[Square] Three Years of the New External Audit Act... Corporate Accounting, Communication Not Regulation

Jeong Eun-bo, the newly appointed Governor of the Financial Supervisory Service (FSS), emphasized in his inauguration speech last month that "the essence of financial supervision is support, not regulation," and warned that "relying on ex-post sanctions can weaken consumer protection." He also called for "thoroughly gathering opinions through dialogue with the market and actively reflecting expert advice" to restructure the financial supervision system.

As the FSS Governor stated, it is now hoped that corporate accounting will shift from being a subject of regulation to one of communication. Corporate accounting has been governed by the External Audit Act enacted in the late 1980s. However, the External Audit Act shifted the responsibility for accounting transparency, which should be borne by companies, onto accountants, becoming the root cause of accounting fraud. The practice began where companies did not prepare financial statements themselves, but accountants prepared them and then audited their own work. The limitations of the External Audit Act led to the introduction of the new External Audit Act. Despite numerous amendments since the enactment of the External Audit Act, the 2017 amendment is called the new External Audit Act because it shifted corporate accounting transparency from being ‘accountant-centered’ to ‘company-centered.’ However, although the new External Audit Act shifted focus to companies, it still pursues corporate accounting transparency under a ‘supervisor-led’ rather than ‘company-led’ approach.

The main product of the new External Audit Act, the ‘periodic designation system,’ refers to a system where companies appoint an accountant for six years, after which the supervisory authority designates the accountant for three years. In the periodic designation system, the role of companies is not visible. Before the periodic designation system was legislated, the selective designation system was mainly discussed. The selective designation system allows companies to recommend three accounting firms, from which the supervisory authority designates one as the auditor. Here, the role of companies is clearly present. However, while the selective designation system was being discussed, the periodic designation system was legislated. This shows that corporate accounting is still handled within a supervisor-led rather than company-led framework.

A study published last November showed that only 18.2% of companies support the periodic designation system. This highlights the need for communication with the market, as emphasized by Governor Jeong. Another major provision of the new External Audit Act is the standard audit hours. Standard audit hours refer to the standard time that should be invested in an audit, but in practice, they are perceived as minimum audit hours, and even audit time is approached from a supervisory perspective. For the standard audit hours to function as a true standard, the audit committee of the company, which has the authority to appoint accountants, must be able to perform its proper role, necessitating improvements to the standard audit hours system.

The balanced ex-ante and ex-post supervision advocated by Governor Jeong has also been declared by previous heads. Why is this declaration repeated? It stems from the supervisory authority’s distrust of the market. It has been 11 years since the introduction of principle-based International Financial Reporting Standards (IFRS) in corporate accounting. Initially, due to confusion over principle-based standards, the supervisory authority had to take the lead in interpreting the standards. However, the application and interpretation of accounting standards are still carried out under supervisory leadership rather than company leadership.

To resolve this, three proposals are made. First, ex-post supervision of accounting treatments from past years that are not reported in business reports should be minimized. If this is a matter of interpretation, it should be avoided even more. Second, the investigation period for accounting treatments should be reasonable. There are cases where accounting investigations last for several years. Tax audits and audits by the Board of Audit and Inspection are conducted within a certain period, and if the period is exceeded, internal and external approval procedures are followed. Accounting investigations should also have a clear period, and strict approval should be required for any extension. Lastly, the reason financial authorities cannot move away from ex-post supervision is inevitably linked to the evaluation system. It means that even if it is unreasonable, sanctions must be imposed to receive a high performance rating. Under such an evaluation system, focus can only be on ex-post supervision rather than ex-ante supervision. I sincerely hope that the support rather than regulation, the harmony of ex-ante and ex-post supervision, and communicative supervision declared by the new FSS Governor Jeong will succeed this time.

Jeong Do-jin, Professor, Department of Business Administration, Chung-Ang University