In its complaint, the SEC indicated that Xerox inappropriately used accounting reserves to…

In its complaint, the SEC indicated that Xerox inappropriately used accounting reserves to inflate earnings. Walter P. Schuetze noted in a 1999 speech:

 One of the accounting “hotspots” that we are considering this morning is accounting for restructuring charges and restructuring reserves. A better title would be accounting for general reserves, contingency reserves, rainy day reserves, or cookie jar reserves. Accounting for so-called restructurings has become an art form. Some companies like the idea so much that they establish restructuring reserves every year. Why not? Analysts seem to like the idea of recognizing as a liability today, a budget of expenditures planned for the next year or next several years in down-sizing , right-sizing , or improving operations, and portraying that amount as a special, below-the-line charge in the current period’s income statement. This year’s earnings are happily reported in press releases as “before charges.” CNBC analysts and commentators talk about earnings “before charges.” The financial press talks about earnings before “special charges.” (Funny, no one talks about earnings before credits—only charges.) It’s as if special charges aren’t real. Out of sight, out of mind (Speech by SEC Staff: Cookie Jar Reserves, April 22, 1999).

What responsibility do auditors have regarding accounting reserves established by company management? How should auditors test the reasonableness of accounting reserves established by company management?


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