Part VI Case Studies
Case VI.1 Xerox Miscopies Foreign Interest Rate Data
On May 31, 2001, Xerox disclosed in a filing
with the Securities and Exchange Commission
(SEC) that several years earlier it had changed
the way in which some of its foreign affiliates
booked revenues from copiers leased to cus-
tomers. The company said that the effect of
this change in accounting practices, which
involved changing the discount-rate assump-
tions on its leases, was to add $253 million to
Xerox’s pretax income over the past three years.
In response, the SEC launched an investiga-
tion to determine if Xerox changed its lease-
accounting assumptions in order to artificially
boost revenues and profits in Latin America
and elsewhere. A Xerox spokesman stated that
the company had used proper accounting
where
Pthe price of the copier
Rthe residual value in present value terms
nthe number of months in the lease
rthe monthly interest rate imbedded in the
lease
To illustrate, suppose the implicit interest
rate is 12% (1% monthly), the lease term is
five years, the price is $10,000, and the resid-
ual value in present value terms is $2,000.
Substituting these numbers into the equation
yields a monthly lease payment of $178. The
value of the lease receivable given the lease
payments and assumed residual value in this
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Case VI.1 •Xerox Miscopies Foreign Interest Rate Data 711
assumptions were used in other foreign units
as well to book revenues and value their lease
Questions
1. What is the purpose and consequence of
using a discount rate that is close to the mar-
ket interest rate in valuing lease rentals?
2. Why were interest rates so high in Mexico in
the late 1990s? What factors were built into
these interest rates?
3. Assuming a $10,000 copier price and $3,500
residual value in present value terms, what
was the consequence of Xerox Mexico book-
ing peso revenues using interest rates of
18% in 1997, 10% in 1998, and 6% in 1999
instead of the comparable Mexican interest
rates during this period of 34.4% in 1996,
22.5% in 1997, 24.5% in 1998, and 24.1%
in 1999? That is, on each $10,000 copier
lease, how much revenue did Xerox Mexico
book in each? Compare those figures to their
present values using the market rates.
$3,500 residual value in present value terms,
how much revenue was booked by using
a 6% discount rate on a 60-month lease?
Compare this figure to its present value using
a 30% discount rate.
5. How did the use of low discount rates help
managers at Xerox Mexico get their bonuses?
How might these low discount rates affect the
amount of exchange risk that managers were
willing to tolerate?
6. Suppose Xerox tried to sell its foreign lease
receivables to an investor. What could you
say about the price it would likely receive as
compared to their book values? Explain.
7. Do you agree or disagree with Xerox’s claim
that it used proper accounting assumptions
in booking its revenues and recording asset
values for foreign lease receivables? Explain.
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