Xerox Corporation is a long-established company whose very name has been lent to the process of copying documents. The firm develops copying technology through an extensive research program and manufactures and markets a large range of document processing products. Many of its sales are made with lease financing arrangements through its Xerox Credit Corporation in the United States and through other subsidiaries worldwide. The firm's traditional black and white lens copiers (which provided 40 percent of revenues in 1999) were under challenge in the late 1990s from new digital technology, and Xerox de- veloped digital copiers, printers, and production publishers in response. Xerox initiated a major restructuring of its operations in 1998, and the implementation of the restructuring caused some difficulties in the field. In 1999, total revenues of $19.2 billion were down 1 percent from $19.4 billion in 1998. An announcement that revenues would not meet expectations in October 1999 resulted in a 24 percent share price drop. During 1999 Xerox's share price dropped from $59 to $24. However, income from continuing operations for the full 1999 year, ending December 31, was $1.43 billion, up from $585 million in 1998. Xerox's income statements for 1997, 1998, and 1999 are reproduced in Exhibit 17.4, along with sections of its cash flow statements. Also given are extracts from the 1999 footnotes, XEROX CORP Income Statements (in milions, except per share data) Year Ended December 31 1999 1998 1997 Revenues Sales Service and rentals $10,346 $10,696 $ 9,881 7,856 7,678 7,257 Finance income Total revenues Costs and expenses Cost of sales 1,026 1,073 1,006 19,228 19,447 18,144 5,744 5,562 5,330 Cost of service and rentals 4,481 4,205 3,778 Inventory charges 0 113 0 Equipment financing interest 547 570 520 Research and development expenses 979 1,040 1,065 Selling, administrative, and general expenses 5,144 5,321 5,212 Restructuring charge and asset impairments 0 1,531 0 Other, net 297 242 98 Total costs and expenses 17,152 18,684 16,003 Income before income taxes, equity income, and minority interests 2,036 763 2,141 Income taxes 631 207 728 Equity in net income of unconsolidated affiliates 68 74 127 Minority interests in earnings of subsidiaries Income from continuing operations Discontinued operations Net income 49 45 88 1,424 585 1,452 (190) $1,424 395 0 $1,452 Partial Cash Flow Statements (in milions) Year Ended December 311 Cash flows from operating activities Income from continuing operations Adjustments required to reconcile income to cash flows from operating activities 1999 1998 1997 $1,424 $ 585 $1,452 Depreciation and amortization 935 821 739 Provision for doubtful accounts 359 301 265 Restructuring charge and other charges. 0 1,644 0 Provision for postretirement medical benefits, 41 33 29 net of payments Cash charges against 1998 restructuring reserve (437) (332) Minorities' interests in earnings of subsidiaries 49 45 88 Undistributed equity in income of affiliated companies (68) (27) (84) Decrease (increase) in inventories 58 (558) (170) increase in on-lease equipment (401) (473) (347) Increase in finance receivables (1,788) (2,169) (1,629) Proceeds from securization of finance receivables 1,495 0 0 Increase in accounts receivable (94) (540) (188) (Decrease) increase in accounts payable and accrued compensation and benefit costs (94) 127 250 Net change in other current and noncurrent liabilities 277 (192) Change in current and deferred income taxes (78) 67 Other, net (464) (497) Total 1,224 (1,165) Cash flows from investing activities Cast of additions to land, buildings, and equipment Proceeds from sales of land, buildings, (594) (566) *** 361 (377) 472 (520) and equipment 99 74 36 Acquisitions, net of cash acquired (107) 13901 (812) Other net (25) 5 Total $ (627) $ (867) 45 $1.251)

Peruse the statements and footnotes. What questions arise about the quality of the ear ings reported in 1998 and 1999? Extracts from Footnotes The following footnote extracts refer to 1999. Dollar amounts are in millions. 2 Restructuring In 1998, we announced a worldwide restructuring program intended to enhance our competi- tive position and lower our overall cust structure. In connection with this program, we recorded a pretax provision of $1,644. The program includes the elimination of approxi- mately 9,000 jobs, net, worldwide, the closing and consolidation of facilities, and the write down of certain assets. The charges associated with this restructuring program include $113 of inventory charges recorded as cost of revenues and $316 of asset impairments. Included in the asset impairment charge is facility fixed asset write-downs of $156 and other asset write- downs of $160. Key initiatives of the restructuring include: 1. Consolidating 56 European customer support centers into one facility and implementing a shared services organization for back-office operations 2. Streamlining manufacturing, logistics, distribution, and service operations. This will in- clude centralizing US. parts depots and outsourcing storage and distribution. 3. Overhauling cur internal processes and associated resources, including closing one of four geographically organized US. customer administrative centers. The reductions are occurring primarily in administrative functions, but also impact service, research, and manufacturing. The following table summarizes the status of the restructuring reserve (in millions): Charges Total against Reserve Reserve 12/31/99 Balance Severance and related costs $1,017 $717 $300 Asset impairment 316 316 Lease cancellation and other costs 198 104 94 Inventory charges 113 113 0 Total $1,644 $1,250 $394 5 Finance Receivables, Net Finance receivables result from installment sales and sales-type leases arising from the marketing of our business equipment products. These receivables generally mature over to to five years and are typically collateralized by a security interest in the underlying assets. The components of finance receivables, net at December 31, 1999, 1998, and 1997 follow: 1997 1999 1998 Gross receivables $14,666 $16,139 $14,094 Unearned income (1.677) (2,084) (1,909) Unguaranteed residual values 752 699 557 Allowance for doubtful accounts (423) (441) (389) Finance receivables, net 13,318 14,313 12,353 Less current portion 5.115 5.220 4.599 Amounts due after one year, net 58,203 $ 9.093 $ 7,754 6 Inventories The components of inventories at December 31, 1999, 1998, and 1997 follow: Finished goods Work in process Raw materials Equipment on operating leases, net Inventories 1999 1998 1997 $1,800 $1,923 $1,549 122 111 97 363 454 406 676 771 740 $2,961 $3,269 $2,792 7 Investments in Affliates, at Equity Investments in corporate joint ventures and other companies in which we generally have a 20 to 50 percent ownership interest at December 31, 1999, 1998, and 1997 follow: Fuji Xerox Other investments Investments in affiliates, at equity 1999 $1,513 1998 $1,354 1997 $1,231 102 102 101 $1,615 $1,456 $1,332 Xerex Limited owns 50 percent of the outstanding stock of Fuji Xerox, a corporate joint venture with Fuji Photo Film Co. Ltd. (Puji Photo). Fuji Xerox is headquartered in Tokyo and operates in Japan and other areas of the Pacific Rim, Australia, and New Zealand, except for China. Condensed financial data of Puji Xerox for its last three fiscal years follow. 1999 1998 1997 Summary of operations Revenues $7,751 $6,809 $7,415 Costs and expenses 7,440 6.506 6,882 Income before income taxes 3111 303 533 Income taxes 201 195 295 Net income $110 $108 $ 238 Balance sheet data Assets Current assets $3,521 $2,760 $2,461 Noncurrent assets 3,521 3,519 2,942 Total assess 57,042 $6,279 $5,403 Liabilities and shareholders' equity Current liabilities $2.951 $2.628 $2,218 Long-term debt 169 101 286 Other noncurrent liabilities 1,079 1,028 679 Shareholders' equity 2,843 2.522 2,220 Total liabilities and shareholders' equity $7,042 $6,279 $5,403 8 Segment Reporting Our reportable segments are as follows: Core Business, Fuji Xerox, Paper and Media, and Other. Document Processing Segments 1999 Core Fuji Paper Business Xerox and Media Other Information about profit or loss Revenues from external customers Finance income Intercompany revenues Total segment revenues $15,224 $ 0 $1,148 $1,830 1,016 0 0 10 (206) 0 0 206 16,034 0 1,148 2,046 Depreciation and amortization 930 0 0 5 Interest expense 803 0 0 0 Segment profit (loss) 2,014 0 62 (40) Earnings of nonconsolidated affiliates 13 $55 D 0 Information about assets Investments in nonconsolidated affiliates Total assets Capital expenditures 102 25,319 1,513 1,513 580 0 0 1,896 14