[Chatham House Roundtable] "Designated Audit System, Multiple Auditor Recommendations... Audit Cycle Should Be Extended"

Conflicts Arise Over Periodic Auditor Appointment System After New External Audit Act Enforcement
Growing Corporate Complaints Over Increased Time and Costs Without Assurance of Audit Quality
Need for Improvements on Uniform Auditor Appointment and Short Audit Cycles

Editor's NoteWith the introduction of the periodic auditor designation system (designated audit system), complaints from companies have been growing that only time and costs have increased without any guarantee of audit quality. The designated audit system is a system where listed companies, etc., that have autonomously appointed auditors for six years must have their auditors designated by the Financial Services Commission for the next three years. It was introduced with the intention of preventing incidents such as accounting fraud by reducing the possibility of collusion between companies and accounting firms. However, four years after the system's implementation, the audit market is experiencing significant side effects that undermine market competition. Factors such as the designation of auditors unsuitable for the company's status and excessive strengthening of auditor authority have emerged as sources of conflict. Although the system was initially introduced to prevent corporate arbitrariness, the balance has now tipped excessively toward auditors. On the 21st, Asia Economy held a 'Chatham House Roundtable' at its headquarters in Jung-gu, Seoul, to discuss the institutional achievements, side effects, and improvement measures following the implementation of the periodic auditor designation system. The Chatham House is a nickname for the Royal Institute of International Affairs (RIIA) in the UK, regarded as a top research institution in diplomacy and security. The roundtable was attended by Bae Hong-gi, CEO of Seohyun Accounting Corporation; Jeong Do-jin, Professor of Business Administration at Chung-Ang University; Jeong Seok-woo, Professor of Business Administration at Korea University; and Jeong Woo-yong, Vice Chairman of Policy at the Korea Listed Companies Association (in alphabetical order). The roundtable followed the Chatham House rule, disclosing the list of participants but anonymizing each speaker's remarks.

On February 21, at the Asia Economy headquarters in Jung-gu, Seoul, participants are sharing their opinions on the issues and improvement measures of the mandatory rotation system for auditors during the 'Chatham House Roundtable.' From the left, clockwise: Baehonggi, CEO of Seohyun Accounting Corporation; Jeong Seok-woo, Professor at Korea University Business School; Jeong Wooyong, Vice Chairman of Policy at the Korea Listed Companies Association; and Jeong Dojin, Professor at Chung-Ang University Department of Business Administration. Photo by Yoon Dong-ju doso7@

At the 'Chatham House Roundtable' held on February 21 at the Asia Economy headquarters in Jung-gu, Seoul, participants are sharing their opinions on the issues and improvement measures of the periodic auditor designation system. From the left, clockwise: Baehonggi, CEO of Seohyun Accounting Corporation; Jeong Seok-woo, Professor at Korea University Business School; Jeong Woo-yong, Policy Vice Chairman of the Korea Listed Companies Association; Jeong Do-jin, Professor at Chung-Ang University Business Administration Department; Lee Seon-ae, Head of Securities Capital Market Department. Photo by Yoon Dong-ju doso7@

▶Moderator = Lee Seon-ae, Head of Securities and Capital Markets Department

Since the enforcement of the new External Audit Act, the periodic auditor designation system has been identified as the biggest source of conflict. Do you think the system needs improvement?

It is difficult to consider all companies on the same level, but the biggest issue raised is that audit costs have increased too much. Especially for small and medium-sized enterprises, the costs are a significant burden. The second issue is expertise. While accountants have expertise, each has specialized fields by industry. When auditing an unfamiliar company for the first time, time is needed to understand it. For large companies, it takes one to two years just to grasp the situation. In conclusion, companies should not be treated uniformly but categorized accordingly.

For example, in the distribution sector, it does not take long for a new external auditor to learn the business. However, platforms take a long time to understand. Is it really appropriate to uniformly set the designated audit period to three years? Different industries require different periods. Secondly, due to time constraints, sometimes the quality of reports feels lacking. I question whether the current structure, where the designated auditor serves three years and then is replaced, is appropriate. I do not see the validity of the system in these respects.

It might be meaningful to look at the purpose behind the creation of the designated audit system. When the law was enacted, large-scale accounting fraud incidents were continuously occurring, mainly in order-receiving industries such as shipbuilding and construction. Although South Korea's economy ranks in the top 10 globally, accounting fraud incidents kept happening, and transparency surveys consistently placed Korea at the bottom. The system started as a reflection on the failure to achieve accounting transparency befitting Korea's status. Various measures were proposed. There was a six-year periodic mandatory replacement system, but since incidents continued, the designated audit system was introduced as a last resort. Another aspect is audit quality. Accounting audits are a public good for social trust. The backlash against the designated audit system may stem from a lack of perception that audits are a public good. The cost bearer is the company, but the actual users are third parties such as investors. This lack of recognition of audits as a public good may have caused disagreements between external auditors and companies.

No one can deny that point. It is naturally a public good. However, how to achieve that, what roles participants have, and what level of responsibility is assigned are important. There must be mutual agreement on roles and responsibilities before the system is introduced. If the system is introduced first, related debates will just swing back and forth like a pendulum. In fact, no country protects the audit market with an external audit law as we do. Previously, auditors were in a subordinate position when contracting with companies. If a company requested certain accounting treatments, auditors could not refuse. There were also cases where accountants died from overwork and stress during audits. The designated audit system was introduced in this context. Previously, the pendulum was on the right, and it would have been good if the system brought it to the center, but companies say it has swung too far to the left. Regarding excessive audit fee increases, the cost increase is due not only to the designated audit system but also to internal accounting control systems and standard audit hour systems. When discussing the designated audit system, I regret that the contentious issue of the term?whether '6+3' or '9+3'?was not discussed more leisurely before implementation.

An important point from your remarks is that we must first consider stakeholders. Social sciences are based on personal experience and subjectivity, so there is no absolute answer. Therefore, in creating social science institutions or policies, healthy discussions among stakeholders are fundamental to legitimacy. Your suggestion to take it slowly can be interpreted that way. We should consider how much healthy discussion among stakeholders there was when the system was first introduced. Especially last year, when easing and improvement measures were discussed, and even now at the Financial Services Commission. The term 'easing' itself unconsciously implies a correct answer. It was a meeting to ease the burden on companies, but we must see who has led the system from the beginning and now. Is it companies and auditors resolving issues, or is it policy authorities? I believe healthy discussions among stakeholders are not guaranteed.

It is right for various stakeholders to openly discuss the best methods and pace to find wisdom. Two years ago, the Financial Services Commission commissioned a project to academia, and one conclusion was that it is still too early to evaluate the designated audit system. The '6+3' cycle has not yet been completed. There is still a need to examine effects and costs. Partial supplementation is necessary; if we touch the entire system, costs will be very high. We have too little information. This is why improvement measures have not met expectations. It is appropriate to reevaluate when we better understand the system's full effects and problems.

On February 21, at the Asia Economy headquarters in Jung-gu, Seoul, participants are sharing their opinions on the issues and improvement measures of the mandatory rotation system for auditors during the 'Chatham House Roundtable.' From the left, clockwise: Woo-yong Jeong, Vice Chairman of Policy at the Korea Listed Companies Association; Do-jin Jeong, Professor of Business Administration at Chung-Ang University; Hong-gi Bae, CEO of Seohyun Accounting Corporation; Seok-woo Jeong, Professor of Business Administration at Korea University. Photo by Dong-joo Yoon doso7@

In June last year, supplementary measures were announced. Among them is a neutral dispute resolution body. Is this body functioning properly? Does it contribute to companies' objections to auditors' 'power harassment,' communication between businesspeople and auditors, and stakeholder coordination?

Establishing a dispute resolution body is desirable. However, disputes vary from clear, intense conflicts between both parties to mild disagreements where neither side wants to confront. When both sides strongly clash, they can ask a neutral body to mediate, but many cases are ambiguous. Companies often say they just endure and move on. When a new auditor arrives, conflicts with the previous auditor or increased demands at the start of an audit are ambiguous issues that are often suppressed internally. I am not sure if the resolution body fulfills its role in such cases. The body itself is good, but there are complaints about these aspects.

It is fundamentally good to have a way to resolve conflicts before they enter the legal domain. However, it seems the body is not very effective. With changes including the designated audit system, companies and auditors bear much more responsibility when accounting errors occur. The designated audit system holds designated auditors more accountable. This is a fundamental cause of conflicts. Accounting risks have become legal risks. Small and medium-sized companies often struggle when there are accounting disagreements. When previous and current auditors?experts?have differing opinions, companies do not know what to do and often follow the current auditor's opinion, but conflicts arise when the previous auditor disagrees. The Korean Institute of Certified Public Accountants is supposed to mediate, but unanimous opinions like 5-0 or 3-0 are rare. Opinions often split 2-3 or 4-1. In such cases, the dispute resolution body seems to play a role. Auditors also fear that if they make a professional judgment and are later told 'you were wrong,' they will face social disputes. When experts disagree, having the resolution body judge provides a basis if problems arise later.

The supplementary measure announced in June last year included establishing a neutral dispute resolution body, but I think the timing was somewhat late. Honestly, when the designated audit system was first implemented, there were many disagreements about audit input time and fees. Over the years, such conflicts have relatively eased. When opinions differ, most follow the current auditor's opinion. Having a communication channel is good, but the timing feels late.

The neutral body, auditor designation scoring system, and all other measures are ultimately supplements due to the designated audit system. This forces companies to look to the supervisory authorities. It is like deciding who the expert will be. Even if it works, there is doubt whether it truly functions. This is the biggest flaw of the designated system. The market should be centered on companies and auditors, but instead, we increasingly wait for supervisory authorities' judgments.

Before the authorities announced the designated audit system, companies demanded its abolition, claiming it is an unprecedented system unique to Korea. The alternative proposed was a mandatory auditor rotation system. What do you think about demands for such a system?

The mandatory auditor rotation system has not been proven effective domestically or internationally. It is too simplistic and intuitive a demand. Once a system is implemented, it should be consistent. Abolishing the designated audit system now would be worse for companies and increase costs. We need fundamental consideration to enhance the system's effectiveness rather than repeatedly tweaking supplements. Now is not the time to move between substitutes and complements. If we want to change, we must do so fundamentally; touching the sides only increases indirect costs. It is inappropriate to be swayed by ideas thrown out as mere suggestions.

The European Union (EU) introduced mandatory auditor rotation first, but it was not effective. Korea also tried mandatory auditor assignment, which worsened the situation and caused chaos. It is a failed system. On the other hand, if an auditor stays too long, independence may be compromised. This has been studied extensively in academia. The EU reports that about ten years is a good tenure for auditors. Beyond ten years, it is hard to determine pros and cons. Academic research shows that major audit failures occur within four years, after a new auditor takes over.

Those advocating for abolishing the designated audit system are mainly companies. Since it is difficult to revert to the past without alternatives, the idea of returning to the previous mandatory rotation system has emerged. Regarding whether to abolish the designated audit system, some say if abolished, then implement mandatory rotation. Others argue that even if the system is maintained, the term should be extended from '6+3' to '9+3' or '12+3.' One reason is that when a new auditor comes in for three years, there is some initial inexperience. After the designated period ends, companies freely appoint auditors, but the same problem recurs early on. Ultimately, the effective audit period is only three to four years. Therefore, if the designated system is to be maintained, it is better to extend the free appointment period.

At the 'Chatham House Roundtable' held on February 21 at the Asia Economy headquarters in Jung-gu, Seoul, participants are sharing their opinions on the issues and improvement measures of the mandatory auditor rotation system. From the left, clockwise: Honggi Bae, CEO of Seohyun Accounting Corporation; Seokwoo Jeong, Professor at Korea University Business School; Wooyong Jeong, Vice Chairman of Policy at the Korea Listed Companies Association; Dojin Jeong, Professor at Chung-Ang University Department of Business Administration; Sunae Lee, Head of Securities and Capital Markets Department. Photo by Dongju Yoon doso7@

If the periodic auditor designation system continues, expanding the free appointment period and broadening audit exemption reasons are mentioned as improvements. However, from the panelists' comments, fundamental solutions are also needed.

Honestly, I am cautious about suggesting ideas. Basically, it is better not to take temporary actions until evaluation results of the current system come out. Since you asked, one improvement could be a 'selective designation system.' Companies often say, 'It's my company; why should the authorities choose? Let me select my auditor.' Instead of designating one auditor, authorities could propose multiple options. Companies should have the opportunity to choose accounting firms with industry expertise. It is right to give companies supervisory sovereignty and responsibility. Currently, the supervisory authority bears audit supervision responsibility. If they bear responsibility, they must bear it fully, but when accounting fraud occurs, only companies and auditors are blamed. The basic mindset must change. To enhance accounting transparency, companies must be held accountable. Audit committees should be given clearer authority and responsibility. If they make mistakes, they should bear the burden, and decisions should be made by the audit committee. Then, if they say, 'We think three years is insufficient; six years is needed,' they should be allowed six years. If they say, 'Three years designated and then free appointment is better,' they should be allowed three years. Choice is an option in accounting. Options create economic and social value. But we keep eliminating the value of options.

One company demand is to designate multiple auditors and allow selection. I agree that the supervisory authority should not try to do everything. Accounting fraud ultimately occurs because government authorities fail to do their job properly. Initially, there was talk of government responsibility, but it faded away. Businesspeople feel emotional resistance despite cost burdens. They dislike being treated like criminals. They work hard but hate being treated as criminals.

From the left, Jung Wooyong, Vice Chairman of Policy at the Korea Listed Companies Association; Jung Seokwoo, Professor at Korea University Business School; Bae Honggi, CEO of Seohyun Accounting Corporation; Jeong Dojin, Professor at Chung-Ang University Department of Business Administration. Photo by Dongju Yoon doso7@

Various directions for the system's future were discussed today. Please give your closing remarks.

The designated audit system was strongly demanded by external auditors. To maintain companies' trust in auditors amid audit cost issues, auditors must have a public spirit regardless of whether they belong to large or small accounting firms.

I agree. The accounting industry must think carefully. No one can deny that accounting services are an essential public good. However, looking back, accountants have much to reflect on regarding whether they have truly acted as guardians of the capital market with such public awareness.

I agree that shameful issues such as low fees and outsourcing costs are occurring.

When meeting businesspeople, I have not seen anyone denying accounting transparency. Although it may seem that companies and auditors are in conflict, that is not the case. They must coexist. Proper audits help companies manage funds well and reinvest for the future. Accountants lead companies. I hope we can cooperate to create an advanced audit culture.

▶Summary = Park So-yeon, Kim Dae-hyun, Lee Seung-hyung Reporters