding intentional misstatements. Executives apparently calculated the exact amount that would have to be altered in order to allow the company to just meet or slightly exceed expectations on Wall Street, which were determined prior to a company’s release of earnings data.
This is evident in the vertical financial statement analysis. The changes in percentages don’t fluctuate at all. In all Xerox accelerated the recognition of equipment revenues by approximately $3 billion and increased pre-tax earnings by approximately $1. 4 billion in Xerox’s 1997-2000 financial results. Also, in the SEC complaint against Xerox, management cashed in on stock options valued at an estimated $35 million. The company’s stock rose to as high as $60 a share in mid-1999, when the company was carrying out the accounting fraud.
Some of the noticeable red flags within the Xerox 1998 to 2000 financial statements are as follows: * Cash and cash equivalent increased to 6% from zero in vertical analysis, yet company was had net loss in 2000 * Selling, administrative and general expenses increased from 27% to 30% in the vertical analysis 1999 and 2000, respectively, how much relates to executive pay * Long term debt increased relatively high compared to total of liabilities and equity in 2000 * Based on vertical analysis revenue percentage are flat, raising a question why revenues are so even year to year and no major fluctuations and how does this compare to industry trend.
In my opinion this fraud could have been uncovered sooner than it did by asking the right questions and understanding the policies behind the numbers. Understanding what accounting rules company was following is the key factor. Below are affected financial data from 1997-2000 as originally reported and restated. The impact to revenues and net income is astonishing. In June of 2000, the SEC launched its investigation into Xerox. By June of 2002, SEC concluded that Xerox had used incorrect accounting for these photocopy machine sales and forced Xerox to restate approximately $2. 1 billion in revenue for the period of 1997-2000. In addition to the restatement, Xerox settled the charges with the SEC, agreeing to pay a $10 million fine.
Securities and Exchange Commission. (Dated Published: April 11, 2002) Complaint: SEC vs. Xerox Corporation (Date Retrieved: October 2, 2010) from http://www.sec.gov/litigation/complaints/complr17465.htm