Why Rigged Accounts Are Acceptable

Something that is hard to comprehend from an average person's point of view has occurred: An accounting firm inspected the almost bankrupt Dong Ah Construction and concluded it would be of more value liquidated than kept afloat. In a frantic attempt to stave off liquidation, the company executives submitted a report to court, confessing that the company had doctored its account books to inflate its assets by at least 700 billion won ($583 million) between 1988 and 1997. The expected value from its liquidation, they argued, is therefore not going to be bigger than keeping it in business.

According to the results of a special audit announced by the Financial Supervisory Commi-ssion in September, the net value of the assets of Daewoo Group's 12 subsidiaries stood at minus 28.6 trillion won or 42.9 trillion won less than the 14.3 trillion won the business group reported in August 1999, out of which 22.9 trillion won were bogus figures. Korea has managed to set the greatest accounting fraud record in world corporate history, to add to its notoriety of having one of the globe's highest rates of death caused by traffic accidents.

Daewoo deliberately left out 15 trillion won in debts, including loans, from its books, cooked up 4 trillion won in nonexistent or non-performing bonds, 2 trillion won in absent or worthless inventory assets and an additional 2 trillion won in other types of nonexistent assets. Such fraudulent accounting at the nation's representative corporations are casting the financial statements of other listed companies under doubt and forcing the entire capital market to put up with considerable discount rates.

The corporate financial accounting standards that the government enacted suffer from similarly eroded confidence. For instance, methods of stock and bond valuation changed 11 times between 1974 and 1998. Companies, for their part, constantly changed their methods of accounting depreciation and research and development costs, and virtually left it impossible to make valid comparisons among companies or among fiscal years?he most important aspect of financial analysis. The method of accounting foreign-exchange valuation losses has undergone seven changes since 1974. In late 1997, the government allowed companies to defer foreign-exchange valuation losses accruing from the valuation of long-term foreign currency-denominated liabilities. At the request of international financial institutions including the International Monetary Fund, however, the government changed the accounting standard in 1999 to incorporate such losses into current losses. The change caused a staggering 20 trillion won in deferred balance to be offset with asset revaluation reserve funds. As a result, surplus profits were overstated, on top of which the gains on foreign-exchange valuation obtained in 1999 were written into the net income of the year, thus further inflating the management performance of listed companies and distorting economic indices.

Truthfully speaking, Korea has been a society in which there was no demand for transparent and reliable accounting information. Large shareholders exercised total control over management and monopolized internal corporate information, which eliminated any need for supplementary accounting information. Small shareholders also remained happy as long as the books showed high profits, regardless of the actual facts. Institutional investors made investment decisions without regard to corporate accounting information. Financial institutions also often based their loan decisions more on collateral or political pressure than on the financial health or repayment capabilities of companies. As such was the case, it sufficed to receive financial statements, inflated or otherwise, capable of justifying the loans.

The government also played a part in promoting accounting irregularities by conducting tax investigations on the companies that incurred operational losses or whose taxes failed to meet government goals. When tax revenues fell short, the government even allocated tax payments to companies. It also kept up consistent pressure on businesses to cough up money for its slush funds. No one welcomed strict accounting audits in the circumstances. The absence of any social demand for a sound accounting system became the fundamental cause of the widespread practice of falsifying account books.

We are finally beginning to see some signs of changes. First of all, President Kim Dae-jung and other leaders are stressing the importance of transparent accounting standards. The inauguration of Korea Accounting Institute is also helping to accelerate efforts to make the nation's accounting system consistent with internationally recognized standards. The attitude of outside auditors has changed a great deal since the bankruptcy of Daewoo Group, and an increasing number of companies now fear the market's strict evaluation of the transparency of their management and account books. The changes represent encouraging movements towards eradicating accounting improprieties.