Xerox’s Accounting Scandal Recovery Tactics
The turn of the century was marked with a number of accounting and ethics scandals that would significantly alter the importance of corporate ethics and compliance. The Securities and Exchange Commission (SEC) began investigating the accounting practices at Xerox in 2000, which eventually led to Xerox agreeing to pay a $10 million settlement.
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 post discusses the tactics deployed at Xerox to regain consumer confidence and improve the ethical culture of the company.
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Xerox Scandal: Accounting
In 2002, the SEC filed civil fraud charges against Xerox. The charges were filed after a two-year investigation into the company's accounting practices. The SEC charges came at a time when major fraud scandals - WorldCom and Enron - broke out. 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.
The accounting techniques used by Xerox violated the generally accepted accounting principles (GAAP). Revenues were assigned to time periods in which they were not yet received. This resulted in inflated revenues, and also provided investors with inaccurate information on the company's income and assets. It was reported that management was aware of, and even approved, these accounting methods.
According to the initial complaint filed by the SEC:
"The allegations in the complaint center around seven different accounting actions used, in Xerox parlance, to "close the gap" between the company's operating results and the market's expectations from 1997 through 2000. Many of these actions had the purpose and effect of accelerating Xerox's recognition of revenue at the expense of future periods. According to the complaint, Xerox fraudulently disguised these actions so that investors remained unaware that the company was meeting earnings expectations only by using accounting maneuvers that could compromise future results."
Another interesting point to consider is the fact that, unlike Siemens, it was reported that during the Xerox scandal, they didn't fully cooperate with SEC investigators. The lack of cooperation lead to the stiff penalty handed down by the SEC. The $10 million fine was the largest fine administered by the SEC in a financial fraud case at that time.
Practices at Xerox are much different today, as the company - like many others that find themselves facing compromising charges - has learned its lesson. Before settling with the SEC, Xerox had already ousted executives who had participated in the accounting fraud schemes. Following the $10 million settlement with the SEC and the restatement of company financials from the 1997-2000 time period, Xerox began its transformation, lead by CEO Anne Mulcahy.
Mulcahy's first step was to replace the company's accounting team and begin cutting costs to reduce the company's large debts. Mulcahy's optimism in her role as CEO and the company's ability to achieve greatness was well documented and this optimism rubbed off on employees. Mulcahy managed to change the tone at the top at Xerox, which contributed to her ability to rebuild Xerox into the company it is today.
The case study From Goliath to Lazarus: Xerox is Revived by the Power of Customer-led Innovation, discusses how Mulcahy responded to feedback from both employees and customers to make positive changes. The case study also documented Mulcahy's efforts to open up the lines of communication within the company by traveling to speak with people who would provide her with constructive criticism to bring the company back to success.
Of course, turning the company around and working towards gaining a profit wasn't easy. Employees were laid off and various corporate functions were outsourced to save money.
Outsourcing Internal Audit
One of the processes selected for outsourcing was the company's internal audit. Many experts recommend outsourcing the internal audit function to maintain the objectivity that comes from an external auditor who doesn't have any direct relationship to the company.
Benefits of internal audit outsourcing include:
- An independent auditor can be more objective.
- Outsourced auditors tend to be efficient and focused, given the tools and methodologies they bring to the table.
- Costs are variable and can be lower than in-house.
- The supplier can usually provide access to better and more varied resources.
Companies can learn from the mistakes other organizations have made to avoid making similar ones. The Xerox scandal forced its company executives to reevaluate the way accounting matters were handled within the company, while new members were brought in to ensure that known inaccuracies were reported and corrected.