[THE KOREA TIMES_김상준 회계사] Accounting fraud and accounting standards

By Kim Sang-jun

The issue of whether accounting fraud has been committed is now being hotly debated among a certain bio-industry company, its accounting firm and the Financial Supervisory Service. The last accuses the first of fraud.

However, the company protests that its accounting practices were in full compliance with International Financial Reporting Standards (IFRS), and its accounting firm backs this up.

Generally, “accounting fraud” refers to any and all acts of falsifying financial statements to present them in a better condition than they actually are, to the benefit of the company or its owners.

Accounting fraud can be conducted through simple or complex methods for each business line or transaction type, as the case may be. Specifically, the following acts are deemed to be kinds of accounting fraud: i) counting non-existent sales as sales; ii) recording sales for the next accounting period as being for the current accounting period; iii) overestimating sales based on exaggerated sales unit costs; iv) overestimating profits with actual sales, based on lower than actual costs; v) exaggerating profits by carrying actual costs forward to the next accounting period; vi) failing to enter existing liabilities in financial statements; vii) overestimating the value of assets without a market price valuation; viii) recording non-existent assets in statements; ix) making financial statements without first offsetting internal translations; and/or x) failing to disclose important financial matters appropriately.

In the case of the company under scrutiny, the valuation of investment shares owned by the company is at issue. According to current accounting standards, shares of a subsidiary company shall be valued at the book value as entered in the consolidated financial statement, and shares invested in unconsolidated investment entities shall be valued at the market value.

The company reclassified its investment shares from an investment in a subsidiary company to an investment in unconsolidated investment entities, leading to a considerable valuation difference reflected in the financial statement. A highly controversial question stems from such a valuation difference: whether such a difference is an appropriate margin based on accounting standards, or whether it is fraudulent accounting in violation of accounting standards.

The valuation matter in this case seems like a trickier problem than general accounting fraud because the content and applicable accounting standards are far more complicated than those relating to examples of normal accounting fraud. This difficulty in determining instances of fraud may have something to do with the fact that the accounting standards applicable to Korea’s listed companies recently changed to the IFRS, under which companies became subject to more complicated rules.

Corporate accounting documents are not only a source for valuation by investors and creditors of the company concerned, but also provide a basis for statistical data with which the government determines its economic policies. In this regard, it is not too much to say that the question of whether accounting activities by companies are in accordance with accounting standards is of great importance.

However, these increasingly complicated accounting standards make it more difficult for even accounting professionals to understand matters accurately. Is it a pipe dream that we will one day have accounting standards that the ordinary layman can understand easily?