[Dimmed Accounting Reform]④Embezzlement Not Prevented Even with Strengthened Internal Accounting Control System

Occurrence of Embezzlement and Conclusion of 'No Significant Results'
Accounting Quality Improvement Only in Companies with Assets Over 2 Trillion Won

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The internal control over financial reporting system, whose certification level was strengthened from 'review' to 'audit' with the introduction of the new External Audit Act, shows no significant correlation between the enhanced certification level and the occurrence of embezzlement. Additionally, the effect on improving accounting quality was found to be limited.

According to the Korea Accounting Association's "Study on the Evaluation and Improvement Measures of Accounting Reform Systems," there was consistently "no significant result" regarding the relationship between the strengthened certification level of the internal control over financial reporting system and the occurrence of embezzlement. This conclusion was drawn from an investigation into discretionary accruals and embezzlement occurrences in companies with assets exceeding 2 trillion KRW, whose certification level was strengthened in 2019. The same findings were derived from a 2020 survey targeting companies with assets between 500 billion KRW and 2 trillion KRW, where the certification level was also enhanced.

When examining the effect on companies with assets over 2 trillion KRW, discretionary accruals?which reflect management's estimates or judgments to make the company's financial performance appear more favorable?were found to be lower than in the comparison group. This indicates a partial improvement in accounting quality. The closer the discretionary accruals are to zero in total amount, the more it is interpreted as an improvement in audit quality. However, for companies with assets between 500 billion KRW and 2 trillion KRW, a decrease in discretionary accruals was only confirmed in companies with assets over 2 trillion KRW.

Companies with assets under 100 billion KRW at the end of the previous fiscal year are exempt from audit

The internal control over financial reporting system refers to internal controls related to financial reporting that companies must establish to prepare and disclose reliable accounting information. It applies to publicly listed companies under the External Audit Act or unlisted companies with total assets of 100 billion KRW or more at the end of the previous fiscal year. The External Audit Act defines roles and responsibilities for the company, CEO, auditor (audit committee), and external auditor. The audit report on the internal control over financial reporting system is prepared separately from the financial statement audit report. The auditor directly verifies whether the system is effectively designed and operated and issues an audit opinion such as unqualified, qualified, or disclaimer of opinion depending on the scope limitations.

The mandatory audit is applied in stages: fiscal year 2019 (companies with assets of 2 trillion KRW or more at the end of the previous fiscal year), fiscal year 2020 (companies with assets between 500 billion KRW and 2 trillion KRW), and 2022 (companies with assets between 100 billion KRW and 500 billion KRW). Companies with assets under 100 billion KRW at the end of the previous fiscal year are exempt from audit.

Companies negatively evaluate due to costs and workload burdens

Companies have long argued that the implementation of external audits on the internal control over financial reporting system has increased costs and workload burdens. According to the accounting association's analysis, audit fees for companies with assets over 2 trillion KRW increased by 31.96% in 2019 compared to the previous year. For companies with assets between 500 billion KRW and 2 trillion KRW, audit fees increased by 48.77% in 2020 compared to the previous year, and for companies with assets under 500 billion KRW, fees rose by 28.58%.

Consulting costs for establishing the internal control over financial reporting system also increased. Consulting fees paid by companies to the Big Four accounting firms (Samil, Samjong, Han Young, Anjin) to build the system tended to surge sharply in the year before the audit was implemented according to asset size. For listed companies with assets over 2 trillion KRW, consulting fees for building the internal control system jumped from 2.399 billion KRW in 2017 to 34.617 billion KRW in 2018. For listed companies with assets between 500 billion KRW and 2 trillion KRW, fees rose from 1.071 billion KRW in 2018 to 23.969 billion KRW in 2019, and for those with assets between 100 billion KRW and 500 billion KRW, fees increased from 7.354 billion KRW in 2020 to 44.980 billion KRW in 2021.

Companies criticized, saying, "The audit of the internal control over financial reporting system was introduced without sufficient verification of the system's benefits or effectiveness," and "Contrary to the original purpose of improving the quality of accounting information, it has effectively turned into paperwork creation." A professor of business administration at a university in the Seoul metropolitan area explained, "The main purpose of the internal control over financial reporting system is to enhance the reliability of the financial statement preparation process rather than to prevent embezzlement," adding, "It is difficult to judge whether the system causes improvements in accounting quality because various factors are mixed." He further noted, "Since this is a topic where conclusions are hard to reach, it inevitably operates according to the policy authorities' objectives."

The Korea Accounting Association also evaluated, "The strengthened certification level has no significant correlation with the occurrence of embezzlement, and the improvement in accounting quality measured by discretionary accruals was only confirmed in companies with assets over 2 trillion KRW, raising questions about the system's effectiveness," adding, "The sharp increase in consulting costs and audit fees incurred during the establishment and operation of the internal control system reduces companies' willingness to accept the system."

They proposed alternatives including ▲unifying audit opinions on the internal control over financial reporting system on a consolidated basis ▲further deferring the implementation timing of the consolidated internal control system ▲introducing an audit grace period for companies subject to the internal control audit for the first time ▲establishing separate audit standards for medium-sized companies subject to the internal control system.