ECA Annual Report - 2

THE 2004 Annual Report of the European Court of Auditors is a voluminous 324-page document, excluding annexes. This should come as no surprise given the broad context of the EU annual general budget and the complexity of much of the subject matter. A quick look at the headings of the various chapters, in which the annual report is divided, is enough to illustrate this point.

One chapter is dedicated to Revenue items. The bulk of the EU budget is financed by what are referred to as 'Own Resources', but there is also a small share that is made up of other revenue (e.g. bank interest, contributions from non-member countries to certain Community programmes etc.).

'Own Resources' can be defined as revenue accruing directly to the EU to finance its budget. It comprises customs duties together with agricultural duties and sugar levies (together called the 'traditional own resources') plus the Value Added Tax (VAT) -based resource and the Gross National Income (GNI)-based resource.

The 'Own Resource' based on VAT is levied on member states' VAT receipts, which are harmonised for this purpose in accordance with Community rules. The resource based on GNI is levied on each member state's GNI, which is measured in accordance with Community rules.

Expenditure items (payments) are grouped under seven chapters, in recognition of their varied nature and significant differences in the responsibility for their implementation and control. One chapter covers the Common Agricultural Policy and another "Structural Measures". Together, these two headings encompass the bulk of EU expenditure and most of the relevant expenditure is subject to shared management between the Commission and the member states.

A third chapter covers internal policies, comprising EU programmes administered directly by the Commission. Two other chapters cover "External Actions" and "Pre-accession Strategy", both being expenditure items which are implemented outside of the EU. Another chapter covers administrative expenditure, which is the actual expense for staff that run the various EU institutions.

Finally, there is a separate chapter called "Financial Instruments and Banking Activities" which covers the Commission's shareholding in the European Investment Bank and in the European Bank for Reconstruction and Development, as well as assets held by financial institutions on behalf of the Commission.

Chapter one of the annual report contains the ECA's "Statement of Assurance". This incorporates the main conclusions of the ECA and, in some ways, it can be said to provide an executive summary of the rest of the report. The salient points of the "Statement of Assurance" are typically reproduced in a press release issued by the ECA to coincide with the publication of its annual report and this practice has, again, been followed this year. There are two key sentences in this press release, which I would like to quote since, together, they capture the principal conclusions of the ECA. The following is the first one.

"The ECA is of the opinion that the 2004 consolidated accounts on the implementation of the EU general budget faithfully reflect the revenue and expenditure of the year and the financial situation at the year end, except in the case of sundry debtors."

This sentence concerns the reliability of the Community accounts; i.e. the extent to which the Commission's accounts accurately capture and depict the financial transactions (revenue and expenditure) that have taken place during the financial year in question. In many ways, it could be said that this part of the Statement of Assurance is quite similar, in scope, to the declaration made by private audit firms upon the publication of the annual accounts of Public Liability Companies.

Notwithstanding the huge complexity of the EU context, this aspect of the ECA's audit has not uncovered any particular problems with the sole exception of 'sundry debtors'. This partial qualification, however, warrants an explanation.

Until last year, the Commission applied a 'cash'-based accounting system which presents certain intrinsic difficulties when recording 'advance payments' made in connection with programmes that are part financed from Community funds. This is not to say that such advances have not been properly recorded when they were made but the 'cash' based accounting system makes it difficult to ascertain whether all the consequent assets and liabilities have been accurately captured at the end of the financial year in question.

As from this year, the Commission will have switched to an 'accrual'-based accounting system which should resolve this problem although it cannot be excluded that the complexity of this transition might create some new problems.

The audit of the EU budget does not rest only upon the reliability of the accounts but the ECA must also express itself on the 'legality and regularity' of the underlying transactions. In other words, the ECA must also evaluate whether all the relevant rules and regulations have been followed when making the expenditures shown in the accounts.

To give a simple example: the purchase of certain items of equipment could have been properly recorded but the relevant public procurement procedures might not have been followed. This would imply a situation where the accounts are reliable but the underlying transactions cannot be deemed to have been regular.

This is only one example. In reality there are many rules and regulations that could be relevant, many of them pertaining to specific programmes in a given country or even region. For example, in a particular region, a specific programme might have been adopted to target Small and Medium Enterprises (SMEs) in the pharmaceutical sector. In such a case, it would be necessary to check whether all the participants in the programme actually had the required credentials to qualify as SMEs and whether they were all effectively operating in the pharmaceutical sector, before establishing whether all the relevant transactions were legal and regular.

This brings me to the second sentence I would like to quote from the ECA's press release: "The Court found the supervisory and control systems implemented and operating effectively and the transactions underlying the accounts, taken as a whole, to be legal and regular in respect of revenue, commitments, administrative expenditure and pre-accession strategy, although varying degrees of risk still exist in the implementing organisations in the latter case.

For the remainder of the payments' budget - agricultural spending, structural measures, internal policies and external action - the Court is again not in a position to provide an unqualified opinion on the legality and regularity of underlying transactions". In simpler words: the ECA's audits discovered 'errors' (deficiencies) in the transactions underlying payments in the areas of Agriculture, Structural Funds, Internal Policies and External Aid which puts into doubt the legality and regularity of these transactions.

In his address to the European Parliament, Hubert Weber, president of the ECA, was very emphatic: "This is the result of inherently risky transactions and supervisory and control systems that are ineffective in terms of limiting the risk of irregularity to an adequate level".

It is well known that many of the programmes eligible for funding under the Common Agricultural Policy and the Structural Funds represent an intrinsic risk because of the decentralised nature of the assistance given, the fact that management responsibility is shared between the Commission and the member states and as a result of the varied and often complex nature of the interventions that are covered.

Nevertheless, it can be convincingly argued that improvements in the relevant supervisory and control systems could go a long way towards mitigating these risks.

This point was stressed by the president of the ECA who, as an example, highlighted the significant improvement in the results achieved by those regions where the Integrated Administration & Control System (IACS) has been correctly implemented and properly applied to regulate expenditure under the Common Agricultural Policy.

This positive development is reflected in the results of the ECA's audits and, in fact, in its latest Annual Report, the ECA has opined that IACS, when properly applied, is effective in limiting the risk of irregularity to acceptable levels.

It is important that similar improvements are achieved also in the other areas of EU expenditure in which the ECA's audit have highlighted 'errors'. To again quote the ECA president: "It is indeed of critical importance that the Commission and the member states work together to identify weaknesses in the design and operation of internal control systems and introduce appropriate changes to such systems to provide assurance that EU expenditure is legal and regular and provides value for money".