Provisions in Unstable Countries – Need for Proper Guideline

Recently, financial regulatory authorities have begun requiring that foreign lawsuits be treated according to the same standards as domestic lawsuits. This has led to issues disconnected from reality. Concerns have been raised that applying domestic standards to lawsuits in underdeveloped countries with unstable judicial systems could force companies to recognize unnecessary losses and disrupt their financial statements.

K-IFRS Standard No. 1037 addresses provisions, contingent liabilities, and contingent assets, while No. 1010 deals with events after the reporting period that require adjustments. Specifically, it mandates that provisions be recognized when lawsuits are finalized. However, these standards were developed with domestic lawsuits in mind and lack clear guidelines for foreign lawsuits.

In some countries with unstable judicial systems, the fairness and consistency of trials are not guaranteed. Initial judgments are often overturned in appeals or final decisions for unreasonable reasons. Applying the same accounting standards to lawsuits in such countries as those applied domestically could cause unnecessary volatility in financial statements, undermining corporate credibility and international competitiveness.

In certain Middle Eastern countries, for instance, court rulings are highly unpredictable, with corruption and irrational judgments frequently occurring during trials. One Korean company, embroiled in an unreasonable damages lawsuit in a Middle Eastern country, lost in the first instance but refrained from accounting for the loss as a provision, considering the irrationality of that country’s judicial system. The company only recognized the loss after the case was finalized in the highest court. While this approach reflected the company's understanding of the local judicial shortcomings, financial regulators have reportedly taken issue with this decision.

As a result, the company now faces potential disadvantages in international bids and risks to its financial statement credibility. Reports from the EU and the U.S. State Department have highlighted that the judicial systems in such countries lack independence and fairness, often succumbing to corruption and political interference. Courts in these regions frequently lack transparency and fail to meet international standards, leading to unjust rulings.

Experts argue that applying the same K-IFRS standards to domestic and foreign lawsuits is unrealistic. Specifically, if financial regulators impose domestic standards on lawsuits in countries with irrational judicial systems, Korean companies may be exposed to unfavorable lawsuits from competitors abroad. This highlights the need for regulators to establish separate guidelines for lawsuits originating from countries with unstable judicial systems.

According to the Ministry of Economy and Finance and the Korea Institute of Public Finance’s Financial Reporting Q&A, even for domestic lawsuits, "The possibility of resource outflows varies depending on the case and requires judgment. Uniform criteria for such matters are not prescribed in the National Accounting Rules based on trial outcomes (e.g., first-instance losses or appeal losses). Entities must independently assess the likelihood of resource outflows."

Accounting and disclosure standards for foreign lawsuits must reflect the characteristics and realities of judicial systems in each country. If financial regulators introduce specific guidelines for lawsuits arising in countries with unstable judicial systems, companies could reduce unnecessary risks and maintain the reliability of their financial statements.

Additionally, when setting provisions for lawsuits in such countries, an assessment of the judicial system's reliability should precede the accounting decision. For lawsuits in countries with unstable judicial systems, it would be reasonable to base accounting treatment on the final judgment. Establishing such guidelines would help companies avoid exposure to unfavorable lawsuits abroad and secure their competitiveness in the global market.

An expert familiar with this issue stated, “Applying domestic standards to lawsuits in countries with unstable judicial systems fails to reflect reality and could undermine the reliability of corporate financial statements and disclosures. The Financial Supervisory Service must recognize this problem and provide practical, flexible guidelines to help Korean companies maintain their competitiveness in the global market.”

Seoul Tribune (C)

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