Caution on Accounting for Related Party Income... Financial Supervisory Service Announces Financial Statement Inspection Points

[Asia Economy Reporter Park Jihwan] The Financial Supervisory Service (FSS) has decided to focus on reviewing accounting treatments related to revenue recognition with special related parties when examining financial statements next year. In particular, since last year, industries subject to review by accounting issues have been presented, requiring companies and auditors in the relevant industries to exercise special caution.

On the 27th, the FSS announced the '2022 Financial Statements Focused Review Accounting Issues and Industry Pre-Announcement,' stating, "The four selected accounting issues will proceed through procedures such as selecting target companies and reviewing financial statements during 2022, when the 2021 financial statements are finalized."

The FSS will first examine the appropriateness of impairment accounting treatment for investments in subsidiaries and affiliates. This is because there is an incentive to understate losses by arbitrarily reviewing impairments despite signs of impairment in subsidiaries and affiliates amid concerns over deteriorating performance. In particular, it has been pointed out that cases of asset overstatement due to undervaluation of investments in subsidiaries and affiliates acquired through unfair transactions such as no-capital mergers and acquisitions (M&A) are frequent.

The target industries include manufacturing (petroleum refining, steel, automobiles), distribution, air transportation, video production and distribution, travel, and related sectors. The FSS plans to review signs of impairment for investments in subsidiaries, affiliates, and joint ventures and conduct impairment evaluations based on reasonable assumptions. It will comprehensively examine internal and external information to detect signs of impairment and, if signs exist, compare the recoverable amount with the book value.

The FSS will inspect the appropriateness of revenue recognition accounting treatment related to special related parties across all industries. This is based on the judgment that there are frequent cases where profits and losses are distorted through transactions with special related parties and related transaction details are not sufficiently disclosed in notes to conceal or reduce them.

The FSS stated, "Accounting treatment should be applied to transactions with special related parties according to the new revenue standard (K-IFRS No. 1115), based on objective evidence and substance of the transaction, and related note disclosure requirements must be faithfully recorded." The five-step revenue recognition model is applied, including identifying performance obligations per contract with customers, estimating variable consideration, allocating transaction prices, and recognizing revenue over time. Whether transactions with special related parties and related transaction amounts (sales of goods or services), and receivable balances have been faithfully disclosed in the notes is also subject to inspection.

The FSS will also check whether accounting treatment for recognition and measurement of financial liabilities has been properly conducted in industries such as manufacturing (beverages, metals, machinery and transportation equipment), construction, and transportation. It will review agreements and contracts related to financial liabilities to ensure that financial liabilities are fully recognized without omission and that note disclosure requirements are faithfully recorded.

Finally, the presentation of operating profit and disclosure of operating segment information will also be inspected. The FSS plans to check across all industries whether operating profit is properly presented and whether note disclosure requirements related to operating segments have been faithfully disclosed. Companies should be careful to properly present operating profit as the profit obtained by deducting cost of sales and selling and administrative expenses from revenue generated from main operating activities. In addition, segment financial information (current profit or loss, etc.) and revenue amounts by customers accounting for 10% or more of total company revenue should be disclosed in the notes.

The FSS stated, "We will encourage companies to pay sufficient attention when preparing the 2021 financial statements by referring to the key points related to the focused review accounting issues."

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