Roles and responsibilities of accounting firms

According to a Global Competitiveness Report recently published by the World Economic Forum, Korea’s financial accounting transparency fell 16 notches from 75th to 91st.

Considering significant efforts made by the Korean government, this is a very surprising result. International Auditing Standard (IAS) and International Financial Reporting Standards (IFRS) were promptly put in place and even the Mandatory Auditing Firm Rotation Rule was temporarily adopted.

In addition, local regulators’ oversight over accounting firms has increased with more stringent quality reviews and inspections amid rapidly increasing lawsuits against auditors for investment losses.

Despite such efforts, what has caused this decline in Korea’s financial accounting transparency? The answer to this question can be found on the frontline of each audit engagement, at the heart of the accounting firms.

Many young, talented public accountants are seeking new careers and the number of leading college graduates entering the accounting profession is dramatically decreasing.

The reason for this is that they see no vision or future in this profession. Every day they realize that the legal rights of public accountants are not justifiable compared to the legal obligation and risk faced by the individuals and collectively by the firm, which is significant enough to shake the very foundation of their economic existence.

Most firms close financial years in December. Accordingly, public accountants are most busy with audits in the few months preceding the yearend.

With the added burden of IFRS, ISA and consolidated financial statement reporting being adopted in recent years, experience of one audit season by any public accountant is enough to demolish any passion or any scent of desire for the profession.

Article 1 of the Act on External Audit of Stock Companies states that the “appropriateness of a company’s accounting is ensured through an external auditor’s audit.”

As a result of this article, when accounting errors are found in a company’s financial statements, the auditor is blamed for not providing sufficient guidance.

Due to this interpretation, even in case of management fraud, the auditor is considered jointly liable together with the fraudulent management for the entire investment loss.

Recently, a bill to change the auditor’s “joint and several liability” to a “separate and proportionate liability” was finally passed in the National Assembly.

Yet, critiques remain very vocal that the amendment of the Act will only reduce auditors’ responsibility and hence increase fraudulent financial reporting. The gross misconception that distorted financial information is due to fraud is the responsibility of the auditor remains unchanged.

In Germany and the United States, the two operate under a very different auditor responsibility model and yet both markets are renowned for their high level of financial accounting transparency.

In Germany, the “high risk, high return” philosophy of the stock market is extended to the auditors responsibility model where audit reports are considered only as another source of market information, such as a corporate analysts’ report in making investment decisions.

Accordingly, even when gross auditor negligence is identified in management fraud cases, the auditor is not considered to be responsible. In such cases, the auditor is only considered responsible for infringement of investors’ right to information.

In stark contrast, auditor responsibility in the United States is extended even to third parties for full compensation for investment losses. However, unlike Korea, this only applies to intentional and gross auditor negligence while minor negligence is commonly exempted.

It is also worth noting that in the U.S., prior to placing responsibility on the auditor after the event, a more severe responsibility, as a preventative measure is placed on management by categorizing management fraud as a crime similar to murder with penalties of imprisonment of up to 20 years.

It is clear that there are significant limitations to improving financial accounting transparency with our current framework of auditor responsibilities. Why not redirect the responsibility of transparent financial accounting to the preparer of the financial information, the company?

Let’s provide the entrepreneurial CEOs of companies the opportunity to understand and contemplate the meaning of transparent financial reporting.

It is this foundation together with the amendment of the Act on External Audit of Stock Companies that will truly raise Korea’s transparency in financial accounting to the standards of other developed countries that we compete with.

At the very least, the acceptance of responsibility for financial accounting transparency will ensure a more careful consideration in completing and understanding the meaning of this World Economic Forum’s survey.

By Kim Young-sik (Assurance managing partner at Samil PwC)
The Korea Times