The amendment to the Regulation on External Audit and Accounting, etc. (the “External Audit Regulations”) was pre-announced in connection with the external audit system for joint stock companies. In the relevant press release, the Financial Services Commission (the “FSC”) announced that the amended External Audit Regulations will be applied starting from the designation of auditors for FY2023 (October 2022) after the FSC's resolution in September 2022, based on the proposed amendment described below. The amendment at issue (the “Amendment”) aims to address the following issues of the external audit system:
1) The auditors of more than half of listed companies are auditors designated by the FSC, undermining competition in terms of audit quality among accounting firms.
2) The current method of matching auditors and companies fails to sufficiently consider the importance of the company and the quality and capability of the accounting firm's audit, resulting in inefficient allocation of accounting resources.
- Local accounting firms are being appointed as an external auditor for large companies with assets of KRW 2 trillion or more, which rarely occurred under the free engagement structure (where appointment of global accounting firms is inevitable due to requests of foreign investors, foreign counterparties, etc.).
- Mid-sized accounting firms with relatively inadequate level of audit quality control are being assigned to a number of companies that exceed their audit capability.
- Accounting firms that are not registered as auditors for listed companies are alienated from the designation of auditors.
The key details of the Amendment are as follows:
1) Enhancing accounting transparency by improving the classification of companies and auditors (Annex 4 of the Proposed Amendment)
For large companies with assets of KRW 2 trillion or more, accounting firms with the highest level of audit quality control will serve as designated auditors. The requirements for classification of accounting firms are improved with a focus on audit quality and investor protection, such as quality control personnel and ability to compensate for damages.
2) Linking matters on audit quality with the auditor designation system (Annex 3 and Annex 4 of the Proposed Amendment).
- Current: The scores for auditor designation mainly rely on the number of accountants and incentives are lacking for accounting firms to improve quality as there are no audit quality control indicators in place.
- Improvement Proposal: While maintaining the basic framework based on the number of accountants, reflect the results of quality control supervision and quality control evaluation of auditors in the scores for auditor designation.
3) Improving market efficiency by mitigating the concentration in mid-sized accounting firms (Article 15, Annex 4 of the Proposed Amendment)
- Current: Due to the downward re-designation system, concentration in the designation of mid-sized accounting firms (from Group B (Na) to D (Ra)) registered as auditors for listed companies has been further intensified.
- Improvement Proposal: Downward re-designation will be restricted for companies subject to designation with high risk of committing accounting fraud (39% of all companies subject to designation). In addition to the current upward/downward re-designation, re-designation within the same classification is allowed to enhance the bargaining power of audit fees.
4) Improving accounting transparency by leveraging the capabilities of accounting firms that are not registered as auditors for listed companies (Annex 4 of the Proposed Amendment). Two mid-sized unlisted companies will be assigned first to mid-sized accounting firms with audit quality capabilities that are not registered as auditors for listed companies.
Following the enforcement of the Act on External Audit of Stock Companies, the designation of external auditors by the financial supervisory authorities has become mandatory, and a number of companies have been subject to such mandatory designation on a regular basis. Therefore, the Amendment regarding the designated audit system should also be noted in this relation.
