FSS Warns KT&G Faces Severe Sanctions for Intentional Accounting Violations... Key Issue Is Substantial Control

Indonesian Tobacco Company Trisakti
Violation During Acquisition Process in July 2011
Decision Made 2 Years and 4 Months After Audit Started
"Shareholder Contract Restrictions, No Control... Consolidated Financial Statements Not Prepared"

Subsidiary Judgment Based on Shareholding and Board Composition, Fierce Dispute
KT&G "Will Explain During Review"

[Asia Economy Reporter Ji-hwan Park] KT&G is facing the risk of severe disciplinary action from financial authorities over allegations of accounting fraud. The issue stems from KT&G’s intentional accounting manipulation during the acquisition of Indonesian tobacco company Trisakti in 2011. KT&G and the Financial Supervisory Service (FSS) are expected to engage in intense disputes over the key issue of this accounting standard violation: the proof of 'substantial control.'

According to financial authorities on the 4th, the FSS recently sent KT&G a preliminary notice of disciplinary action, concluding that KT&G deliberately violated accounting standards in relation to Trisakti, which it acquired in July 2011. The notice reportedly includes warnings of severe penalties such as executive dismissal and referral to the prosecution.

The FSS began an audit in November 2017 following repeated suspicions raised by political circles regarding KT&G’s fraudulent activities. This recent action by the FSS comes after two years and four months.

The FSS’s audit concluded that KT&G’s preparation of consolidated financial statements for Trisakti, despite lacking substantial control, constituted intentional accounting fraud violating accounting standards. Although KT&G acquired Renzoluk, a Singapore-based special purpose company (SPC) holding over 50% of Trisakti’s shares and management rights in 2011, the FSS judged that due to hidden agreements with existing shareholders, KT&G did not have actual control and therefore should not have prepared consolidated financial statements.

Regarding this, a KT&G official stated, "The audit committee has not yet convened, and since this is an ongoing investigation under the Capital Markets Act, it is difficult to provide detailed explanations at this stage."

An accounting industry insider said, "The FSS appears to have taken issue with KT&G’s inability to make significant decisions independently due to restrictions in shareholder agreements."

The future dispute between the FSS and KT&G is expected to focus on whether substantial control is recognized. Under current K-IFRS, subsidiary status is determined by considering factors such as shareholding percentage and board composition. Even if shareholding is below 50%, if a company exercises de facto substantial control, it is considered a consolidated accounting target. Conversely, having a large shareholding does not automatically mean inclusion as a subsidiary.

A representative from a major accounting firm explained, "Although rare, there are cases where consolidated accounting is not applied despite holding over 50% of shares. For example, if two companies each hold 50% of shares in a particular company, neither shareholder can be said to have clear control, so consolidated accounting should not be applied to either." Conversely, even with only 30% shareholding, if minority shareholders have low attendance at general meetings and the shareholder can secure two-thirds of total voting rights, control is considered to exist.

A financial authority official said, "The application of consolidated accounting is judged by reviewing both the 50% shareholding threshold and the substantial control criteria. Whether a company is subject to consolidation or equity method accounting involves considering multiple practical factors."

The FSS also cited KT&G’s under-provisioning of contingent liabilities related to contracts with Middle Eastern trading partner Alokozay as another reason for accounting violations.

KT&G’s audit disciplinary measures are expected to be discussed this month at the Audit Committee, a specialized accounting body under the Financial Services Commission. Subsequently, the final penalty level will be determined after review by the Securities and Futures Commission and the Financial Services Commission. If severe penalties such as referral to prosecution are confirmed, trading of KT&G’s shares could be suspended or the company could face delisting review depending on the amount involved in the accounting violations.

KT&G stated, "We have been diligently explaining our position during the FSS audit process and will continue to clarify the appropriateness of our accounting standards at the upcoming Audit Committee and Securities and Futures Commission hearings."

This content was produced with the assistance of AI translation services.