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April 30, 2008

Korean profession at crossroads

Accounting firms in South Korea are busy strengthening resources in preparation for the implementation of IFRS. Moses Awe, Ernst & Young Han Young senior vice chairman of client service and accounts, tells David Hayes the changes will deliver significant challenges as well as opportunities.

As IFRS spreads to the Far East, the South Korean profession is preparing for a challenging period over the next few years. Listed companies, including financial institutions, will be required to prepare their financial statements using the international standards in 2011.

The adoption of IFRS, which is intended to enhance the reliability of Korean accounting standards, will also serve to reduce compliance costs for the growing number of multinational corporations operating in South Korea. Under a road map to IFRS, which the Financial Supervisory Commission and the Korea Accounting Standards Board have agreed, all companies in South Korea except financial institutions will be permitted to adopt IFRS by 2009. Full adoption of IFRS for listed companies, including financial institutions, will become mandatory by 2011.

Adoption is expected to provide a major boost to the country’s capital markets, which have been rebuilding slowly since the Asian financial crisis in 1997. Adopting IFRS is expected to lead to greater transparency in Korean companies’ financial reporting as the country’s accounting standards are regarded by the profession as different to international standards in global capital markets.

Additional work Plans to adopt IFRS are already creating new work for Korean firms which will need to support clients during the transition period. Ernst & Young Han Young (E&Y), for example, is undertaking a large staff expansion programme to support the rapid increase in workload expected to follow the adoption of IFRS, and to expand the practice’s tax and transaction advisory service activities.

“The accounting market here is good and challenging. From our perspective there is a lot of interest by the regulator and a business focus on internal controls ready for IFRS. The focus is audit quality,” comments Moses Awe, E&Y senior vice chairman of client service and accounts. “Korean Sarbanes-Oxley [K-SOX] rules for internal controls were adopted in 2006. There was a big explosion among companies in 2006 to see what changes to make. Some had to change their accounting and controls. K-SOX has been taking off this past year. We expect it will be similar to the US and take three to four years to implement.”

In fact, Awe believes implementation could be even quicker as controls and audit requirements already exist. Accounting firms, rather than companies, face the burden of the onerous checks involved in the regulators’ requirements, which include those of the Ministry of Finance and Economy. “The accounting profession is struggling as regulators are active here. They require external audits to heavily test documents instead of auditing internal standards,” Awe notes. “Here the regulators not only test controls, there is substantive auditing as well. There is a lot more auditing here.”

Financial controls and oversight of company audits were tightened up in the wake of the Asian financial crisis, which exposed weaknesses in South Korea’s system of internal controls and financial reporting. One of the government’s early moves was to establish the Finance Supervisory Commission (FSC) in 1998 to monitor the finance sector. The FSC also oversees the Financial Supervisory Service (FSS) set up in 1999, which reviews both company records and audit firm records to monitor procedures.

Auditing firms were also the focus of a new requirement introduced in 2006 for mandatory auditor rotation every six years for listed companies.

While the impact of the 1997 financial crisis continues to influence economic development, the industrial sector has regained its dynamism and in 2006 South Korea was ranked as the world’s 11th-largest economy in terms of GDP. The country is a leading global player in various industrial fields, including information technology, shipbuilding, steel making, automobile production and telecommunications technology.

“For E&Y, South Korea is a key practice in the Far East. Hong Kong is our Far East headquarters, as China is a major practice. We have ten country practices in the Far East. South Korea is a separate practice and reports to Hong Kong,” Awe explains. Second-largest firm According to E&Y, Big Four firms audit 53 percent of the 1,760 listed companies in South Korea. E&Y claims to be South Korea’s second largest auditing firm, auditing 13 percent of listed Korean companies. The firm claims it is behind PricewaterhouseCoopers, which has a 19.3 percent share, and ahead of Deloitte with 12.7 percent and KPMG with 8 percent. “Our competitors are other Big Four firms. The mid-tier firms are not competing with us, but 47 percent of South Korean listed companies are not with Big Four firms,” Awe says.

E&Y’s total revenue rose 7.8 percent to KRW110.7 billion ($117 million) in the 2007 fiscal year. Audit is the firm’s main service line, generating 80 percent of the practice’s revenue, while tax work represents 10 percent, and transaction advisory services, mostly M&A work, contributes the remaining 10 percent. Efforts are being made to expand the smaller service line activities, which now offer significant growth potential.

“Our service line revenue has not grown at the same rate in South Korea as for E&Y Global. Transaction advisory revenues grew 30 percent globally last year but 10 percent in South Korea. Tax revenue grew over 20 percent globally but remained flat in South Korea,” Awe reveals. “We are looking to change the nature of the services offered and the clients served. We want to provide clients with more support in tax and transaction advisory services.

“Our competitor Big Four firms and local accounting firms have done well here in tax work and we have not; it’s the nature of our clients. Now we have 80 percent audit clients and revenue but in future it will be 50 percent audit clients and 60 percent in audit revenue. Other service lines will grow faster than audit. The advisory part of audit has a risk side and management consulting. Clients are asking for more of this, but they are asking for independence of external auditors.”

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Big Four preference E&Y believes that some Korean companies would be willing to use a different Big Four company as external auditor rather than for other services.

“Our goal is to provide companies with a choice for these services,” Awe says. “We are focusing on listed companies. We are second here in serving listed companies with about 240 listed companies as clients. Many are start-up companies and need special services as they face risks. We support these on internal controls and reporting when they go public. We also plan to go upper end – recently SK Energy [South Korea’s largest oil and gas company, a former division of the SK Group] had to decide on a new independent auditor and we were selected.”

Korean Air and Hana Financial Group are other new Korean audit clients, while established clients include electronics manufacturer LG International, Shilla Hotel, computer hardware manufacturer Hynix Semiconductors and logistics company Glovis. Foreign inbound referral clients include IBM, Standard Chartered Bank and Dutch insurance conglomerate ING.

To support new and existing clients adopting IFRS, E&Y is providing consulting, training and other IFRS-related services, including process innovation advisory, tax advisory and business advisory services. In addition, the practice recently began to focus on developing specialised services for specific industries.

Awe notes that E&Y Global has launched an IFRS training system that is available in South Korea to provide consistency in the interpretation and application of IFRS-based financial statements.

E&Y’s programme to increase revenue from non-audit services coincides with South Korea’s plan to adopt IFRS. As South Korea is expected to become more open to foreign investment and Korean firms likely to become more globally active, E&Y is investing heavily to adopt E&Y Global methodologies, according to Awe.

Structural changes One of the major structural changes E&Y has undergone over the past two years is the merger of two accounting firms into one. “Our focus in South Korea has changed. Two accounting firms came together to create the foundation. Their operations were not fully integrated before. We have had 18 months of putting in common methodologies for people and work. E&Y now is working with the E&Y Far East office to ensure a common standard of work so our South Korea people can work anywhere and our E&Y overseas people can come here,” Awe says.

“Audit methodology, for example, follows a global E&Y framework but is augmented for local requirements… Our clients are asking for this. For example, previously E&Y and KPMG shared ING, but last year ING chose E&Y as its worldwide auditor. South Korea is in the top five in insurance worldwide. ING has big business here so we need the right expertise in assurance and banking; also we need the right global experience. This is an example of how we support inbound clients.

 “Historically, not many clients are international companies. But now international companies are coming in. Also, we have South Korean clients going outbound. South Korea has a big engineering and construction industry, and there are a lot of Korean companies in the Middle East such as in Dubai. E&Y has a large Middle East practice with over 50 percent of the market.”

To support outbound clients, E&Y has set up Korean desks in E&Y offices in China, Vietnam, India, Malaysia, Australia, New York and Europe. Awe notes that E&Y Korea also plans to establish a West Coast US desk this year to serve South Korean electronics companies. The growing list of inbound referrals has also resulted in a number of foreign language desks being set up in E&Y’s Seoul office.

Organic growth Another area in which the firm plans to invest heavily is staff. E&Y employs 1,300 staff in South Korea and is aiming to add another 100 people to lift the total number to 1,400 by the end of this year. Currently, 80 percent of staff members are certified public accountants (CPAs), including the 90 partners.

There are plans for another 15 partners to be appointed to the South Korea practice during 2008. “There is tremendous growth in our staff in South Korea and in service lines. We want to reach over 100 partners in South Korea by July 2008 and over 130 partners by 2010. This includes replacements for retiring partners,” Awe notes. “The government controls CPA licences which are issued each year. About 20,000 trainees sat the exam last year but only about 800 got licences; this does not mean that all the others failed. We are concerned, as we need to add staff numbers. We are targeting top graduates from university and bringing in key resources from around the world to E&Y Korea.

“You must be a licensed CPA to do an audit in South Korea. In other countries an audit is just supervised by a CPA, but in South Korea the auditor must be certified to start. This ensures top quality but restricts staff resources. Audit will be 60 percent of our business in future and non-audit 40 percent, which means we can resource experts for clients using non-Korean CPAs.”

Awe says staff recruitment will remain an issue for E&Y and other accounting firms unless the number of new CPAs grows rapidly in the future.

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