[Exclusive] Periodic Auditor Appointment System Likely to Remain... Outline of Accounting Reform Improvement Plan Emerges

Financial Services Commission to Announce Accounting Reform Improvement Plan by End of June
Maintaining Current Periodic Designation System of 6 Years Voluntary + 3 Years Mandatory
Reduction in Ex Officio Designation Reasons... Exemption from Internal Accounting Audit for Listed Companies Under 2 Trillion Won Consolidated Standards

The Korean Accounting Association held the symposium "Evaluation and Improvement Plans for Accounting Reform Systems" on February 10 at the Federation of Korean Industries Building. Photo by Lee Jung-yoon

The effect of the accounting reform system introduced under the new External Audit Act (amendment to the External Audit Act) has not been significant, while the difficulties faced by the business community have been substantial. As a result, financial authorities plan to announce an improvement plan focused on 'relaxation' at the end of June. The periodic designation system will be maintained as is, and the reasons for discretionary designation will be reduced. The audit of the internal accounting control system on a consolidated basis for listed companies with assets under 2 trillion won will also be deferred.

According to financial authorities, the financial investment industry, and the accounting industry on the 30th, the 'Accounting Reform Evaluation and Improvement Task Force,' formed by the Financial Services Commission last September with companies, the accounting industry, and academia, will announce the accounting reform improvement plan at the end of June. According to research commissioned by the Financial Services Commission to the Korean Accounting Association, while the effects such as improvement in audit quality were not clearly confirmed, the burden on companies increased significantly, with audit fees, audit hours, and hourly audit fees all rising, so the focus is expected to be on 'relaxation.'

A source familiar with the financial authorities said, "It was concluded to maintain the periodic designation system as it is, considering that one cycle must pass since the system was implemented and that legal amendments are necessary," adding, "Since opposition from companies wanting abolition is expected, the reasons for discretionary designation will be reduced instead." He added, "There is a tense standoff between the accounting industry and companies regarding the internal accounting control system, and the financial authorities are deeply concerned, but ultimately the focus was placed on relaxation."

Periodic Designation System '6+3' Maintained... Business Community "Very Disappointed"

The periodic auditor designation system, which was fully implemented in 2019, is a system where if a company autonomously appoints an auditor for six consecutive years, the financial authorities designate the auditor for the next three years. It was introduced under the amended External Audit Act (new External Audit Act), implemented in November 2018, triggered by the Daewoo Shipbuilding & Marine Engineering accounting fraud scandal. Since the introduction of this system, there have been evaluations that accounting transparency has improved, but companies have consistently raised complaints about significantly increased audit hours and costs. There have also been complaints about increased excessive document requests by auditors.

A company official expressed dissatisfaction, saying, "Due to a lack of understanding of the company, there is considerable inefficiency during the inspection process, and disagreements with the previous auditor occur frequently, leading to frequent restatements of financial statements." Another company official lamented, "The designated auditor is high-handed and makes many unilateral claims, even requesting documents that have never been requested before."

The Korean Accounting Association also acknowledged, "As of 2021, the proportion of designated auditors (periodic and discretionary designation) among listed companies exceeded 50%, and there are opinions that audit fees have sharply increased and auditors' excessive and unreasonable requests have increased due to the appointment of designated auditors. Considering that the auditor appointment method is basically a free appointment system, there is a need to ease the designated auditor system, which exceeds 50%."

The accounting industry proposed expanding the free appointment period of the periodic auditor designation system from the current six years to nine years or shortening the designation period from the current three years to two years. However, shortening the designation period to two years can be done by enforcement decree, but expanding the free appointment period to nine years requires a legal amendment. In particular, the business community views shortening the designation period to two years as practically meaningless, judging that frequent changes would increase fatigue. Moreover, audit contracts are conducted on a three-year cycle.

The business community wanted to abolish this system, which exists only in Korea, arguing that it artificially distorts the audit market and escalates conflicts between auditors and companies. A company official said, "Although it has been proven by previous research results, the voices from the field say that the effect of improving accounting transparency cannot be confirmed or felt. The periodic designation system is ultimately a system where authorities artificially intervene in the market, and since it is unsustainable, there is a need to seek a fundamental accounting supervision method to replace it."

The Financial Services Commission concluded that increasing the period to nine years is difficult due to the need for legal amendments and concerns about various adverse effects. Furthermore, it agreed with the business community's view on shortening the period to two years. However, it drew a line on abolition. A senior official from the accounting industry said, "The Korean Accounting Association directly requested the Financial Services Commission to reanalyze based on accumulated data after one cycle of the periodic designation system has been sufficiently implemented and to conduct a comprehensive review based on this," adding, "The Financial Services Commission also concluded to maintain the periodic designation system as is."

A senior company official said, "Despite the current government's policy direction aiming for global standards in corporate regulation, the National Assembly Legislative Research Office and the Korean Accounting Association decided to maintain the world's only abnormal system with a 'wait and see' stance, ignoring the voices and realities of severe inefficiency and cost burdens in the field, which is very disappointing," adding, "We hope the Financial Services Commission will review the cost-benefit of the periodic designation system as soon as possible (within 2-3 years) and reach a conclusion."

Reasons for Designation Expected to Decrease from Current 27

The reasons for designation will be reduced from the current 27. The discretionary designation system is a system where auditors are designated when a fair audit is necessary to protect investors, based on 27 discretionary designation reasons such as audit designation measures following the Securities and Futures Commission's inspection results, failure to appoint an auditor within the appointment deadline, planned listing, management item status, and three consecutive business years of operating losses (financial basis). Since the periodic designation system is set to be maintained as is, this is interpreted as a measure to reduce the burden on companies.

As a relaxation improvement plan for the internal accounting control system, deferral of the audit of the internal accounting control system on a consolidated basis for listed companies with assets under 2 trillion won is being considered. The internal accounting control system refers to internal controls designed and operated to prepare and disclose reliable financial statements. It requires verification of the design and operation of internal controls over accounting information, including reports on the operation status of the internal accounting control system, through accounting firms. Under the new External Audit Act, the certification level was strengthened from 'review' to 'audit.' The separate internal accounting control system was implemented in 2019. From this year, the consolidated internal accounting control system will be implemented for listed companies with assets of 2 trillion won or more. Subsequently, it is scheduled to be implemented for companies with assets of 500 billion won or more in 2024 and for all listed companies in 2025. The scope of internal accounting control system operation for unlisted companies is limited to separate (individual) corporate financial information.

There has been intense conflict between the accounting industry and the business community regarding the internal accounting control system. The accounting industry argues that the demand for internal accounting control has increased due to several embezzlement incidents such as Osstem Implant and Woori Bank. They foresee that if the system is relaxed, the purpose of enhancing corporate transparency, which was the reason for introducing the system, will be weakened. Although there is a cost burden on companies, they argue that the system must be operated as planned to create a capital market trusted not only domestically but globally and to ensure sustainable management.

The business community opposes this, especially showing strong resistance to the consolidated internal accounting control system. A company official claimed, "It is premature when the separate internal accounting control system has not yet been fully established."

The strong resistance is mainly due to cost issues. While welcoming the system improvement aspect, they argue that considering cost-benefit, abolition rather than deferral of the consolidated internal accounting control system is desirable. It is known that large companies with total assets of 2 trillion won or more have about 100 to 400 subsidiaries, and if the system is established for all these companies for the consolidated internal accounting control system, the cost burden will increase relative to the benefits, and practical difficulties will increase.

They also emphasize that the circumstances of the United States, which introduced the consolidated internal accounting control system earlier than Korea, and domestic companies are different. The consolidated internal accounting control system includes overseas subsidiaries, but if there is no obligation for internal accounting control under local laws, the resistance of those subsidiaries is high, making it difficult to establish the internal accounting control system. While the consolidated basis is common in the U.S., both separate (individual) and consolidated bases are used in Korea, creating different audit environments. Under these circumstances, unless a company belongs to a country with economic power and national credibility like the U.S., it is difficult to effectively and practically perform the consolidated internal accounting control system for overseas subsidiaries.

There is also a response that since U.S. companies often own 100% of subsidiary shares, whereas many Korean companies have less than 100% ownership in subsidiaries, it is difficult to impose the consolidated internal accounting control system on subsidiaries like U.S. companies. Additionally, the business community said, "In the U.S., based on consistent research results showing cost burdens on small companies, the scope of audit exemptions for small companies is continuously expanding."

In this situation of intense conflict over the internal accounting control system, the financial authorities' shift toward relaxing the system is interpreted as a conclusion that resolving corporate difficulties is more desirable in the current economic situation despite opposition from the accounting industry. Professor Jeong Do-jin of Chung-Ang University's Department of Business Administration explained, "The internal accounting control system was introduced on the premise that if internal management is not done, external parties cannot correct erroneous accounting treatments. However, since individual companies can sufficiently detect errors, applying this on a consolidated basis at this point is judged to incur more costs than benefits." He added, "Social costs vary depending on the situation, and at that time, it was not a period of interest rate hikes. If the system is announced to be implemented after the economy stabilizes, the financial authorities' judgment seems appropriate."