Accounting Big Bang to Boost Market Confidence
By Park Hyong-ki
Staff Reporter
Adopting new global accounting standards may not be an easy process, and may raise confusion among companies. But the ``big bang'' in corporate accounting system will generate new opportunities for them, said the chief of a global professional services firm.
Gweon Seung-wha, country managing partner and CEO of Ernst & Young Han Young, said it will, above all, boost investors' confidence, as the adoption will help capital markets leap forward in achieving higher transparency.
``Simply put, it will enable investors ― whether foreign or local ― to access more financial information about corporations they seek to invest,'' said Gweon in an interview with The Korea Times.
Amid rapid globalization, the country is gearing up to adopt the International Financial Reporting Standards (IFRS) ― often referred to as the ``Accounting Big Bang'' ― by 2011. The IFRS is endorsed by the International Accounting Standards Board and promoted by the International Organization of Securities Commissions.
The chief executive analogizes the IFRS adoption as ``seeing the forest for the trees.''
Even though Korea's transparency level has improved since the Asian financial crisis, caused by foreign exchange inefficiency, inappropriate fiscal policies and corruptions, the ``Korea Discount,'' or chaebol discount, still remains deeply ingrained in the markets, giving foreign investors second thoughts about investing in Korea.
Gweon said the IFRS will help turn this tide around, and spur inflows of foreign capital.
The country has been utilizing the Korean-version of the Generally Accepted Accounting Principles (GAAP). When the currency crisis erupted, the International Monetary Fund and the International Bank for Reconstruction and Development advised the government to adopt the IFRS.
Around 100 countries are using the new accounting standards, notably the European Union member economies showing the most successful adaptation.
Basically, the major difference between the two is that the IFRS is a principle based set of standards, while the GAAP is a rule-based.
Gweon elaborated this by saying that companies ― at least stock-listed ― will have the freedom to choose from a variety of accounting principles and methods then apply the right ones in accordance with their business structures and operations under the IFRS. Meanwhile, the GAAP mandates companies to follow strict rules and guidelines when computing their financial statements.
``There's no reason for companies of different sorts to follow the same rules. For instance, a shipbuilding firm can use its own set of accounting principles under the IFRS that match its business environment,'' he said.
Gweon, however, predicts that it will not be so easy for Korea to adopt the global accounting standards compared with other countries due to cultural differences. Adopting the IFRS simply means willing to show more of firms' financial capability and background to investors. ``Given that Korea has relatively kept its doors closed and walls high, it will be somewhat difficult to accept further openness.''
He exemplified that in Europe, investors can literally see the ``gardens'' of companies, and see what kind of flowers they are growing and how they have cultivated them. Since people there are quite used to the openness culture, they were able to make a smooth IFRS transition.
The other challenge corporations will face is issuing consolidated financial statements in which many see as a major conversional task.
Under the planned adoption, listed companies with assets of over 2 trillion won must disclose quarterly and semiannual consolidated financial statements beginning in 2011. Those with assets of less than 2 trillion won must do so in 2013.
Until now, small- and medium-sized enterprises (SME), conglomerates and their subsidiaries have filed their statements separately without including overseas businesses even though they were operating under the same roof.
However, the global standards will require listed parent or holding companies to disclose not only their financial reports but also their subsidiaries' and overseas ventures' altogether.
``That's what I mean by seeing the whole forest and garden. Before, investors had to track down each scattered financial statement. With the IFRS, they will be able to see the overall financial details of companies and their affiliates both at home and abroad all at once,'' said Gweon.
He reiterated that it will give investors a ``hawk-eye view on companies, enabling them to scrutinize Korean financial statements much more easily.''
The global audit firm noted that while most large corporations appear to be well positioned to make the conversion, SMEs may face difficulties.
``The transitional cost may be too burdensome for SMEs,'' said the chief executive, adding that companies need a sufficient amount of capital to overhaul their accounting, management and computing systems.
He noted that firms will have to change their accounting software, and shifting to IFRS will affect not only their accounting division but the rest as well. So far, accounting departments within firms have been able to calculate numbers without involving other internal or external organizations.
But given that they need to record all capital flows, including asset and investment holdings, based on fair market value in a consolidated financial statement, other managerial departments will have to participate and provide financial data.
``The process may seem more complicated, but the vast range of financial information and footnotes to be disclosed to investors will certainly help them make better and reasonable investment judgments,'' said Gweon.
He confidently said that Korean companies are capable to make the transition as most are undergoing full preparations. ``The IFRS uses fair value accounting, which is relatively new and may potentially lead to more volatile corporate profits. But since companies are going through diagnosis and solution development, I believe risks following its implementation are very low.''
IFRS a Catalyst to Attract Foreign Capital
The followings are additional comments by Gweon Seung-wha, CEO of Ernst & Young Han Young, in an interview with The Korea Times ― ED.
What are your thoughts on globalization?
Globalization is even more of a feature of today's capital markets, and therefore the adoption of a single set of global accounting standards is a natural progression for the stakeholders, investors and regulators. By 2011, it is expected that over 150 countries will be using the IFRS, so Korea must start to use it in order to remain as an attractive location for foreign capital. Using truly global accounting standards can only be seen as an opportunity for Korean corporations to have easier access to the world's capital markets.
Could you explain the differences between the IFRS and the GAAP?
While there are a range of detailed differences, more fundamentally the IFRS is a principle based set of standards, whereas the Korean GAAP is rule based. This means that greater judgment will be needed when management applies the IFRS than has been necessary in the past. This change in philosophy presents the greatest ongoing challenges to the Korean accounting profession. Some of the main areas of technical accounting differences between the IFRS and the GAAP include the consolidation and business combination standards, financial instruments, employee benefits and foreign currency accounting.
What are some immediate effects of the IFRS adoption?
In Europe, the majority of preparers and users of the IFRS believe that it has made financial statements easier to compare between competitors in different countries and across industrial sectors. When Korean corporations start issuing the IFRS financial statements, investors and analysts globally will be able to scrutinize Korean financial statements much more easily. We believe the consistency of Korean practice with international norms will be improved, and ultimately should lead to greater confidence in the Korean market from overseas investors. We expect that any perceived or actual discount should be reduced.
What are some key tasks ahead for both corporations and professional services firms like Ernst & Young?
As IFRS conversion approaches we expect growing curiosity and uncertainty from investors about the potential impact. For this reason we think it is important for listed-entities to start now so they can understand the potential impacts on their business and financial statements as early as possible. This will allow them to educate and communicate with local and global investors and analysts about the potential changes and so reduce the level of uncertainty. The IFRS conversion is a significant project for most companies and the level of effort involved should not be underestimated. We expect that most unlisted firms will initially retain the GAAP accounting. However, those firms that have foreign subsidiaries or parents that already use global accounting standards may decide that the effort of converting and maintaining an IFRS ledger is worthwhile. Our key internal task has been to ensure that our professionals are appropriately trained in IFRS to support and advise our clients. Naturally this advice cannot be one-size fits all. We believe it is important to tailor our advice to match the client's needs and long-term strategy.