[Dimmed Accounting Reform]③ "Interpreted as contributing to quality improvement due to increased audit time" Accounting Association also withholds evaluation

Increase in Audit Hours and Fees, Quality Improvement After Introduction of Standard Audit Time System
Expert: "Quality Competition Incentives Disappear... Sunset Clause Needed"

[Photo by Unsplash]

Since the introduction of the standard audit hours system, audit hours and fees have increased, and there has been a growing tendency toward quality improvement. However, companies express skepticism about the effectiveness, stating that only a tendency exists without a clear correlation. They also claim that the system's implementation has caused significant difficulties.

According to the Korean Accounting Association's "Study on the Evaluation and Improvement Measures of Accounting Reform Systems," the positive relationship between audit hours and audit fees, hourly audit fees, and audit quality has strengthened since the introduction of the standard audit hours system. The average audit hours for the entire sample of 13,526 companies from 2014 to 2018, before the system's introduction, were 1,526.9 hours, which increased to 2,049.8 hours from 2019 to 2021 after the system was implemented. The average audit fee also rose from 115.58 million KRW to 190.71 million KRW during the same period, and the average hourly audit fee increased from 78,900 KRW to 94,000 KRW.

Tendency for Discretionary Accruals to Decrease as Audit Hours Increase

Additionally, as audit hours increased, there was a tendency for discretionary accruals to decrease, and this relationship was found to have strengthened further after the introduction of the standard audit hours system. Discretionary accruals refer to adjustments reflecting management's estimates or judgments regarding the timing of revenue recognition or asset and liability valuations, which can make a company's financial performance appear more favorable. The closer the discretionary accruals converge to '0' on a total basis, the more it indicates that company management made minimal such adjustments to the financial statements, serving as an indicator of improved audit quality.

However, the Korean Accounting Association did not present a clear causal relationship that the decrease in discretionary accruals after the introduction of the standard audit hours system directly led to improved audit quality. The association explained, "This result suggests that the increased audit hours due to the introduction of the standard audit hours system contribute to the enhancement of audit quality," leaving room for interpretation.

"Only a Tendency Exists, but No Clear Correlation Established"

Moreover, an analysis showed that while the likelihood of audit adjustments increases as audit hours increase, this relationship weakens after the introduction of the standard audit hours system. The Korean Accounting Association stated, "This result can be understood as indicating that the effect of improved audit quality with increased audit hours is perceived as diminishing." In response, companies argue, "It only shows a tendency that audit quality improves as audit hours increase, but it does not clarify whether the standard audit hours system is related to audit quality improvement." The extent of audit adjustments is measured by the proportion of companies where the difference in net income before and after audit adjustments exceeds 5%. A larger adjustment degree suggests lower reliability of the financial statements prepared by the company, and a strong tendency for audit adjustments before the system's introduction is interpreted as an effect of the standard audit hours system.

Companies also claim that skepticism about the standard audit hours system and issues with its application have led to low acceptance, and conflicts between auditors regarding appropriate audit hours for each company are increasing. According to the External Audit Act, the Korean Institute of Certified Public Accountants (KICPA) must review the validity of the standard audit hours every three years after setting them and make adjustments accordingly. If actual audit hours fall significantly short of the standard audit hours, it may be grounds for auditor designation.

The KICPA classifies companies into 11 groups based on company size and listing status and calculates the standard audit hours by reflecting adjustment factors such as connection status, number of subsidiaries, proportion of high-risk accounts, holding company status, initial audit status, current net loss status, and adverse opinion status on top of the basic time calculated by company size and industry for each group. The final standard audit hours are determined by considering the characteristics of the individual audit team, the company's specific traits, and unique environment. A business official criticized, "Although the standard audit hours are based on law and are merely a reference with a rough audit time calculation method, companies are being forced to treat them as minimum audit hours."

The Korean Accounting Association has also recognized these issues. The association stated, "The standard audit hours calculated according to the regulations are not an absolute standard that must be uniformly applied to all companies," and added, "It is necessary to amend provisions related to mandatory norms included in the External Audit Act, KICPA bylaws, and code of conduct to clearly indicate that the standard audit hours serve as guidelines." They also proposed measures to enhance the process of agreeing on audit hours between auditors and companies, such as listening to stakeholders' opinions when setting standard audit hours and documenting the basis for the planned input hours.

"The Audit Market Is Also a Market... Uniform Time Determination Is Inappropriate"

Along with doubts about clear causal relationships and various difficulties raised, there are suggestions for introducing a sunset clause. Professor Jeong Do-jin of Chung-Ang University's Department of Business Administration said, "Since the audit market is also a market, quality competition should occur, but setting uniform audit hours through the standard audit hours system is inappropriate," adding, "If a minimum time is guaranteed, the incentive to compete on quality disappears." He further explained, "If it becomes clear when the system will end, accounting firms will strive to decide what competitiveness they will have in terms of price or audit quality."