External Audit Act Now Applicable to Yuhan Hoesa After its Amendment
External Audit of a Yuhan Hoesa Now Mandatory Subsequent to Wholly Amended External Audit Act
The Act on External Audit of Joint Stock Companies (hereinafter “External Audit Act”) currently in effect imposes an obligation on joint stock companies of a certain size to conduct an accounting audit through an external auditor (hereinafter “external audit”) and other related obligations. However, the abovementioned Act was not applicable to a yuhan hoesa in the past.
In order to take advantage of this, many companies (especially Korean subsidiaries of foreign companies) were established in the form of a yuhan hoesa or were subsequently converted from a joint stock company to a yuhan hoesa.
Until now, the form of a large-scale yuhan hoesa has been at the center of criticism that they are benefitting from a loophole in the accounting supervision regulations. Thus, to promote fairness in the accounting supervision regulations and to induce accounting information users to make proper decisions, the National Assembly of Korea (hereinafter “Assembly”) has made a resolution to amend the External Audit Act (hereinafter “Amended Act”), to include a yuhan hoesa that possess similar economic qualities as that of joint stock companies, as those subject to a mandatory external audit by external auditors.
According to the current External Audit Act, a joint stock company is subject to a mandatory external audit only if it meets any one of the following criteria: (i) a company with 12 Billion KRW or more in total assets at the end of the immediately preceding fiscal year; (ii) a stock-listed corporation or a company about to be stock-listed in this fiscal year or the upcoming fiscal year; (iii) a joint stock company with 7 Billion KRW or more in total liabilities and total assets in the immediately preceding fiscal year; or (iv) a joint stock company with 300 or more employees and 7 Billion KRW or more in total assets in the immediately preceding fiscal year. However, under the Amended Act, a yuhan hoesa becomes subject to a mandatory external audit if, after consideration of additional factors such as the number of employees and the time subsequent to the modification in form, it falls under the definition provided in the enforcement decree (which is to be subsequently amended).
Enforcement Period of the Amended Act on External Audit
The Amended Act was passed by the Assembly’s plenary session on September 28, 2017 and officially announced on October 31, 2017. It will become effective as of November 1, 2018, which is exactly one year after the date of the announcement.
The above noted section regarding the yuhan hoesa of the Amended Act will be applied to fiscal years starting after the one-year mark of the enforcement date of the Amended Act (i.e., November 1, 2019). Fiscal years are determined differently for each company according to their articles of incorporation, but the Amended Act is to be applied first to companies with fiscal years starting on November 1 every year. For the companies concerned, they are subject to the Amended Act starting November 1, 2019, and will be required to start to prepare an audit report for the fiscal year ending in October 31, 2020.
Obligations of Companies Subject to Mandatory External Audit Under the External Audit Act
Companies subject to a mandatory external audit under the Amended Act (hereinafter referred to as “Target Companies”) should be mindful of the obligations that will apply to them under the Amended Act in order to prepare for its enforcement. The main obligations are listed below, and details will be prescribed by the enforcement decree to subsequently be amended. Target Companies should be mindful since a violation of the obligations may result in imprisonment or a criminal fine.
Appointment of External Auditors and Their Obligation to Report
Target Companies have the obligation to appoint an external auditor for the relevant fiscal year within forty-five days from the start date of each fiscal year (but a company that was not subject to an accounting audit in the immediately preceding fiscal year has the obligation to appoint an external auditor within four months from the start date of the relevant fiscal year). If a company fails to appoint an external auditor within the prescribed period, it must appoint an accounting firm designated by the Securities and Futures Commission (hereinafter “SFC”) as its external auditor.
Also, when a Target Company appoints an external auditor or modifies an appointment, the company must either (i) report such fact to the annual general meeting of members that is convened after the appointment of the external auditor; or (ii) must either notify the members via a written or electronic document, or make a public announcement on the internet homepage immediately following the external auditor’s appointment. Also, the company must report such fact to the SFC [Art. 12].
Preparation of Financial Statements and the Audit Conducted by the External Auditor
Target Companies have the obligation to submit to the external auditor, financial statements of the relevant fiscal year that have been prepared in compliance with the accounting standards, within the period prescribed by the enforcement decree to be amended (for your reference, under the current External Audit Act, a joint stock company subject to the external audit requirement, depending on whether the company is obligated to prepare a consolidated financial statement and whether it is subject to the K-IFRS, the financial statements should be submitted 4 to 6 weeks before the general meeting of the shareholders is held or within 90 days after the end of the fiscal year) [Art. 5(3), 6(2), and 39(1)].
The external auditor conducts an audit based on such financial statements in compliance with the accounting audit standard generally accepted as fair and reasonable. At that time, the external auditor may have the following rights with regards to the Target Company, its parent company, or subsidiary (the threshold for designation as a parent company or a subsidiary is the ownership of 20% or more of the total shares) [Art. 16 and 21(1)]:
the external auditor has access to, and may copy the company’s accounting ledger or documents; the external auditor may request that accounting-related documents be submitted; and if deemed necessary to perform the audit, the external auditor may investigate the work scope of and the financial conditions of the Target Company and its affiliates.
The Submission, Furnishing, and Public Announcement of the Audit Report
The external auditor prepares an “audit working paper” which is a document including the results of the audit, the details of audit procedures and information obtained in such process, and the analysis of such information that have been obtained. The audit working paper must be submitted to the SFC, the company (and its statutory auditors and statutory audit board) and the Korean Institute of Certified Public Accountants (the “KICPA”) within the period specified by the enforcement decree that is to be subsequently amended. For reference, a joint stock company currently subject to the external audit requirement, depending on whether the company is obligated to prepare a consolidated financial statement or is subject to the K-IFRS, the external auditor must submit such document to the company at least a week before the annual general meeting of members, and to the SFC and the KICPA within two weeks from the end of such general meeting, or within 120 days after the end of fiscal year.
The SFC as well as the KICPA allows the public to have access to the audit reports prepared by the external auditor (via dart.fss.or.kr) during the period prescribed by the enforcement decree that is to be amended in the future (This period is currently set as 2 years by the current External Audit Act). Additionally, Target Companies shall furnish and publicly provide the financial statements and the audit report prepared by the external auditor at all times, which should be available to Target Companies’ members and creditors during business hours. [Art. 18, 19, 23(1), and 23(2)].
Supervision and Measures taken by the Securities and Futures Commission
The SFC is in charge of reviewing the audit report submitted by the external auditor. If required for adequate review, the SFC may request Target Companies or its affiliates and external auditors to submit required data, or to state or report an opinion. It may also request the Governor of the Financial Supervisory Service to inspect the accounting ledger, the documents, the work scope and the financial status of the Target Companies or its affiliates. Depending on the results of the inspection, the SFC has the authority to take appropriate measures on Target Companies, such as to recommend the dismissal, termination, or suspension (for a period not exceeding six months) of officers, to restrict the issuance of securities for a certain period, or to request that the violation of accounting standards be corrected [Art. 26, and 29(1)]. In addition, if it is discovered that financial statements prepared by Target Companies violate accounting standards, the SFC may, for a period of up to three years from the date of confirming the violation, officially announce such fact. [Art. 30(1)].
Obligations on Operation of Internal Accounting Management System
Among Target Companies, those with total assets of 100 Billion KRW or more in the immediately preceding fiscal year have the obligation to have internal accounting management regulations and an organization that manages and operates such regulations for the reliable preparation and disclosure of accounting information. An internal accounting manager must be appointed. Internal accounting management regulations must include certain matters that are stipulated in the External Audit Act. The company audit must include an evaluation of the operating conditions of the internal accounting management system, which is to be reported to the Board of Directors every year. The evaluation report must be furnished at Target Companies’ head offices for five years thereon [Art. 8(5)].
Possible Alternative: Establishment of a Limited Liability Company
As we examined above, a yuhan hoesa, along with others, are to be subject to a mandatory external audit under the Amended Act. Because of this, financial information of a yuhan hoesa, including their financial statements, will now be disclosed to the financial authorities and other stakeholders. The audit process may even result in the disclosure of the financial information of affiliated companies.
To circumvent such obligations, one measure that can be taken is for companies to utilize the Limited Liability Company (yuhan chaek-im hoesa; hereinafter referred to as an “LLC”) form, which is still not subject to mandatory external audit regulations despite the Amended Act.
Characteristics of a Limited Liability Company
The main characteristics of an LLC are as provided below:
Minimum Amount of Capital: No requirement as to a minimum amount of capital exists under the Commercial Code. 1 KRW or more is sufficient. However, if the member is a foreigner, the capital contribution must be made in a foreign currency and the actual investment amount must be at least 100 Million KRW in order for the relevant investment to be recognized as a foreign investment under the Foreign Investment Promotion Act. Decision-Making Body: The requirements for a decision-making are determined either by the Commercial Code or the Articles of Incorporation. For a yuhan hoesa, the Commercial Code requires that a general meeting of members be held. In contrast, the Commercial Code does not require that a general meeting of members be held for LLCs. Nonetheless, it still leaves the possibility for LLCs to convene a general meeting of members, as well as to set the decision-making requirements based on its Articles of Incorporation. Organization in Charge of Management: For a yuhan hoesa, a director is in charge of the management of the company, and such director must be a living individual. However, for LLCs, a manager is in charge of the management, and such manager may be a corporate body. Amendment of the Articles of Incorporation, and etc.: A yuhan hoesa, at the general meeting of members, determines matters such as an amendment of the Articles of Incorporation, a capital reduction, and the appointment of directors. Voting requirements are determined either by the Commercial Code or the Articles of Incorporation, but in most cases, unanimity is not required. However, an LLC requires that consent of all members be provided for the approval of these matters.
In addition to the above, provided below is a chart that provides a summary of the main similarities and differences in the operation of yuhan hoesa and LLCs.
Limited Liability Company
Number of Members
1 or more
Limited to the Contribution Amount
Distribution of Profit
Distributed in proportion to the Number of Units Contributed
Requirements for Decision-Making as to the Amendment of the Articles of Incorporation
Amendment of the Articles of Incorporation is possible with a decision made at the general meeting of members (consent of at least half of the total members and 3/4 of the total voting rights required)
Amendment of the Articles of Incorporation is possible with the unanimous consent of the members
- Member stakes are determined by the number of units contributed
- The value of one contributed unit must be uniform and at least 100 KRW
Stakes are determined by the actual amount contributed
Organization in Charge of the Execution of Tasks
- One or multiple director(s) manage and represent the company
- May have one or multiple statutory auditor(s) under the Articles of Incorporation
- One or multiple director(s) manage and represent the company
- A corporate body cannot be a director nor a statutory auditor
- Even a corporate body may be the manager
General Meeting of Members
- Each member has one vote per one unit contributed
- Decision-making by the general meeting of members is required for the following matters
(i) Assignment of all or substantial part of the business operations
(ii) Agreements that include an entire leasing of or the delegation of management; agreements that share the profit and losses of the company entirely with another person; or the signing, modification, or termination of an agreement that entails similar qualities as the above-mentioned agreements
(iii) Acquisition of all or part of the business of another company that has a significant effect on the business of the company
A general meeting of members is not obligatory, but may be held voluntarily
Transfer of Stakes
May assign all or part of the units contributed, subject to the restrictions under the Articles of Incorporation. However, if the assignee’s name, address, or the number of units contributed is not recorded in the members’ registry, such assignment does not take effect against the company or a third party.
May assign all or part of the stakes with the consent of all members; subject to the restrictions under the articles of incorporation
Conversion from a Yuhan Hoesa to a Limited Liability Company
Under the current Commercial Code, the conversion from a yuhan hoesa to an LLC is not acknowledged. Considering that the conversion from a joint stock company to a yuhan hoesa and vice versa is acknowledged as well as the conversion from a joint stock company to an LLC and vice versa, such an omission may simply be a failure of legislators to include it in the legislation. Meanwhile, even if a yuhan hoesa decides to transform into an LLC via a general meeting of members, such conversion is only effective if it is registered with the court registration office. Since the registration authority will refuse to register a conversion not based on a specific provision under the Commercial Code, a yuhan hoesa cannot legally transform itself into an LLC. Accordingly, Target Companies should consider a two-step process, which entails first transforming from a yuhan hoesa to a joint stock company, then thereafter transforming from a joint stock company to an LLC, which will ultimately result in a conversion from a yuhan hoesa to an LLC.
The following list provides major steps to be taken for a two-step conversion. The whole process is expected to take approximately four to five months.
Yuhan hoesa’s general meeting of members (1 week for convening; can be shortened with the consent of all members) Yuhan hoesa’s creditor protection period (of at least one month) Procedure for the review and accreditation by the court for approval of yuhan hoesa’s conversion into a joint stock company Registration of yuhan hoesa’s conversion into a joint-stock company Joint stock company’s general meeting of the shareholders (2 weeks for convening; can be shortened with the consent of all members) Joint stock company’s creditor protection period (of at least one month) Registration of joint stock company’s conversion into an LLC
The Establishment of a Limited Liability Company and Transfer of Existing Operations
In case the abovementioned two-step procedure is deemed to take too long and is impractical, one alternative that the member (parent company) of a yuhan hoesa may take is to first establish a separate LLC and to transfer the existing operations of the yuhan hoesa to the LLC, either by asset transfer or by business transfer, and thereafter liquidating the yuhan hoesa. However, the drawback of this alternative is that more capital must be invested in the new LLC before the capital investment in the existing yuhan hoesa is redeemed.