Financial statements are prepared by management. Management wants to show good numbers, so users find it hard to take those numbers at face value. An audit is the work of an independent professional who expresses an opinion on whether the financial statements are prepared fairly, in all material respects, in accordance with the accounting standards, raising the credibility of the information. This course follows an audit from planning to reporting. The financial statements being audited were covered in Principles of Accounting and Intermediate Accounting.

1. Who must be audited

Korea’s Act on External Audit of Stock Companies, etc. (the External Audit Act) makes external audits mandatory for companies above a certain size. A stock company is subject to audit if it is listed or about to list, or if at the end of the previous fiscal year it meets any of the following (Enforcement Decree of the External Audit Act, Article 5).

Thresholds for external audit of stock companies
Criterion	Requirement
Assets	Total assets of ₩50 billion or more
Revenue	Revenue of ₩50 billion or more
Two or more size criteria	Total assets ₩12 billion or more, total liabilities ₩7 billion or more, revenue ₩10 billion or more, 100 or more employees

Determining whether an external audit is required

\text{Required} \iff A \ge 500 \;\lor\; S \ge 500 \;\lor\; \#\{A \ge 120,\ L \ge 70,\ S \ge 100,\ E \ge 100\} \ge 2

A is total assets, L total liabilities and S revenue (unit: ₩100 million), and E the number of employees. Limited companies have separate thresholds with an added requirement on the number of members.

An unlisted stock company with assets of ₩15 billion, liabilities of ₩8 billion, revenue of ₩9 billion and 60 employees meets the two criteria of assets and liabilities and must be audited. The rules may be amended, so check the Enforcement Decree for the year concerned.

2. The purpose of an audit: reasonable assurance

KSA 200 sets the auditor’s overall objectives as obtaining reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and expressing an opinion accordingly.

Reasonable assurance is a high level of assurance but not absolute assurance, because the auditor tests samples, evaluates management’s judgements, and evidence is generally persuasive rather than conclusive.
An audit does not check every transaction. It assesses the risk of material misstatement and designs procedures to respond to it (chapter 2).
Failing to detect a material misstatement does not in itself mean the audit failed; the test is whether it was performed properly in accordance with the standards.

3. Professional skepticism and professional judgement

Professional skepticism is a questioning mind: being alert to conditions that may indicate fraud or error and critically assessing evidence. The auditor assumes neither that management is honest nor that it is dishonest. For example, if large sales bunch up at year-end and many returns follow early the next month, the auditor does not accept management’s explanation at face value but verifies it with contracts, shipping records and confirmations from customers.

Professional judgement is applying auditing standards and experience in determining materiality, assessing risk and evaluating the sufficiency of evidence. The basis for judgements is documented in the audit working papers.

4. Independence

If the auditor is not independent of the company, the audit opinion is worthless. Independence has two sides: independence of mind (actually being objective) and independence in appearance (being seen as independent by a reasonable third party).

Article 21 of the Certified Public Accountant Act prohibits an audit where the auditor holds shares in the company, was an officer or employee, or has a debtor-creditor relationship with it.
The External Audit Act restricts providing certain non-audit services (such as bookkeeping or outsourced internal audit) to an audit client at the same time.
Auditing the same company for a long time creates a familiarity threat. The External Audit Act, fully revised in 2018, introduced periodic designation: when listed companies and certain others have freely appointed their auditor for six consecutive fiscal years, they must appoint an auditor designated by the Securities and Futures Commission for the next three fiscal years.

Check your understanding

Unlisted stock company AD had, at the end of the previous fiscal year, total assets of ₩11 billion, total liabilities of ₩7.5 billion, revenue of ₩10.5 billion and 90 employees. Is AD subject to external audit? And if a partner of the accounting firm appointed as AD’s auditor holds 100 shares in AD, what is the problem?

AD does not meet the ₩50 billion assets or revenue thresholds, but it meets two of the size criteria — liabilities of ₩7 billion or more and revenue of ₩10 billion or more — so it must be audited. A share held by the engagement partner impairs independence through a financial interest regardless of the amount. The partner must dispose of the shares or be removed from the engagement; if the threat is not eliminated, the firm cannot take on the audit.

References

Act on External Audit of Stock Companies, etc. and Enforcement Decree, Article 5 — Korea Law Information Center
Korean Institute of CPAs, Korean Standards on Auditing, KSA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Auditing Standards
Alvin Arens, Randal Elder and Mark Beasley, Auditing and Assurance Services, ch. 1–4

Auditing — The Purpose and Framework of an Audit: Reasonable Assurance, Professional Skepticism and Independence