Mandatory firm rotations improve Korean audit

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oupled with growth in the capital market and greater online presence among South Korean business driven by Covid-19, there is now a huge demand for staff, which industry experts say is leading to greater retention and smoother recruitment.

The Korean government introduced mandatory audit firm rotation for fiscal years starting on or after 1 January 2020. The change of auditor will be made in accordance with the principles set by the Financial Supervisory Service (FSS) and a standard audit hours rule has been introduced from 2019 which considers the size, industry and subsidiaries of the entity.

K-SOX for separated financial statements has been changed from review to audit from 2021 for entities whose total assets are KRW100bn ($85.1m) or more, and from 2022 for entities whose total assets are less than KRW100bn.

K-SOX for consolidated financial statements will be applied from 2023 for entities whose total assets are two trillion won or more, from 2024 for entities whose total assets are KRW500bn or more, and from 2025 for entities whose total assets are less than KRW500bn.

“The above changes will have a positive effect on Korean accounting firms,” says Tae-Wook Park, partner at PrimeGlobal member firm Induk Accounting.

The 52-hour weekly hours rule was introduced in July 2018 and has been applied to entities with more than five employees since 1 July 2021.

“The auditor's supervision office focused on responding to the strengthening of the public nature of accounting firms and shifting the supervision method into the improvement of external audit quality and preventive measures,” says Young Chang Kwon, international contact partner at Nexia Samduk.

However, the boom has its downside. “The Korean accounting industry is better than before in terms of customer demand for transparency in financial data, but worse in terms of fee pressure due to the fee increase of audit, including SOX audit services," says Michael Oak, international liaison partner at PKF Seo-hyun.

The fee increase and the increased demands have put pressure on member firms in terms of staffing and have led to some resistance from listed companies to implementing the changes.

“From the standpoint of customer expectations, the listed companies showed very strong aversion to implementation of this new external auditor designation system and the standard audit hour system of the Korean regulatory body at the beginning as these regulatory changes led to significant increases in their audit fee burdens,” says HeungJu Hwang, managing partner at IBG of Crowe Korea/Hanul.

However, the situation is now improving to a certain extent and a considerable number of the listed companies are more focused on the quality of audit services as they expect to receive more quality audit services that correspond to the audit fee increases, adds Hwang.

“Because of the 52-hour weekly hours rule, standard audit hours and K-SOX scope changes, staff demand is significantly increased,” says Park. “As such, recruitment and retention is one of the most important tasks facing accounting firms.”

But clients and the accounting industry are catching up, and the South Korean accounting industry is only getting stronger according to Kwon.

“As the capital market develops, managers of listed companies, venture capital and private equity funds need various accounting information for decision-making purposes,” he says. “As demand for accounting increases, staff recruitment and retention is getting smoother and overall, the health of the accounting industry is improving.”

Hwang is confident the fee situation is already beginning to level out. “Accounting firms in Korea are experiencing quite positive impacts in that audit engagement fee structures are now getting closer to realistic levels, resulting in significant audit revenue increases for the accounting firms registered with the FSS,” he says.

Hwang observes that as audit revenue volume and audit hours increase, staff salary and benefit costs are also increasing significantly. However, even with the increased salary and benefit costs, mid-tier firms are ironically experiencing more difficulties in recruiting audit staff resources, as migration from the Big Four is now minimal.

“On the other hand, as the FSS has been quite stringent in supervising the firms registered with it in terms of quality management, those firms are now driven to spend more money and increase their efforts to implement and improve their quality and risk management units for manpower and best practice. Audit quality has been a top priority since the implementation of the new external audit law.”

“The IMD competitiveness ranking puts Korea 15 places higher than last year in terms of accounting reliability,” says Young Ham, partner at MGI Hanmi. “As the FSS designates audit firms for more companies, scrutinises compliance of standard hour input and monitors standard hourly rates, both fee pressure and audit quality have improved meaningfully.”

According to Kwon, the accounting service sector that has grown the fastest in Korea over the past 12 months is the market for response services to designated auditors.

Meanwhile, the Covid-19 pandemic has led to significant growth in accounting consulting services for online companies. As investments are concentrated in companies in the online industry, those receiving investments are asking accounting firms for consulting to enhance their accounting infrastructure.

Other business opportunities have been opening up as a result of auditors having to present audit opinions on the internal accounting management system of all listed companies in South Korea by 2023. Oak sees the new opportunities being spread across two main areas: the upgrade of internal accounting and management control systems, and the evaluation of system design and operation.

“Other accounting firms can get a chance to deliver this business as not being an external auditor because of the independence issue,” he says.

According to Kwon, the service market for the internal accounting management system is expected to be promising for at least a few years, as it will be gradually required to express its audit opinion on the consolidated internal accounting management system.

This market has also enhanced the sector’s reputation. “The FSS required a high level of quality control for registered accounting firms, which means accounting firms have to improve their audit quality and risk management system to get registered and join the ‘major league’,” says Ham. “But once you get registered, you will likely have more audit engagement assigned by the FSS. This carrot-and-stick approach has led to general enhancement of the reliability of the accounting profession.”

Registration alone has made a difference to the bottom line, according to Hwang. “Qualified firms that are registered with the FSS – including Big Four and mid-tier firms – have benefited significantly resulting in significant revenue increases, while working environments of accounting firms registered with the FSS have also improved significantly,” he says.

“The leading accounting firms who responded proactively to these regulatory changes and successfully registered with the FSS achieved a significant growth in both revenue volume and headcounts during 2020,” adds Hwang “In our firm’s case, revenue volume and headcounts have increased on a fiscal year basis by 28% and 18% respectively.”

As the Korean accountancy market continues to adapt and develop, there are likely to be many new areas opening up for progressive firms looking to expand their business.

For example, as the mandatory three-year terms of external auditors designated for the listed companies for calendar year 2020 will elapse at end of 2022, the leading accounting firms registered with the FSS are already pitching for more audit engagement opportunities targeting large listed group companies in Korea that will be released from the mandatory three-year terms of external auditors designated by FSS and become free to appoint an external auditor of their choice for the following six years – first three-year terms and extensions for second three-year terms are allowed.

Hwang reckons competition will likely become more fierce towards the end of 2022.

“With the adoption of new compulsory external audit of separate and consolidated internal control over financial reporting of listed companies in Korea, accounting firms will have more opportunities to provide advisory services,” he says.

”In addition, as environmental, social and governance-related rules and requirements have been rapidly increasing, related advisory service needs are increasing correspondingly. In these areas, competition among the leading accounting firms registered with the FSS is becoming hotter.”

The Korean non-profit sector is expected to open up shortly as a result of the periodic auditor designation system for private universities, which will be implemented from 2022. “As a result of this system, the institutional foundation for securing auditors' independence has been firmly established in the non-profit sector,” says Kwon “In the future, accounting transparency will continue to increase in Korea.”

Ham predicts a flurry of mergers and acquisitions to shake up the accounting landscape in the short term. “We expect the number of M&As taking place among accounting firms to increase over the next 12 months,” he concludes.

“Increased regulation gives bigger firms a competitive edge since overhead costs such as quality control or risk management teams as well as special audit support experts benefit from economies of scale. The easiest way to attain that is through M&A.”