Research Service on 'Periodic Designation System Relaxation'... Financial Services Commission "Reviewing Improvement Possibility and Measures"

[Asia Economy Reporter Lee Jung-yoon] Research results on the relaxation of the periodic auditor designation system, which requires companies to change their auditors periodically, have been announced.

The Korean Accounting Association held a symposium on "Evaluation and Improvement Plans for Accounting Reform Systems" on the 10th at the Federation of Korean Industries Building in Yeouido, where the "Evaluation and Improvement Plans for Accounting Reform Systems" were presented. This research was commissioned by the Financial Services Commission, with Professor Jeong Seok-woo of Korea University Business School, Professor Oh Myung-jeon of Sookmyung Women's University Department of Business Administration, and Professors Hwang Moon-ho and Choi Seung-wook of Kyung Hee University Department of Accounting and Taxation participating.

The research team proposed a specific improvement plan for the periodic designation system to extend the free appointment period from the current 6 years to 9 years. The team explained, "Many prior studies have reported that the continuous audit period during which audit quality is maintained is over 6 years, and the auditor regulation cycle in European countries is 10 years. Our analysis found no significant difference in audit quality based on the continuous audit period before designation. Therefore, even if the free appointment period is extended to a relatively long 9 years, it is expected not to significantly undermine accounting transparency."

Another alternative proposed was to reduce the auditor designation period from 3 years to 2 years. This is because the research analysis found no significant difference in audit quality between the 2nd and 3rd years of designation.

The research team also stated, "Considering that the domestic auditor appointment method is basically a free appointment system, there is a need for measures to ease the proportion of designated audits exceeding 50%," adding, "Measures should be prepared to prevent conflicts between companies and designated auditors and to curb inappropriate behavior by designated auditors."

They also saw the need to adjust the reasons for ex officio designation. The team noted, "Due to the continuous expansion policy of designated targets, there are currently 27 reasons for ex officio designation, and as of 2021, 1,295 companies were selected as ex officio designation targets." They added, "Since the periodic designation system has been introduced and the auditor designation system is becoming a generally applied accounting system for all listed companies, the ex officio designation system, which has been maintained as a punitive accounting supervision measure, needs a comprehensive re-examination of the justification for each reason."

However, the research team explained, "At this point, due to limitations in analysis, policy judgment is required, and a more in-depth analysis must be conducted again 3 to 5 years after the designation system has been sufficiently implemented."

Furthermore, they called for measures to prevent inappropriate behavior by designated auditors. Regarding excessive audit fee claims by designated auditors, they explained that the standard audit hours system should be operated consistently to ensure a thorough agreement process on audit hours, and that designated auditors' audit fees should be subject to external monitoring to induce self-regulation. Regarding inappropriate audit work by designated auditors, they proposed establishing and operating a company-auditor conflict mediation committee as a neutral arbitration body.

The periodic auditor designation system has been implemented under the revised External Audit Act (New External Audit Act) enacted in November 2018. It was introduced as part of a comprehensive revision of the External Audit Act to enhance accounting transparency and reliability following the Daewoo Shipbuilding & Marine Engineering accounting scandal in 2015. If a company freely appoints an auditor for six consecutive years, it must have an auditor designated by the financial authorities for the next three years. Although the introduction of the periodic auditor designation system has been credited with improving accounting transparency, companies have expressed dissatisfaction due to significant increases in audit hours and fees.

A Financial Services Commission official attending the symposium said, "We are reviewing the necessity and possible improvements of the current accounting system, including the periodic auditor designation system," but added, "No specific measures have been decided yet." The official further stated, "The government will comprehensively consider the contents discussed in the task force (TF), research results, and opinions raised to make future decisions."