KPMG Prepares For SEC Charges Over Xerox Audit

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In preparation for charges expected to be filed by the U.S. Securities and Exchange Commission, accounting firm KPMG released a statement to the media explaining the facts about its audits of Xerox Corporation. Last April, the SEC charged Xerox with use of fraudulent accounting tactics designed to accelerate the recognition of revenue, resulting in a $6.4 billion restatement that is believed to be one of the largest in history. The SEC blames KPMG for approving these tactics.

In its statement, KPMG said it continues to believe that Xerox's basic accounting methodology was appropriate. Here is KPMG's account of what happened:

  • During the 1999 audit, KPMG insisted that Xerox book virtually every audit adjustment resulting from non-compliance with generally accepted accounting principles, including immaterial amounts. No large audit adjustments were "passed" as immaterial.

  • When KPMG later learned of new information that raised concerns about the company's "tone at the top," the firm refused - in the face of strong client resistance - to issue its audit report on Xerox's 2000 financial statements. Instead, it advised its client of the need for a full scale special investigation, using outside independent counsel and another audit firm.
  • Xerox's audit committee engaged a prestigious New York law firm to conduct the investigation, and the law firm engaged PricewaterhouseCoopers to assist them. The investigators found that the fundamental lease accounting methodology used by the company complied with generally accepted accounting principles, but the methodology had been misapplied at times. KPMG insisted, again in the face of strong client resistance, that Xerox restate its 1997 - 2000 financial statements for these misapplications.
  • KPMG also insisted on numerous changes in Xerox's financial reporting structure and personnel. It issued a management letter that it believes was unprecedented for a Fortune 500 company. The letter identified problems with the "tone at the top" of the company regarding financial reporting matters as a material weakness.
  • KPMG had numerous conversations with the SEC staff during the 2000 audit and the special investigation undertaken in 2001. It even went so far as to specifically ask the staff about any other concerns prior to the issuance of its report. KPMG was not advised at the time that the SEC staff considered Xerox's accounting methodology fraudulent.
  • KPMG continues to believe that Xerox's basic accounting methodology is appropriate – and others have agreed, including three teams from PwC and four independent, respected accounting experts, one of whom is a former Chief Accountant of the SEC.
  • Xerox's June 2002 restatement represented a total about-face by the company, allowing it to take nearly $2 billion in previously recognized revenue and recognize it again in 2002 and future years. The rest of the restatement simply reallocated revenues among prior periods.

Eugene D. O'Kelly, Chairman and CEO of KPMG LLP, said, "KPMG stands firmly behind our audits of Xerox's financial statements and the professional judgments made during the course of the audits. . . We support the SEC's commitment to quality, transparency, and other steps being taken relative to needed reforms in the capital markets and ensuring investor protection. In the Xerox matter, however, we find that well-intentioned people have reached the wrong decision. . . The result is a great injustice to KPMG and the four partners involved. At the very worst, this is a disagreement over complex professional judgments."

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