[Accounting Reform Pros and Cons②] "Designated Audit Power Abuse" vs "Compliant Accounting Firms"

Sharp Increase in Audit Fees After Enforcement of the External Audit Act
Hourly Audit Fees Return to 2010 Levels

[Asia Economy Reporter Ji Yeon-jin] "(If a re-audit results in a refusal of the audit opinion, it leads to delisting, but who would dare report it fearing retaliation from the accounting firm? I understand that more audit fees are charged due to stricter reviews during re-audits, but charging 5 to 10 times more makes me suspect that negative audit opinions are being given intentionally.)" (CEO A of a KOSDAQ-listed company, requesting anonymity)

The External Audit Act (New External Audit Act), now in its fourth year since implementation, has been filling accounting firms' pockets and raising accountants' market value, prompting such complaints among companies. Since the introduction of the core provisions of the External Audit Act?the standard audit hours system and the periodic auditor designation system?audit fees charged by accounting firms have surged, especially in cases like re-audits or designated audits where companies have no choice but to pay excessively high fees.

In fact, audit fees have sharply increased since the External Audit Act was enacted. According to the Korean Institute of Certified Public Accountants, the average audit fee for listed companies rose 82% from 1.2234 billion KRW in 2017, just before the Act's enforcement, to 2.2363 billion KRW in 2020. A survey by the Korea Listed Companies Association showed an increase from 125 million KRW in 2017 to 283 million KRW last year, more than doubling. In the same survey, 94.2% of respondents said that the economic burden had increased due to the three major accounting regulations (introduction of standard audit hours, periodic auditor designation system, and strengthening of internal accounting control systems).

The accounting industry also has its say. While average audit fees have surged, hourly audit fees remain at levels seen 10 years ago. Hourly audit fees steadily declined from 102,000 KRW in 2008 to 78,000 KRW in 2017. In 2020, the hourly audit fee was 98,000 KRW, slightly lower than 99,000 KRW in 2010.

The introduction of International Financial Reporting Standards (IFRS) in 2011 led to increased audit hours, but fierce price competition among accounting firms resulted in the practice of so-called ‘accounting shopping,’ where companies choose accounting firms that suit their preferences. This ultimately led to the accounting fraud scandal at Daewoo Shipbuilding & Marine Engineering, the very case that triggered the creation of the External Audit Act.

Companies regard the three major accounting regulations under the External Audit Act as follows: the standard audit hours system mandates a minimum number of audit hours based on the company's industry and size; the periodic auditor designation system allows companies to freely select an accounting firm for six years but requires them to appoint a government-designated auditor for three years. Both systems were introduced to enhance audit quality and prevent collusion between accounting firms and companies for investor protection, but they are considered ‘extreme measures’ unprecedented worldwide.

Especially since the full-scale implementation of the periodic auditor designation system in 2020, the number of government-designated audits has significantly increased. Designated audits include both periodic auditor designation and ‘compulsory designation’ by the Securities and Futures Commission for companies found to have accounting fraud or irregularities. Last year, the number of companies under designated audits rose 29.5% year-on-year to 1,969.

This increase is due to the designation of periodic auditors for 220 companies, including Samsung Electronics, in 2020, with about 200 companies added annually to the periodic audit target list. The forced replacement of accounting firms and the rise in detected accounting fraud cases have contributed to this trend. Last year, more than half (51.1%) of listed companies subject to external audits were under designated audits. An accounting industry insider said, "Using audit fees as an excuse to undermine the External Audit Act means wanting to use compliant accounting firms like in the past." He added, "With the periodic auditor designation system, many cases of accounting fraud previously covered up by former accounting firms have come to light."

In fact, the embezzlement scandal at Osstem Implant, which shook the stock market earlier this year, was uncovered when the finance team leader, Mr. Lee (45), suddenly disappeared at the end of last year, just before the external auditor’s year-end balance confirmation. Mr. Lee embezzled 221.5 billion KRW by forging balance certificates and other documents. Lee Sang-ho, a research fellow at the Korea Capital Market Institute, evaluated, "With the expansion of reasons for compulsory designation and the implementation of the periodic designation system, the audit environment has strengthened, significantly increasing the likelihood of detecting embezzlement and breach of trust cases compared to before."