House of Cards: Can ‘Today’s House’ Recover from a Staggering 800 Billion Won Loss

Accounting is very important when running a business. If managers or finance managers do not know much about accounting and handle it roughly, the company may face a crisis or suffer a large loss. Let’s look at accounting issues through actual cases that occurred during a company’s external audit.

‘Today’s House (Company Name: Bucket Place)’, an e-commerce company specializing in interior design, is in a state of complete capital erosion as of the end of the first half of this year. According to media reports, the total capital in the consolidated financial statements as of the end of last year was a whopping minus 798.9 billion won. People who are surprised by the TimePrice (Timon + WeMakePrice) incident will think, ‘Isn’t Today’s House going to fail like that?’ In fact, recently, after a daily newspaper reported on Today’s House’s capital erosion, there was a phenomenon of companies leaving stores. Are the financial stability and soundness of Today’s House really in serious crisis?

In the 2023 audit report of WeMakePrice, which has entered corporate rehabilitation (legal receivership), an external auditor (accounting firm) stated that there were ‘significant uncertainties related to going concern.’ He said it was unclear whether the company would be able to continue its operations, and pointed to the continued deficit and current liabilities exceeding current assets as the basis for this. Today’s House also continues to make losses, and its current liabilities are much larger than its current assets. Even though the total capital is close to minus 800 billion won, the company’s audit report does not include any uncertainties related to going concern. Did the external auditor make a mistake? Or did he just turn a blind eye to it? Let’s take a look.

When a startup receives investment from venture capital (VC) or private equity fund (PEF), it usually issues ‘redeemable convertible preferred stock (RCPS)’. This RCPS contains the right for investors to request the company to “repay investment principal and interest early” or “convert preferred stock to common stock.” When judging the financial statements of an RCPS issuing company, two things must be carefully considered.

Companies that prepare financial statements in accordance with General Corporate Accounting Standards (K-GAAP) classify RCPS issuance as equity. No matter what conditions it is issued, it is just preferred stock. The Korean International Financial Reporting Standards (K-IFRS) that listed companies or companies seeking to be listed must use are different. Depending on the conditions of issuance, it may be debt or equity. If the investor has the right to demand early repayment from the issuer, it is a debt. However, if the investor cannot demand repayment and the issuer is issued under conditions that allow it to decide whether to repay the investment principal or interest, it is classified as capital.

Today’s House has issued RCPS while attracting a cumulative external investment of approximately 300 billion won since 2014. Since it was an unlisted startup using K-GAAP, it was classified as capital. However, when this company closed its accounts last year, it changed its financial statement preparation standards to K-IFRS. The company voluntarily converted to K-IFRS in preparation for future listing. The 300 billion won RCPS issued by Today House contains the investor’s right to demand repayment. Therefore, RCPS has now changed from capital to financial liability. Although the company’s business or financial situation has not changed, its liabilities have increased significantly due to changes in accounting standards.

There is another aspect that requires careful consideration when interpreting Today’s House’s financial statements. It was said that this RCPS contains the obligation to respond to investors’ requests for repayment or conversion. This obligation is a ‘debt.’ Let’s look at a simple example to help you understand. Let’s say Today’s House’s current per share value is 10,000 won and it is obligated to issue 10 shares when converting RCPS to common stock. The value of this obligation, or liability, is 100,000 won (10,000 won However, if the value per share has risen to 100,000 won, the value of the debt is now 1 million won (100,000 won x 10 shares). In this way, if the convertible derivative financial liability increases from 100,000 won to 1 million won, that is, 900,000 won, this must be reflected as a loss expense in the income statement.

General capital erosion occurs when a company continues to incur losses in its business activities and accumulates deficits (deficits). However, unlisted companies that have attracted a lot of investment through the issuance of RCPS may fall into capital erosion due to the ‘accounting change to IFRS’ and the subsequent ‘continuous increase in corporate value (increase in stock value)’. You could say that it is a kind of optical illusion brought about by accounting. This capital erosion will be resolved once the conversion of RCPS to common stock is implemented. When the conversion obligation is fulfilled, the related debt is eliminated and capital is increased.

Today’s House’s current liabilities according to the consolidated financial statements based on K-IFRS at the end of last year were KRW 907.4 billion. If you look at this in K-GAAP, it decreases significantly to 160.4 billion won. There is a dramatic change in total capital, from minus KRW 794.6 billion to plus KRW 224.3 billion. This is because when K-GAAP is applied, approximately 1 trillion won in liabilities, including 300 billion won in RCPS (financial liabilities) and 700 billion won in convertible right valuation (derivative financial liabilities), are eliminated and recognized as capital. The current ratio is less than 40% (based on K-IFRS) and well over 200% when applying K-GAAP. Real liquidity can be said to be at the level of a blue-chip company. This is why Today’s House was able to make an early settlement of 67.5 billion won to its partners (store companies) in early August, when everyone was having a difficult time due to the Timef incident. The external auditor had no reason to record material uncertainties related to going concern for Today House.

☞What about Center Director Kim Soo-heon?
He graduated from Korea University’s Department of Public Administration, worked as a reporter for JoongAng Ilbo and E-Daily, and served as CEO of Global Monitor. As the author of the bestseller in the accounting field, ‘I Almost Worked Without Knowing Accounting,’ he explained corporate and capital market issues for two years on Sampro TV’s Understanding channel.