Financial Supervisory Service Provides Key Inspection Guidelines for Preventing Accounting Fraud

[Asia Economy Reporter Minji Lee] Despite strict measures against major accounting fraud cases, the Financial Supervisory Service (FSS) stated that accounting fraud led by management in listed companies and others has not been eradicated, and provided guidelines for inspection items to prevent accounting fraud.

On the 21st, the FSS analyzed major accounting fraud cases detected during the two-year accounting supervision process to help external auditors and internal audit organizations perform thorough inspections and monitoring functions. The cases were categorized into △false revenue recognition △false asset recognition △other types, and key inspection points were presented.

False revenue recognition included cases of inflating new business performance. Company A, which entered the healthcare sector, falsely recorded sales of healthcare equipment that was not actually delivered and also falsely recorded accounts receivable until the following year. The FSS explained, “It is necessary to verify the actual manufacturing status of new products, transportation status, and market sales status to review the appropriateness of revenue recognition.”

There were also cases where false revenue recognition and omission of expenses were used to avoid designation as a management item. For example, Company B, a KOSDAQ-listed company, manipulated operating profit and loss in separate financial statements to avoid being designated as a management item after incurring operating losses for four consecutive years. Company B recorded false sales to a nominee company, made it appear that false accounts receivable were being collected normally by transferring funds to the nominee company through a subsidiary, and recovered the funds under the pretext of accounts receivable repayment. Additionally, it manipulated operating profit and loss in separate financial statements by falsely assigning head office employees to subsidiaries to manipulate labor costs.

In response, the FSS stated, “Internal auditors and external auditors need to inspect the appropriateness of new sales and client-related matters, as well as labor cost management and execution,” and added, “Information users should invest cautiously if they judge that there are signs of accounting fraud, such as operating profit and loss in separate financial statements turning positive without reasonable grounds.”

False asset recognition included cases of falsely recording accounts receivable, advance payments, and tangible assets. For example, Company C raised a total of 30 billion KRW through private placement and convertible bond issuance, and the following year, Mr. Lee was appointed as CEO. Afterward, the CEO frequently engaged in abnormal transactions such as unjust withdrawals without supporting documents and lending large sums to a newly established investment advisory firm. Subsequently, Company C falsely recorded advance payments related to the CEO’s unjust withdrawals and omitted disclosure of related party transactions in the notes.

The FSS pointed out, “Internal and external auditors should check whether cash and accounting duties are separated, the appropriateness of internal control procedures related to cash management, and the appropriateness of accounting treatment for unfair transactions,” and advised, “Information users should be cautious when investing in issuing companies with frequent changes in major shareholders, suspicious no-capital M&A transactions, frequent capital increases, and convertible bonds.”

Other types included cases such as omission of derivative financial liabilities due to concealment of M&A-related agreements, understatement of subsidiary operating profit and loss, and omission of overseas subsidiaries held under nominee names.

Accordingly, the FSS explained that to prevent accounting fraud, companies and their employees must prepare financial statements that faithfully reflect transaction details and asset status. Auditors should notify the audit if there is reasonable suspicion of company accounting fraud and, if necessary, recommend investigation by external experts. Furthermore, employees and business partners who become aware of company accounting fraud should promptly report it to the FSS or other authorities with supporting evidence. Lastly, investors are advised to conduct thorough analysis of companies that are marginal, have frequent changes in major shareholders, or frequent private placements.

The FSS stated, “If accounting fraud is detected, strengthened measures such as fines can have a significant impact on the company and cause serious damage to shareholders and others,” and explained, “Since the introduction of the strengthened External Audit Act, if monitoring functions such as inspections by external auditors and internal audits operate properly, accounting fraud can be sufficiently prevented.”

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