Audit Committees and its role in auditing process: Xerox experience

Members: Hardik Niroshi Bing Bing Omprapa

Outline

• Defining audit committee• Audit committee of Xerox Corporation• Nature of the Auditing Issue in Xerox• Reasons behind the emergence of issue• Breach of Auditing standards in Xerox• Financial & Non financial consequences to the

company management & shareholders• Aftermath

• An audit committee can be defined as a sub-committee in the governing body that will make arrangement for internal audit and facilitate the completion of external audit

• an independent body answerable directly to the Board of Governors and responsible for verifying that the operations of the Company have been conducted and its books kept in a proper manner.

• The audit committee plays a key role in assisting the board in relation to a

company’s:

* financial reporting

* internal control systems

* risk management systems and

* the internal and external audit functions

WHAT IS AN AUDIT COMMITTEE?

About Xerox

• Is a global document management company

• Founded- New York, USA (1906)

• Manufactures & sells a wide range of office and production equipments including photocopiers, printers, scanners, fax machines, multifunction systems and many office supplies

Audit Committee at Xerox

PURPOSE RESPONSIBILITIESCOMPOSITION

Purpose(1) The integrity of the Company's financial statements,

(2) The Company's compliance with legal and regulatory

requirements

(3) The independent auditors’ qualifications and

independence

(4) The performance of the Company's independent

auditors’ and internal audit function

(5) The Company’s code of business conduct and ethics

(6) Prepare the audit committee report that the rules of the

Securities and Exchange Commission require to be

included in the Company's annual proxy statement.

RESPONSIBILITIES

• Internal & External audit responsibilities

• System of internal controls

• Financial reporting process and financial statements

• Compliance with law and regulations

• Compliance with company’s code of conducts

• Reporting & other responsibilities

COMPOSITIONThe Committee shall be comprised of three or more directors, • Each member of the Committee shall be

* independent * financial literate* financial expert

• At least one member of the Committee must have accounting or related financial management expertise • No Director may serve as a member of the Committee if such Director serves on the audit committee of more than two other public companies, • The Chairman of the Committee shall be designated by a majority vote of the entire Board. • Members of the Committee shall be designated annually by a majority vote of the entire Board at the organizational meeting of the Board held in connection with the annual meeting of shareholders.

• By a majority vote of the entire Board, a member of the Committee may be removed.0

NATURE OF XEROX’S PROBLEM

from 1997 and through 1999, the company adopted creative accounting techniques to inflate earnings.

the company used accounting manipulations to misrepresent its assets and liabilities.

REASONS BEHIND THE EMERGENCE OF THE ISSUE

• To cope up with the changing business environment.

• There was pressure from Well Street’s earnings projection.

• Also, Xerox’s compensation system was directly related to its capability of reporting increased revenues and earnings.

Xerox’s Accounting Actions

• Acceleration of Leasing Revenue to Recognize Revenue Immediately at the Expense of Future Periods– ROE– Margin Normalization– Price Increases and Extensions to Existing Leases

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Xerox’s Accounting Actions (contd..)

• Improper Increases in Residual Values of Leased Equipment

• Acceleration of Revenues from “PAS” Transactions

• Failure to Disclose Factoring Transactions

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Xerox’s Accounting Actions (contd..)

• Fraudulent Manipulation of Reserves and other Income– The Rank Reserve– Excess or Cushion Reserves– Manipulation of Tax Related

Income

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Financial and Non-Financial consequences

• Without admitting or denying the SEC allegations Xerox agreed to pay $10 million penalty.

• In 2005, KPMG agreed to pay $22.5 million to settle SEC charges related to its audits of Xerox from 1997 through 2000.

• Xerox has come under new management since then and has restored its financial health, but its stock price remains at less than one-fourth of its pre-scandal peak of $63.69 in mid-1999.

• Five year’s results re-stated – pre- tax income over that period inflated by 36% or $1.41 billion.

Financial consequences (contd..)

1Q ('98) 2Q ('98) 3Q ('98) 4Q ('98) 1Q ('99)

2Q ('99) 3Q ('99) 4Q ('99)0

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Effect of accounting ac-tionsActual profits per share

How Xerox boosted profits

Non-financial consequences

CalPERS Requested Xerox to:• Add three new independent directors. • Consider eliminating Executive Committee. • Adopt CalPERS definition of an independent director. • Maintain 100% independent directors on the Audit,

Compensation and Nominating Committees. • Split Chairman and CEO. • Adopt board evaluation process. • Develop and seek shareholder approval for executive

compensation policy

Non - financial consequences (contd..)• Xerox had agreed to have its

board of directors appoint a committee composed entirely of outside directors to review the company’s material accounting controls and policies.

• Due to several accounting manipulations and fraudulent activities, Xerox Corporation diluted the brand image, company's reputation, and undermined the worldwide stability of the company’s product

Non - financial consequences (contd..)

• The SEC also targeted KPMG, accusing the company's outside auditor in a civil suit of fraud for knowingly or recklessly allowing Xerox to mislead its shareholders by filing false financial statements. Later on the audit company (KPMG) was replaced by PricewaterhouseCoopers.

Thank You!