1. Background
Since the financial crisis evolved in 1997, there have been numerous demands for the reform of accounting and auditing practices in Korea. Among others, the IMF and World Bank required the Korean government to upgrade accounting standards and disclosure rules to meet international practices. To respond to these calls, in March 1998 the Financial Supervisory Commission (FSC) organized the Special Committee and charged it with the responsibility of reviewing current accounting and auditing systems and engineering the measures to reform the systems. After thorough reviews of the current systems and surveys of comments and suggestions of foreign institutions which have keen interests in Korean economy, the Special Committee recommended several reform measures including upgrading financial accounting standards to the level of international standards.
Based on the Special Committee's recommendations and the agreements between the Korean government and the World bank, the FSC has undertaken the reform of accounting standards since May 1998. The reform process has been proceeded in several areas: (1) revision of financial accounting standards that are primary sources of Korean generally accepted accounting principles, (2) establishment of accounting standards for financial institutions, and (3) establishment of accounting standards for combined financial statements.
In the reform process, the FSC’s primary goal was to achieve transparency, credibility and international comparability of Korean accounting standards. Hence, the FSC set as benchmarks the International Accounting Standards (hereafter "IAS") established by the International Accounting Standards Committee. The IAS, however, do not address all the accounting issues. Therefore, the US accounting standards were used as an alternative benchmark where the IAS do not exist or are not sufficient to address particular accounting issues. Employing the IAS or US standards as benchmarks made the revised financial accounting standards consistent with international best practices.
2. Due Process
1) Revision of financial accounting standards
In order to ensure transparency, fairness, and independence of the standard-setting procedure, the FSC developed the due process of setting standards. The FSC also introduced the Korea Financial Accounting Standard Committee (KFASC) in the evolution of accounting standards. The KFASC comprising 11 members from academia, businesses, accountants, and government deliberated on standards at each step of the following due process.
2) Establishment of accounting standards for financial institutions
Similarly, accounting standards for banking, securities, and insurance industries have been promulgated after several deliberations by the KFASC and solicitations of opinions from interested parties. A Steering Committee was organized for each financial industry and served as an advisory committee in the process of drafting a discussion memorandum. The due process taken to establish accounting standards for financial industries is as follows:
3) Establishment of accounting standards for combined financial statements
The Securities & Futures Commission established the standard for combined financial statements according to the due process and issued the final standard on October 22, 1998. (If you have any question concerning the standard for combined financial statement, please direct your question to Dr. Youngsoon Cheon at 02-3771-5765.)
3. Main Features of the Newly Revised/Established Standards
1) Revision of Financial Accounting Standards
a. Scope
The External Audit Law and its Decree require financial statements of joint-stock corporations with total assets of 7 billion won or more to be prepared and audited according to financial accounting standards and working rules set by the FSC. The revised financial accounting standards will apply to the firms subject to the external audit for fiscal years starting on or after January 1, 1999. The primary sources of benchmarks in the revision of the standards are the IAS and US standards.
b. Improvement of foreign currency translation accounting
Under the current standard, the benchmark treatment for gains or losses arising from foreign currency translation is to recognize income or expense in the current income statement. Firms, however, are allowed to defer gains or losses arising from long-term monetary assets or liabilities as a deferred charge or deferred credit when the currency fluctuations are deemed to be extraordinary.
The revised standards eliminate the alternative treatment for the foreign currency gains or losses. As a result, firms must recognize any gain or loss arising from foreign currency translation in the current income statement regardless of their sources. The revised standards are consistent with the US standard as well as the benchmark treatment of the IAS.
c. Accounting for Troubled-debt Restructuring
The revised standards address an accounting treatment for the troubled-debt restructuring. When the contractual terms (i.e., principal, interest rate, and maturity) of impaired loans are modified, both creditor and debtor will adjust the carrying amount of the impaired loans to the present value determined based on the modified terms. This suggests that both creditor and debtor recognize gains and losses arising from the restructuring of the impaired loans as incurred.
Mandating the Equity method for Investment in Associates
The investor has a choice between the cost method and equity method to account for investment in associates under the current standards. The revised standards eliminate the cost method and mandate the equity method for investment in associates in which the investor has significant influence. This accounting treatment is consistent with the US standard the IAS.
e. Accounting for Derivatives
The new standards amend accounting for derivatives in consistent with the US standard. That is, derivatives contracts must be reported as assets or liabilities in the balance sheet at fair value.
f. Accounting for Asset Impairment
The new standards introduce the accounting treatment for impaired long-lived assets. When the carrying amount of an asset is deemed to be unrecoverable, the carrying amount is adjusted to fair value and the impairment loss is recognized as the current period’s loss.
g. Accounting for Effects of Accounting Changes and Error Corrections
Under the current standards, effects on prior years of changes in accounting principles are reflected in the current and future periods. That is, no adjustment is made to previously reported results. This prospective treatment has helped firms easily change accounting methods by spreading the effect of the change over the current and future periods. To deter accounting changes that are intended to manage earnings, the revised standards require the cumulative effect on prior years of accounting method changes to be reflected in the current year’s financial statements. To enhance comparability over years, the effects on net income of past 3 years will be disclosed in footnotes.
Furthermore, the correction of errors will be accounted for as prior period adjustments under the revised standards. Thus, prior years’ financial statements must be restated on a corrected basis when presented for the comparison purpose.
h. Disclosure of segmental information
The revised standards also include disclosure requirements for segmental information. This establishes rules for reporting key financial information by major business lines and geographic regions.
2) Accounting Standards for Financial Institutions-Banking, Securities, and Insurance Industries
a. Scope
To date financial regulators have issued accounting standards for each financial industry. In addition, the regulators have issued accounting guidelines each year to direct year-end closing of financial institutions. This standard-setting practice has caused lack of comparability of accounting standards across the financial industries. Further, financial statements of financial institutions lack transparency and consistency over years, since the year-end closing guidelines not only changed from year to year but also allowed accounting practices that differ from generally accepted accounting principles.
To address these problems, accounting standards for banking, securities, and insurance industries have been established in line with international best practices within the boundary of generally accepted accounting principles. Currently, the FSC is in process of establishing accounting standards for other financial industries including merchant banks and investment trust companies.
The primary sources of benchmarks in the establishment are the IAS and US accounting standards. The new standards will be effective for fiscal years starting from January 1, 1999.
b. Common features of the new standards
The new standards adopt the mark-to-market basis to account for securities including the Fund for Stock Market Stabilization. This implies that financial institutions must report their securities at market value and recognize 100% unrealized holding gains or losses in the current year’s income statement.
Consistent with financial accounting standards, financial-industry accounting standards require financial institutions to recognized restructuring losses as incurred. When the contractual terms of impaired loans are modified, the carrying amount of the impaired loans must be adjusted to the present value calculated based on the modified terms.
Accounting standards established by financial regulators do not require the recognition of allowances for potential losses from guarantee services. In accordance with the accrual basis, the new standards require financial institutions to recognize allowances for potential losses arising from guarantee services and the resulting losses in the current year’s financial statements.
Industry specific feature-Banking
In order to improve usefulness of financial statements prepared by banks, the new standards enhance footnote disclosures of financial information such as maturities of assets and liabilities, transactions with other banks and money market, foreign currency risk exposures, loss from managing trust accounts, and so on.
Industry specific feature-Securities
Pursuant to the Securities & Exchange Act, securities houses have recognized the reserves for losses on securities transactions as liabilities, even though the nature of the reserves is an appropriated retained earnings. The reserves later offset trading losses or losses from securities trading accidents. The new standards rectify this problem by specifying the reserves for losses on securities transactions as an appropriated retained earnings.
Industry specific feature-Insurance
Under the regulatory accounting principles, insurance companies have a choice between the net premium method and cash surrender value method to account for Insurance Reserve (i.e., liability for future policy benefits). In consistent with the US standard and IAS, the new standards specify the net premium method as a GAAP and eliminate the alternative cash surrender value method. The new standards also require acquisition costs to be capitalized and amortized over 7 years based on the straight-line method.
Furthermore, the new standards deal with other costs such as those related to investments, general administration, and policy maintenance. Insurance companies have been allowed to defer part of these general expenses for 5 years. The new standards prohibit the deferral of general expenses.
* Please refer to the attached pdf for details.