Annual Report on the implementation of the budget, together with the institutions' replies
Date: 2006-09-14
Institutions: European Court of Auditors
Subjects: European Court of Auditors, activity report, financial year, general budget (EU), implementation of the budget








C_2006263EN.01000101.xml










31.10.2006   


EN


Official Journal of the European Union


C 263/1





COURT OF AUDITORS



In accordance with the provisions of Article 248(1) and (4) of the EC Treaty, Articles 143 and 181(2) of Council Regulation (EC, Euratom) No 1605/2002 on the Financial Regulation applicable to the general budget of the European Communities and Articles 116 and 135(2) of the Financial Regulation of 27 March 2003 applicable to the Ninth European Development Fund, the Court of Auditors of the European Communities, at its meetings of 7 and 14 September 2006, adopted its
ANNUAL REPORTS
concerning the financial year 2005
The reports, together with the institutions' replies to the Court's observations, were transmitted to the authorities responsible for giving discharge and to the other institutions.


GENERAL INTRODUCTION






0.1.


This document, covering the 2005 financial year, comprises the Court's 29th annual report on the implementation of the general budget of the European Union, as well as its annual report in relation to the European Development Funds.










0.2.


The structure of the annual report on the implementation of the general budget is now as follows: Chapter 1 — the Statement of Assurance; Chapter 2 — the Commission's internal control system (1); Chapter 3 — key observations on budgetary management; Chapters 4 to 10 — revenue and activities financed from different parts of the budget, reflecting the headings of the financial perspective; and Chapter 11 — financial instruments and banking activities. The replies of the Commission — or other EU Institutions where appropriate — are presented with the report.










0.3.


The chapters covering revenue and the major areas of expenditure have the following main elements:






—


detailed analyses of the results of the audit work carried out in the context of the Statement of Assurance in the form of specific assessments,










—


results of follow-up reviews of progress made on implementing recommendations of the Court and the Budgetary Authorities arising from previous audits,










—


a list of the special reports published by the Court since the last annual report.














0.4.


The specific assessments are based on an evaluation of the operation of the principal supervisory and control systems governing revenue and each expenditure area, the results of the Court's testing of underlying transactions and the results of the work of other auditors where relevant. The Court's overall appraisal of all these elements forms the basis for the Statement of Assurance set out in Chapter 1. In addition, the Annexes to Chapters 4 to 9 set out the elements used for monitoring and evaluating the financial management of the EU budget.










0.5.


2005 was the first full year in which the European Union had 25 Members. From a financial perspective the main event was the introduction of accruals-based accounting, and the preparation of consolidated financial statements on this basis. Chapter 1 gives information on this key process. The Commission has been working on this comprehensive and complex change over the past three years, but, as the Court observes, further progress is required.










0.6.


In the financial year 2005, the Court notes a continued improvement in the Commission's internal control system. 2005 also saw a proposal for modifying the Financial Regulation with the aim of simplifying and improving procedures. This has been followed by a revised proposal in 2006 taking into account the opinion of the Court and other institutions. In parallel, the Commission made two proposals to improve the implementing regulations of the current Financial Regulation, on which the Court has also given its opinion.










0.7.


In addition the Commission has proposed changes in sectoral rules and regulations, partly in preparation for the forthcoming 2007 to 2013 financial perspective period. These include new or revised regulations for own resources, structural operations, agriculture, internal polices and external actions. The Court continues to provide input to these processes in the form of opinions, and will closely monitor their application.










0.8.


A major element of the Commission's reform programme on-going since 2000 is the system of annual activity reports and accompanying declarations of directors-general. The quality of these fundamental accountability and communication instruments has been strengthened. However, as reported in this annual report, the Court continues to find a material incidence of error in most of the expenditure areas where complex rules continue to exist and expenditure is mainly based on information supplied by the recipients. The current supervisory and control systems, both at the Commission and in Member and beneficiary States, need to be further strengthened and integrated to manage the associated risks.










0.9.


Within its Opinion No 2/2004 (2) on the ‘single audit’ model, the Court suggested the creation of a Community internal control framework in which current or new systems would be:






—


developed and applied at the Commission and Member States in a coordinated manner and following common principles and standards, and










—


designed to ensure an appropriate balance between the cost of controls, and the benefits they bring in terms of managing the risk of irregularity.














0.10.


Following consideration of, and consultation on, these issues the Commission issued a Communication in January 2006 (3), setting out its action plan towards an integrated internal control framework. The Commission's objective is to provide effective and efficient internal control of EU funds. The Court welcomes these developments on the basis that it is essential that the citizens of the Union have reasonable assurance that European public funds are managed in a legal and regular manner. The Court will evaluate the results of the action plan when the relevant measures have been implemented and it is possible to assess their impact.






(1)  This chapter consolidates the information previously presented in the Statement of Assurance chapter as well as in the individual income and expenditure chapters.

(2)  OJ C 107, 30.4.2004.

(3)  COM(2006) 9 final of 17.1.2006.




ANNUAL REPORT ON THE IMPLEMENTATION OF THE BUDGET

(2006/C 263/01)
TABLE OF CONTENTS






Chapter 1








—


The Statement of Assurance and supporting information














Chapter 2








—


Commission internal control














Chapter 3








—


Budgetary management














Chapter 4








—


Revenue














Chapter 5








—


The common agricultural policy














Chapter 6








—


Structural operations: regional policy, employment and social policy, rural development and fisheries














Chapter 7








—


Internal policies, including research














Chapter 8








—


External actions














Chapter 9








—


Pre-accession strategy














Chapter 10








—


Administrative expenditure














Chapter 11








—


Financial instruments and banking activities














Annex I (1)









—


Financial information on the general budget














Annex II (1)









—


Reports and opinions adopted by the Court of Auditors since 2001










(1)  The annexes related to the Annual report on the implementation of the budget can be found at the end of this publication.



CHAPTER 1
The Statement of Assurance and supporting information
TABLE OF CONTENTS
Statement of Assurance
Reliability of the accounts
Legality and regularity of the underlying transactions
Information in support of the Statement of Assurance
Introduction
Reliability of the accounts
General background
Audit scope and approach
The Commission's management of change
Consolidated opening balance sheet as at 1 January 2005
Consolidated financial statements as at 31 December 2005
Legality and regularity of underlying transactions
The Court's approach
Audit results 2005
STATEMENT OF ASSURANCE








I.


Pursuant to the provisions of Article 248 of the Treaty the Court has examined the ‘Final annual accounts of the European Communities’ consisting of the ‘Consolidated financial statements and the consolidated reports on implementation of the budget’ for the financial year ended 31 December 2005 (1).










II.


In accordance with the Financial Regulation of 25 June 2002, the ‘Consolidated financial statements’ for the financial year 2005 are prepared for the first time on the basis of accounting rules adopted by the Commission's Accounting Officer which adapt accruals based accounting principles to the specific environment of the Communities (2), while the ‘Consolidated reports on implementation of the budget’ continue to be primarily based on movements of cash. The change-over to accruals based accounting required a restatement of the opening balance sheet as at 1 January 2005 and important changes in the presentation (3) and content (4) of the ‘Consolidated financial statements’.










III.


The ‘Final annual accounts of the European Communities’ are consolidated by the Commission's Accounting Officer and approved by the Commission. The Court's responsibility is to provide, based on its audit, the European Parliament and the Council with a statement of assurance as to the reliability of the accounts and the legality and regularity of the underlying transactions.










IV.


The Court carried out its audit in accordance with its own policies and standards which are based on international standards that have been adapted to the Community context. Through its audit, the Court has obtained a reasonable basis for the opinion expressed below. In the case of revenue the scope of the Court's audit work was limited. Firstly, VAT and GNI own resources are based on macroeconomic statistics for which the underlying data cannot be audited directly by the Court, and secondly, the audits of traditional own resources cannot cover the imports that have not been subject to custom supervision.






Reliability of the accounts








V.


In the Court's opinion, the ‘Final annual accounts of the European Communities’ were drawn up in accordance with the provisions of the Financial Regulation of 25 June 2002 and accounting rules adopted by the Commission's Accounting Officer. Except for the effects of the observations in paragraphs VI to VIII, they present fairly, in all material respects the financial position of the Communities as of 31 December 2005, and the results of their operations and cash flows for the year then ended.










VI.


The Court notes that, in the context of a complex exercise (see paragraph II), the existing financial reporting framework has not been consistently applied, in particular for cut-off, and that accounting systems in certain Directorates-General of the Commission were not able to ensure the quality of financial information which led to multiple corrections after the presentation of the provisional accounts (see paragraphs VII and VIII).










VII.


The Court's audit has identified errors in amounts registered in the accounting system as invoices/cost statements and pre-financing which, after corrections made to the provisional accounts, still have the following net financial impact on the elements of the consolidated financial statements listed below (see also paragraph VIII):






(a)


The consolidated opening balance sheet as at 1 January 2005, which adjusted the consolidated closing balance sheet as at 31 December 2004 on the basis of the new accruals based accounting principles, overstates the accounts payable by some 47 million euro and overstates the total amount of long-term and short-term pre-financing by some 179 million euro. As a result, the net assets are overstated by some 132 million euro.










(b)


The errors identified in (a) above affected the consolidated closing balance sheet as at 31 December 2005 which overstates the accounts payable by some 508 million euro and the total amount of long-term and short-term pre-financing by some 822 million euro. As a result the net assets are overstated by some 314 million euro.














VIII.


The Court's audit also confirmed the general reservation of the Director-General for Education and Culture covering the lack of assurance as regards the correctness of its share of the total amounts, included in both the consolidated opening balance sheet as at 1 January 2005 (assets amounting to 572,5 million euro and liabilities amounting to 198,5 million euro) and the consolidated closing balance sheet as at 31 December 2005 (assets amounting to 382,7 million euro and liabilities amounting to 187,3 million euro). Given the incidence of omissions and double or wrong postings within this Directorate-General, it is not possible to quantify the over- or understatement in its share of the assets and liabilities.






Legality and regularity of the underlying transactions








IX.


In areas where the supervisory and control systems are implemented in a manner which provides for an adequate risk management, the transactions underlying the final annual accounts of the European Communities, taken as a whole, are legal and regular. This is the case for revenue, commitments and payments for administrative expenditure and pre accession strategy with the exception of the SAPARD Programme. Moreover, for Common Agriculture Policy (CAP) expenditure the Court's audit shows that, where properly applied, the integrated administration and control system (IACS) is an effective system to limit the risk of irregular expenditure.










X.


Without calling into question the opinion expressed in paragraph IX, the Court emphasises that, in the area of pre-accession strategy, significant risks still exist at the level of the implementing organisations in the acceding and candidate countries for all programmes and instruments.










XI.


The Court notes that in the other areas, payments are still materially affected by errors and the Commission and the Member and other beneficiary states need to make an increased effort to implement adequate supervisory and control systems, so as to improve the handling of the attendant risks. These areas are listed below, namely: Common Agricultural Policy, Structural measures, Internal policies and External actions.






(a)


In CAP expenditure, the Court found evidence that expenditure which is not subject to IACS, or where IACS is not properly applied or where it has only been recently introduced poses greater risk because control systems are not as effective. In addition, IACS inspection results are insufficiently verified and validated by an independent body and claims for EU aid are not usually checked on the spot by the latter. Clearance systems and post payment checks for CAP subsidies not covered by IACS do not provide reasonable assurance as to compliance with Community legislation. The Court concluded that CAP expenditure, viewed as a whole, was still materially affected by errors.










(b)


In structural measures, the Court again found that the Commission does not maintain effective supervision to mitigate the risk that the controls delegated to Member States fail to prevent reimbursement of overstated or ineligible expenditure. For both programming periods (1994 to1999 and 2000 to2006), the Court found that expenditure was not free of material irregularities. Some programs for the 1994 to 1999 period were closed without a sound basis.










(c)


In internal policies, despite the progress made in certain areas, the Court's audit revealed weaknesses in the supervisory and control systems which led to a material incidence of errors in payments to beneficiaries. Errors arise mainly from complicated cost reimbursement systems and unclear procedures and instructions governing the different programmes.










(d)


In external actions, the improvements of the Commission's supervisory and control systems have not yet had an impact at the implementing organisation level, where a material level of errors still exists, which can be attributed to the lack of a comprehensive approach to the supervision, control and audit of these organisations.











14 September 2006

Hubert WEBER


President








European Court of Auditors




12, rue Alcide De Gasperi, L–1615 Luxembourg










THE COURT'S OBSERVATIONS


THE COMMISSION'S REPLIES




INFORMATION IN SUPPORT OF THE STATEMENT OF ASSURANCE




Introduction










1.1.


Pursuant to Article 248 of the EC Treaty, the Court of Auditors provides the European Parliament and the Council with a Statement of Assurance concerning the reliability of the accounts and the legality and regularity of the underlying transactions (the DAS). The Treaty also authorises the Court to supplement this statement with specific assessments of each major area of Community activity.






 










1.2.


The aim of the work on the reliability of the accounts of the European Communities is to obtain sufficient evidence to conclude on the extent to which revenue, expenditure, assets and liabilities have been properly registered and that the annual accounts faithfully reflect the financial position at the end of the year (see paragraphs 1.5 to 1.58).






 










1.3.


The aim of the work on the legality and regularity of the underlying transactions is to gather sufficient evidence, of a direct or indirect nature, to give an opinion on whether they are in accordance with the applicable regulations or contractual provisions, and have been correctly calculated (see paragraphs 1.59 to 1.65 of this chapter for horizontal issues and chapters 2 and 4 to 10 for details).






 










1.4.


In the absence of systematic indicators presented by the Commission (5), the Court provides certain indicators to monitor progress in improving internal controls both overall, and for each income and expenditure area (see annexes to this chapter and to chapters 2 and 4 to 10).






 




Reliability of the accounts




General background










1.5.


The Court's observations concern the final annual accounts for the financial year 2005, which are drawn up by the Commission's Accounting Officer and approved by the Commission in compliance with Articles 128 and 129 of the Financial Regulation of 25 June 2002 (6) and sent to the Court on 28 July 2006. The annual accounts comprise the ‘consolidated financial statements’ — covering, in particular, the balance sheet setting out the assets and liabilities at the end of the year and the ‘consolidated reports on the implementation of the budget’ — covering the revenue and expenditure for the year.






 










1.6.


The financial year 2005 was a key milestone in the implementation of new elements of the Action Plan for the modernisation of the Communities' accounting system which the Commission adopted on 17 December 2002 (7). This was in response to a number of previous observations by the Court and took into account the provisions of the Financial Regulation (in particular Articles 123 to 138):










—


since 1 January 2005, the consolidated financial statements have to be prepared by applying accruals accounting principles, while the consolidated reports on the implementation of the budget are still based on cash movements as foreseen in the Financial Regulation,










—


while the content of the budgetary reporting was not changed, the financial statements have to comprise new elements: an economic outturn account (including segment reporting), a cash-flow table and a statement of changes in net assets,










—


the scope of consolidation was extended to include various Community bodies for the first time,










—


a new accounting system had to be implemented which ensures that each accounting event, and not just each cash movement, is fully recorded when it occurs. This should provide internal users with more complete and relevant information as a tool for decision-making. It should also translate into a more transparent and informative statement for external readers.






 






Accruals-based accounting: The principal significance of accruals-based accounting is that it shifts the focus of the accounts from the recording of cash transactions to the recognition of the ‘rights and obligations’ as soon as these are acknowledged.The following are the most important impacts of the change-over to accruals-based accounting on the consolidated accounts:Pre-financing: This item now appears as an ‘asset’ in the balance sheet. It represents advances paid to beneficiaries which have not yet been utilised or for which no expenditure claim has been received (28 000 million euro).Accounts payable: Amounts are recognised as costs as soon as they are deemed incurred and eligible by the authorising services (74 200 million euro).Cut-off: Transactions made during a year must be recognised in the accounting period to which they relate.The figures quoted above are taken directly from the final annual accounts of the European Communities (opening balance sheet as at 1 January 2005).



 




Audit scope and approach










1.7.


The Court's audit on the reliability of the accounts focussed on:










—


the Commission's management of the change-over from cash-based to an accruals-based accounting (see paragraphs 1.10 to 1.27),










—


the verification of the accuracy of various elements in the accounts (see paragraphs 1.28 to 1.58).






 










1.8.


In its work on the management of change the Court considered in particular:










—


whether the Commission had ensured the effective application of the relevant accounting standards,










—


whether measures taken within the Commission contribute to the reasonable assurance that the accounts are true and fair.




This was done by analysing the basis for the validation (according to Article 61 of the Financial Regulation) of the 2005 opening and closing balance sheets, the cut-off methodology used and the state of readiness of the local financial management systems which provide data for the Commission's accounts.


 










1.9.


In verifying the reliability of the 2005 accounts, the Court concentrated in particular on:










—


the 2005 opening balance sheet (which has to disclose the impact of the changes made to restate the balance sheet as at 31 December 2004 under the new accounting principles),










—


the closing balance sheet as at 31 December 2005,










—


within the above two elements, data not available under the previous system, but which need to be reflected in the accruals accounts (pre-financing and related guarantees, invoices/cost statements).




This was done by carrying out analytical reviews and substantive tests on comprehensive samples.


 




The Commission's management of change




General achievements










1.10.


The Commission had to plan and implement the modernisation of the accounting system within the calendar and organisational framework imposed by the Financial Regulation. As already observed by the Court in previous Annual Reports (8), the timetable established for the necessary adaptations and validations was very ambitious.












1.10.


The Commission recognises the extraordinary effort made by its departments to move to accrual-based accounting within a very ambitious timetable.




To accomplish the objective to modernise the accounting system, the Commission prepared a very detailed project management plan identifying all the milestones needed to make this project a success.










1.11.


Experience in public administrations undertaking similar reforms (9) shows that projects of a scale and complexity similar to the modernisation of the Communities' accounts inevitably face a variety of problems which complicate and delay their complete implementation. Against this background, important progress has been achieved:










—


on 1 January 2005, the Commission moved the general accounting of the EU from cash-based to accruals-based accounts. New accounting rules (10) and methods, a new harmonised chart of accounts and new consolidation tools were introduced in all Community institutions and agencies,










—


stakeholders were provided with individual and consolidated accounts which comprise the new obligatory elements and contain more detailed information about the resources controlled by the different entities, the costs of their operations and the cash flow operations.












1.11.


Despite the complexity of certain issues, the variety of problems and big challenges, the Commission managed the project without delays regarding the key deadlines. Noteworthy achievements include:










—


the IT systems developed in order to support the new accounting requirements;










—


the transition to the new system was successfully managed which allowed the opening of the new system at the beginning of January 2005;










—


administrative procedures of all the Commission's services were adapted to the needs of accruals based accounting;










—


the opening balances for the first accrual-based accounts were determined and validated;










—


an integrated treasury module was developed to account for the financial activities managed by the Directorate-General for Economic and Financial Affairs;










—


the expenses to be accrued at the end of each year were estimated by all departments;










—


the Commission's accounts were prepared, and consolidated with those of other institutions and agencies.




Finally, the Commission respected the time-limits set in the Financial Regulation for the preparation of financial statements which comply in all material aspects with international standards, and has met its commitment to the European Parliament and to Council to report on its progress towards this goal, which all authorities considered very ambitious.










1.12.




Table 1.1
 contains a follow-up of the Court's reservation concerning the reliability of the accounts which was expressed in the Statement of Assurance for the 2004 financial year, as well as the other points raised by the Court which were (partly) settled in the context of the modernisation of the Community accounting framework. However, as in any new accruals-based accounting system of such a magnitude, certain weaknesses still exist (see below).












1.12.


The Commission has always recognised in the ABAC progress reports that work remains to be done.








Table 1.1 — Follow-up of the qualification expressed in the 2004 Statement of Assurance as to the reliability of the accounts and the impact of the modernisation of the accounting system in respect of certain observations made in the Annual Report concerning the financial year 2004







Qualification in the 2004 Statement of Assurance


Replies in the Annual Report concerning the financial year 2004


Developments




In the absence of effective internal control procedures for miscellaneous revenue and advances, the Court cannot be certain that the transactions relating to the sundry debtors item have been correctly and completely recorded.


The Commission accepts this remark of the Court, but states that the introduction of the new accounting system in 2005 addresses the problems raised.


The Court recognises the important efforts made by all Commission departments, as well as by the other institutions and bodies, to collect the amounts of pre-financing formerly entered as final expenditure. Nevertheless, on the basis of systems analysis and substantive testing, the Court concluded that it cannot yet consider the amounts of pre-financing presented in the balance sheet as complete and sufficiently reliable.




Points (partly) resolved within the framework of the modernisation of the Communities’ accounting system


Replies in the Annual Report concerning the financial year 2004


Evolution of the situation




In the absence of a suitable accounting system, the preparation of the year-end financial statements was still, to a large extent, based on records outside the accounts and the information used for this was not always linked to the budgetary transactions. Furthermore, the accounting system still followed essentially cash-based accounting principles and did not make it possible to distinguish between capital and non-capital expenditure, between final payments and pre-financing, or even to determine the amount of debts and receivables. This affected the calculation of the economic outturn.


The new (accruals based) accounting system was introduced in January 2005. The 2004 closure of accounts was made using the same rules and systems as the previous year, as provided for by both the Financial Regulation and the Commission Communication on the modernisation of the accounting system. The differentiation between capital and non-capital expenditure is one of the improvements arising from the introduction of the new accounting system.


Since the introduction of the new accruals based accounting system most of the problems mentioned by the Court have been addressed. The financial statements are now established on the basis of information extracted from the accounting records. The accounts are kept based on the generally accepted accounting principles and the distinction between capital and non-capital expenditure is made as soon as an operation is initiated. The amounts of pre-financing and open invoices/cost statements are presented in the balance sheet. However, these important changes, which continue to necessitate a cultural change on the part of all concerned, have caused internal delays in the production of the information requested and to inaccuracies in this first set of accounts established on the basis of accruals-based accounting.




The Court is unable to give assurance as to the accuracy and completeness of the amounts entered as held by financial intermediaries (1 313,6 million euro at 31 December 2004).


The new system introduced in 2005 and based on accrual accounting rules will allow the Commission to better control the amounts of pre-financing (such as for financial intermediaries).


The amounts held by financial intermediaries should from 2005 onwards be included under pre-financing. However, as already mentioned before (see under qualification in the 2004 Statement of Assurance), the Court cannot yet consider the amounts of pre-financing presented in the balance sheet as complete and sufficiently reliable.




Other weaknesses concerning the presentation of the accounts persist as regards certain items of agricultural expenditure and advances not paid but shown as such (modulation), and the accounting for pension rights, which neutralises the effect on the economic outturn.


The current modulation system is being phased out and there are no plans to change the entry into the budgetary accounts during its last years. The treatment in the general accounts is under examination as part of the changeover to accrual accounting in 2005. The issue of the pension rights will be re-addressed when an IPSAS on the treatment of pensions in public sector entities is available.


The funds withheld for modulation are now shown under the heading pre-financing in the balance sheet until their utilisation; the budgetary treatment of the payments has remained unchanged. Although there is still no IPSAS dealing with the issue, pension rights are from now on posted to the economic outturn account without corresponding receivable from the Member States.




There continues to be no sufficient and precise indication in the explanatory notes to the accounts that some transactions are likely to be corrected at a later date by the Commission's departments or by the Member States, nor any indication of the possible scale of such corrections. Furthermore, there are other uncertainties which may temporarily affect the accounts.


An additional comment is included in the 2004 final accounts indicating that most payments made during the year are provisional and subject to varying conditions. The Commission has new accounting rules in place, the effects of which should be seen in the 2005 annual accounts. The Commission will also analyse the possibility of improving the information on the financial impact of corrections made concerning prior years. As to the other uncertainties (e.g. qualified or negative opinion from the certifying bodies or postponement of the Commission's financial clearance decision of paying agency accounts), the expenditure concerned is in general limited.


The notes contain more information than in the past that some transactions are likely to be corrected at a later date by the Commission's departments or by the Member States. However, there is no clear or precise distinction between expenditure that has been verified and consequently cleared and that which is subject to further verification.








Findings at the level of the Commission




Internal delays in the work on the Commission's 2005 financial statements










1.13.


Key elements in the process of the preparation of the Commission's 2005 financial statements were the implementation in the different Directorates-General of the overall cut-off methodology/instructions given by the Commission's Accounting Officer and the validation of opening and closing balances by all Authorising Officers (11). These validations were in most cases delayed, in particular at the level of the operational Directorates-General.












1.13.


Some delays compared with the challenging internal working timetables established by the Directorate-General for Budget did occur. A good working programme usually allows for a margin so as to anticipate potential delays. This was the case with the timetables of the Commission. Despite these internal delays the Commission was none-the-less able to meet the deadline set by the Financial Regulation and present the financial statements on time.














1.14.


In many Directorates-General audited by the Court, several weaknesses were identified concerning the validation of the data: weak supervision, lack of staff assigned to the task and inadequate documentation of the work done. The figures presented in the financial annex of the annual activity reports by some operational Directorates-General contained errors (see paragraph 1.16).












1.14.


The Commission services made a major effort during almost two years to identify and record data which were not previously in the old system.




For the opening balance sheet several checks and validation of those data were undertaken in each Directorate-General and at the end, all but one Directors General formally validated the opening and closing balances of the Directorate-General.
The Commission is aware that some improvements in the accounting control environment are needed. The updating/enhancing of the accounting control environment is foreseen as a medium term project. Some steps have been finalised during 2005, while others will be completed in 2006 and 2007.
2005 was the first year when complete figures by Directorate-General were available. Some imperfections occurred in the split of the accounts by Directorates-General, and this is the reason why some figures presented in the financial annex of the individual annual activity report (AAR) of some Directorates-General contained small errors, but these did not affect the Commission's accounts as a whole.










1.15.


The individual methodologies for Directorates-General were frequently not finalised/formalised by the different Authorising Officers before the presentation of the accounts. As a result, cut-off entries for the opening and closing balances were made in the absence of a formalised methodological basis implementing, at the level of a Directorate-General, the overall cut-off methodology/instructions given by the Commission's Accounting Officer.












1.15.


Given that no benchmarks were available in the public sector for the cut off exercise, priority was given to finalising the calculation of the cut-off rather than to formalising the procedure.




Nevertheless, for the cut-off methodology, the accounting services provided a clear methodology to be followed by all services. Some options needed to be chosen by Directorates-General according to operational factors specific to their sectors.
Even if all the implemented methodologies were not formalised, several actions were taken in order to ensure the correct implementation: reviewing and giving feedback, organising workshops and providing close guidance to the services.










1.16.


Furthermore, the Resource Directors (12) were asked to validate formally the financial reports, containing in particular opening and closing balances, in the process of preparation of the annual activity reports (i.e. at the end of March 2006). However, as Directorate-General for the Budget was working to the same deadline, not all validations were received before the provisional accounts were finalised. Validations for the final accounts were received in due time.






 










1.17.


The delays referred to in paragraph 1.13 had an impact on the Court's substantive testing since the Court received opening balances before cut-off (on 18 January 2006) and after cut-off (on 15 March 2006) which were still subject to modifications. The complete provisional opening balance sheet, giving an indication of the impact of the changes made to restate the balance sheet as at 31 December 2004 under the new accounting principles, was obtained on 31 March 2006, together with the consolidated provisional accounts.












1.17.


The Commission understands the Court's audit work this year was challenging, as was the entire project for the Commission.




But:






—


sound procedures were followed and the system was documented;










—


the balances other than cut-off were first uploaded in January 2005;










—


by mid-2005 approximately 95 % of these balances were final and










—


the changes made since then were documented and an audit trail specifically made.








Minor issues still pending at the level of the central accounting system (ABAC) — but still material problems at the level of the local subsidiary accounting systems










1.18.


Following the implementation of a comprehensive action plan to reinforce security within the central accounting system, two issues remain to be completed, namely the revision of access rights in the Directorate-General for the Budget and a reassessment of security in ABAC Workflow (13). As the work remaining on these issues is not considered material by the Director-General for the Budget, in particular because an effective monitoring system is in place, the reservation on system security and access rights, which was introduced in the 2004 annual activity report, was lifted. The Court's audit confirms the improved security of ABAC.






 










1.19.


Many Directorates-General use their own IT systems for financial management purposes and for the creation of transactions which are sent to the central accounting system (ABAC) via an interface. However, it will take longer to validate and modernize such systems.












1.19.


As the situation is constantly evolving, the accounting services' validation team needs to keep track of this evolution, and has also introduced, with effect from 1 June 2006, a procedure for the validation of changes in the local systems, as foreseen in the implementing rules of the Financial Regulation.














1.20.


The Court examined the programme of in-depth controls of local accounting systems undertaken by the services of the Commission's Accounting Officer in 2005 for 13 Directorates-General (i.e. eight for which the high level assessment in 2004 had identified risks (14) plus another five selected on grounds of their financial importance and/or organisational complexity (15)). The Court's audit confirmed the basis of the Commission's Accounting Officer's decision to refuse, due to material deficiencies, validation concerning three local systems in the EuropeAid Co-operation Office, the Directorate-General for Education and Culture and the Directorate-General for External Relations. However, in some cases it is not clear why insufficient results for several validation criteria did not lead to a qualified validation.












1.20.


The validation exercise is not an audit. The conclusions cannot be compared to audit opinions. The validation of local systems is a rather new activity, which translates Article 61 of the Financial Regulation into concrete tasks. The validation reports are produced in order to provide to the Accounting Officer sufficient information for the validation. The scope and limitations are explained in the preamble of the validation reports.














1.21.


The Court considers that, based on the results obtained and issues remaining to be solved, most of the positive validation opinions issued by the Commission's Accounting Officer on local systems have to be regarded as conditional or qualified opinions. This situation is also confirmed by the number and importance of horizontal issues (16) and matters for further consideration (17) highlighted in the Commission's Accounting Officer's final report at the end of 2005.












1.21.


The accounting services are committed to making a follow-up concerning the issues and matters for further consideration, mentioned in the 2005 validation reports.




The follow up activities will take place within all services, including the Directorates-General for Budget and for Informatics in respect of the ABAC system.




Work to improve the quality of accounting systems and data after the presentation of the provisional accounts




The Commission's actions to ensure accurate final accounts










1.22.


The Director-General for the Budget included a reservation in his declaration, which is also confirmed by the Court's audit (see paragraphs 1.18 to 1.21 and 1.28 to 1.58), concerning ‘three local systems not validated and coherence checks on accounting still to be completed’. In the overall conclusion on the combined impact of the weaknesses identified in his declaration he stated: ‘DG BUDGET, together with the other Commission services, will take further action on remaining errors or uncertainties and continue investing over the year 2006 to strengthen the ABAC accounting system for the Community… It is a matter of appropriate tools such as training, documentation and IT systems but also of working on the related cultural change. On this basis, reasonable assurance along the lines foreseen by the declaration can be given’.












1.22.


The Commission recognises the extraordinary effort made by its departments to allow the move to accrual-based accounting. However, three local systems have not been validated by the accounting services. For these reasons, and also because the provisional accounts were to be audited by the Court of Auditors and corrections may be necessary before the approval of the final accounts on 31 July 2006, the Director General for Budget issued on 31 March 2006 a systemic, provisional and time-bound reservation in its 2005 annual activity report.














1.23.


The Director-General for Education and Culture also presented a reservation covering the lack of assurance as regards the correctness of the amounts included in the Commission's balance sheet. Although important risks were also identified by the Commission's services and the Court in other Directorates-General, no other Authorising Officer has presented a reservation (18). However, 26 out of 40 Resource Directors indicated that, due to weaknesses identified in the Annual Activity Reports and/or taking into consideration that this is the first year of the provisional closure of the accounts based on accruals accounting, verifications and, where necessary, corrections may still be needed before the final closure of the accounts.












1.23.


Inconsistent treatment of accrual accounting requirements in the Directorate-General for Education and Culture local accounting system APPFIN had led to differences in the opening and closing balances of its accounts. Modifications to the local system are underway and will ensure correct treatment of transactions in the future; corrections of past errors are ongoing and should be completed by the end of the year.




Despite the efforts by the Directorate General for Education and Culture to correct the accounting figures, it maintained the reserve on the final figures.
For the other, the reservations were included because the ongoing audits were not yet finished by 31 March 2006. As far as possible, the problems identified by the Directorates-General or by the auditors were corrected in the final accounts.




Scope of consolidation










1.24.


The scope of consolidation defined in Accounting Rule No 1 adopted by the Commission's Accounting Officer is larger than the scope foreseen in Article 121 of the Financial Regulation (19) (e.g. inclusion of the Joint Sickness Insurance Scheme or agencies not falling under Article 185 of the Financial Regulation) (20).












1.24.


The scope of consolidation foreseen in the Accounting Rule No 1 takes into account the principle of control and is based on international accounting standards. On the other hand, Article 121 of the Financial Regulation (FR) foresees only the consolidation of Institutions and subsidised Agencies.




To avoid the contradiction between the Accounting Rule and the Financial Regulation, it has been proposed to amend Article 121 of the Financial Regulation in the context of its overall revision in order to foresee also the consolidation of all controlled bodies in accordance with the Accounting rule No 1.










1.25.


Nevertheless, the Joint Sickness Insurance Scheme and two agencies (Community Plant Variety Office and Office for Harmonisation in the Internal Market) were not included in the 2005 consolidated accounts (see also paragraph 1.29). Based on the analysis of the type of control that the European Communities have over the Joint Sickness Insurance Scheme, the Court considers that it should not have been included in the scope of consolidation, as defined in Accounting Rule No 1, and therefore the latter should be reassessed.












1.25.


The accounting rule will be updated with regard to the non-consolidation of the sickness insurance scheme.




The exclusion of the two agencies is permitted by the Financial Regulation for practical reasons: The Office for Harmonisation in the Internal Market still prefers not to be integrated in the scope of consolidation; the Community Plant Variety Office meanwhile agreed to be consolidated, but the consent came too late for the 2005 consolidation. As indicated by the Court in paragraph 1.29, the non inclusion is not material.




Impact of the ongoing work










1.26.


In its Opinion No 2/2001 (21), on a proposal for a Council Regulation on the Financial Regulation applicable to the general budget of the European Communities, the Court addressed the risks arising from a situation where the provisional consolidated financial statements sent to the Court of Auditors are not yet stabilised. The Court stressed that it was important that ‘The provisional financial statements are exhaustive and consistent documents, and are duly drafted by the stipulated deadlines. They are provisional only in that the Commission has not yet formally adopted them and that they may, where appropriate, be subject to corrections proposed by the Court.’






 










1.27.


The Commission did not respect this latter principle that no changes should be made other than those proposed by the Court, as 2005 was a transitional year. Therefore the Commission had to ensure that the Court was informed in due form and time about corrections which, based on the continuing work on the provisional accounts, it considered necessary.












1.27.


It is difficult to respect this principle as the provisional accounts must now be finalised by the same date as the Annual Activity Reports. However, changes will be kept to a minimum.




The provisional accounts were based on all the information available at the time of their preparation. Changes have been made reflecting the receipt of updated information, errors found by the Court and corrections requested by the Directorates-General that could not have been corrected by 31 March 2006. All changes have been documented and explained to the Court.




Consolidated opening balance sheet as at 1 January 2005










1.28.


The Court's examination of the adequacy and accuracy of the adjustments made, in connection with the preparation of the consolidated financial statements as at 1 January 2005, to bring the figures and information of the consolidated financial statements as at 31 December 2004 into line with the new accruals-based accounting principles, is presented hereafter (see paragraphs 1.29 to 1.49).






 










1.29.


Almost the entire impact of the changes made concerns the Commission's financial statements. The inclusion, for the first time, of the agencies in the scope of consolidation has had only a limited impact on the consolidated accounts, the main effect being an increase in cash balances. Thus, the omission of two agencies did not affect the true and fair view.






 




Items with limited adjustments










1.30.


The Court's review of items which were only affected by limited adjustments did not reveal significant findings (i.e. intangible and tangible fixed assets, (short-term) investments, loans, long-term and short-term receivables (22), stocks, employee benefits, provisions for risks and charges, financial and other liabilities and reserves).












1.30.


With regard to footnote 18, the information was not available for the amounts due at 31 December.








Pre-financing










1.31.


Pre-financing relates to payments intended to provide the beneficiaries with a cash advance. If the beneficiaries do not incur eligible expenditure during the period defined in the agreement, they have to return the pre-financing to the Communities.






 










1.32.


For a number of years the Court has stated that the recording of sundry debtors poses problems because pre-financing was entered as final expenditure and amounts to be recovered were not entered immediately (23). On this basis, it qualified the accounts for the years in question (24).






 










1.33.


In order to remedy these deficiencies, during 2004 an inventory of all open pre-financing amounts paid up to 31 December 2004 was prepared by every institution and agency, leading to approximately 30 000 pre-financing entries for a total amount of 28 013 million euro (25).












1.33.


As required by the new accounting rules, the inventory of the pre-financing amounts was done and from January 2005, the pre-financing amounts not yet cleared are included on the asset side of the balance sheet.














1.34.


However, not all technical and conceptual issues and problems of implementation, which had already been partly identified in connection with the Annual Report concerning the financial year 2004 (26), had been solved by the presentation of the opening balance sheet as at 1 January 2005. The resulting deficiencies are presented below.












1.34.


As explained in its replies to the Court's 2004 Annual Report, the follow up of the pre-financing amounts has to take into account the conditions of the various contracts with third parties. Nevertheless, the presentation of the net amount in the balance sheet shows the economic reality of outstanding pre-financing amounts.














1.35.


The audit of a representative sample of 147 pre-financing transactions from the population of pre-financing records, as at November 2005, in the accounting system identified a material level of error in terms of frequency and financial impact. The most common types of errors are:










—


pre-financing entries were recorded for the wrong amount,










—


pre-financing amounts were recorded although they were cleared before 1 January 2005.












1.35.


The Commission will examine the transactions notified by the Court.














1.36.


Furthermore, additional audit work on the identification and validation of pre-financing entries revealed the following problems of completeness/accuracy for the opening balance sheet:












1.36.


 














—


the split between long-term pre-financing (21 285 million euro) and short- term pre-financing (6 728 million euro) took only into consideration amounts related to the Structural Funds, the Cohesion Fund, ISPA and the Solidarity Fund for the 2000 to 2006 programming period. This leads to an underestimation of long-term pre-financing and a corresponding overestimation of short-term pre-financing because contracts for other policy areas with pre-financing where the remaining duration was more than one year were classified as being short-term,












—


The split between long-term and short-term is only made for Structural Fund amounts as the former constitute the ‘real’ long-term pre-financing of the Commission. For other policy areas the long-term amount could not be quantified, and a split can only be made on estimations on implementation of the projects. For the 2006 accounts, following two years experience with the new accounting system, the Commission will have more information on which to base an analysis of the feasibility of making this split.














—


for Directorate-General for Education and Culture, despite work performed after the issuance of the provisional accounts, there is still a risk that omissions and double or wrong postings could lead to errors which are unquantifiable due to the complexity of the problems (27).












—


Material errors identified in the Directorate-General for Education and Culture which resulted from the wrong treatment of pre-financing payments have been corrected.








Accounts payable










1.37.


Accounts payable essentially include accrued charges, which are covered under the section for cut-off (see paragraphs 1.42 to 1.46), and current payables, which comprise invoices and cost statements. The Court's findings concerning current payables are dealt with in this section.






 










1.38.


The establishment of an inventory listing about 7 000 invoices and cost statements received but not yet paid as at 1 January 2005 began in the fourth quarter of 2004 and led to an amount of current payables of 9 412 million euro (28).






 










1.39.


By the presentation of the opening balance sheet as at 1 January 2005 (29), not all technical issues and problems of implementation had been solved. The resulting deficiencies are presented below.












1.39.


The Commission will improve its internal controls to address the technical issues and problems remaining in some Directorates-General.














1.40.


The audit of a representative sample of 141 invoices/cost statements from the population of accounts payable recorded, as at November 2005, in the accounting system identified a material level of error in terms of frequency and financial impact. The most common types of errors are:










—


invoices or cost statements were recorded for the wrong amounts,










—


invoices or cost statements were recorded although they were already paid.












1.40.


The six errors with an impact on the accounts amongst the 141 transactions audited will be examined by the Commission.














1.41.


For Directorate-General for Education and Culture, despite work performed after the issuance of the provisional accounts, there is still a risk that omissions and double or wrong postings could lead to errors which are unquantifiable, due to the complexity of the problems.












1.41.


Material errors identified in the Directorate-General for Education and Culture which resulted from the wrong treatment of invoices/cost statements have been corrected.








Cut-off elements










1.42.


One of the most important aspects of the move to accruals accounting is the exercise of ensuring that transactions made during the year are recognised in the accounting period to which they relate (cut-off exercise). In particular an assessment has to be made concerning eligible expenses that have been incurred by beneficiaries of Community funds but not yet reported (accrued charges), revenue not yet received although services have been rendered, goods have been delivered or a legal obligation exists (accrued revenue), or expenses or revenue recorded in the current year which relate to subsequent periods (deferred charges or revenues).






 










1.43.


Adjustments for accrued charges totalled 64 205 million euro (30). The Court's audit of the other cut-off elements did not reveal significant errors. The findings concerning accrued charges are presented hereafter.






 










1.44.


As described above (see paragraph 1.15), the implementation of the overall cut-off methodology per Directorate-General was not finalised before the cut-off bookings. Furthermore, most of the Directorates-General have not performed sufficient testing as to whether the methodology developed ensures that transactions made during the year are correctly recognised in the accounting period to which they relate. In addition, given that 2005 is the first year of a cut-off exercise and given the particularities of the Communities' activities, no benchmark methods are available which could be used to check the adequacy of the methods and the results of estimations.












1.44.


Apart from the remarks concerning implementation/control, the Commission notes that the Court makes no observation on the overall methodology itself.




For the 2006 closure, more in-depth testing and controls will be made in the light of the experience of this first year.










1.45.


The following weaknesses identified in the cut-off procedures put at risk the correctness of calculations performed by many Directorates-General:










—


only limited checks have been made by the Directorates-General on the result of the calculations,










—


data used were in certain cases of insufficient quality,










—


knowledge and work was often concentrated in one person without appropriate supervision.












1.45.


In 2006, the Commission will strengthen its controls over the application of the cut-off methodology.














1.46.


All Directorates-General (except Directorates-General for Regional Policy, Employment, Social Affairs and Equal Opportunities and Agriculture and Rural Development) decided to estimate the accrued charges on the basis of all open contracts. All Directorates-General audited (except Directorate-General for Education and Culture) could reconcile the data used in the calculations with the basic accounting data, except for some unexplained differences, which, although not material, confirm a certain level of risk as identified above (see paragraph 1.45).












1.46.


Material errors identified in the Directorate-General for Education and Culture which resulted from the wrong treatment of accrued charges have been corrected.








Structure and presentation










1.47.


Because of the adjustments introduced as a part of the move to accruals accounting, total liabilities in the opening balance sheet (as at 1 January 2005) exceed total assets by 51 597 million euro, whereas before the adjustments total assets exceeded the liabilities by 14 507 million euro.






 










1.48.


One major factor explaining this change is the fact that the introduction of pre-financing (total amount of 28 013 million euro) does not compensate for the introduction of accrued charges (total amount of 64 205 million euro). In addition, long-term receivables have greatly decreased because the Communities' pension obligations towards Members of institutions and staff (net present value of 26 012 million euro) are no longer neutralised by a corresponding asset representing the amount receivable from the Member States. The difference between assets and liabilities mainly represents the amounts to be called in future years from Member States.






 










1.49.


The Court observed that the Accounting Officer did not fully comply with Accounting Rules Nos 2 and 12 with regard to the new structure and presentation of the balance sheet and the revised treatment of the Communities' pension liabilities (31). Therefore, action should be taken in order to introduce the necessary amendments. Furthermore, the different character of the liabilities to be covered by the amounts to be called from Member States should be disclosed further, in particular the short-term and long-term nature of those amounts.












1.49.


The Accounting rules Nos 2 and 12 will be adapted.




The different character of the liabilities to be recovered by the amounts to be called from Member States, are disclosed in the note to the balance Sheet 3.20.




Consolidated financial statements as at 31 December 2005










1.50.


During 2005, efforts were made by the Commission with a view to ensuring the complete and correct recording of new pre-financing payments as well as of new open invoices/cost statements, and their clearance. However, a number of errors were identified which are presented hereafter. Furthermore, the deficiencies concerning the adjustments made for the opening balance sheet as at 1 January 2005 have an impact on the economic outturn for the year 2005 and consequently on the consolidated balance sheet and the statement of changes in net assets.












1.50.


During 2005, several controls and validation were done by Directorates-General and Services to assure the correctness of the total amount of the opening balance sheet. Most of the necessary corrections were made against the opening balance sheet without impact on the 2005 economic outturn.














1.51.


The Court's analytical review of intangible and tangible fixed assets, (short-term) investments, loans, long-term and short-term receivables, stocks, financial and other liabilities, employee benefits, provisions for risks and charges and reserves did not produce any significant findings.






 




Consolidated balance sheet as at 31 December 2005




Pre-financing










1.52.


The audit of a representative sample of 162 pre-financings from the population of pre-financings registered, as at March 2006, in the accounting system (29 349 million euro) identified a material level of error in terms of frequency and of financial impact. The same types of errors as for the consolidated opening balance sheet have been identified for the consolidated closing balance sheet (see paragraph 1.35).












1.52.


The nine errors identified with an impact on the accounts amongst the 162 transactions audited will be examined by the Commission.














1.53.


Furthermore, additional audit work on the identification and validation of pre-financings revealed problems of completeness/accuracy for the closing balance sheet:












1.53.


 














—


the split between long-term pre-financing (22 732 million euro) and short -term pre-financing (6 633 million euro) only took into consideration amounts related to the Structural Funds, the Cohesion Fund, ISPA and the Solidarity Fund for the 2000 to 2006 programming period. This leads to an underestimation of long-term pre-financing, and a corresponding overestimation of short-term pre-financing because contracts for other policy areas with pre-financing where the remaining duration was more than one year were classified as being short-term,












—


The split between long-term and short-term is basically only made for Structural Fund amounts as the former constitute the ‘real’ long-term pre-financing of the Commission. For other policy areas the financial impact of the Court's finding could not be quantified. For the 2006 accounts, following two years experience with the new accounting system, the Commission will have more information on which to base an analysis of the feasibility of making this split.














—


for Directorate-General for Education and Culture, despite work performed after the issuance of the provisional accounts, there is still a risk that omissions and double or wrong postings could lead to errors which are unquantifiable due to the complexity of the problems.












—


Material errors identified in DG EAC which resulted from the wrong treatment of pre-financing payments have been corrected.








Accounts payable










1.54.


The audit of a representative sample of 148 invoices/cost statements from the population of accounts payable registered, as at March 2006, in the accounting system (16 194 million euro) identified a material level of error in terms of frequency and financial impact. The same types of errors as for the consolidated opening balance sheet have been identified for the consolidated closing balance sheet (see paragraph 1.40).












1.54.


The nine errors identified with an impact on the accounts amongst the 148 transactions audited will be examined by the Commission.














1.55.


For Directorate-General for Education and Culture, despite work performed after the issuance of the provisional accounts, there is still a risk that omissions and double or wrong postings could lead to errors which are unquantifiable due to the complexity of the problems.












1.55.


Material errors identified in the Directorate-General for Education and Culture which resulted from the wrong treatment of invoices/cost statements have been corrected.








Cut-off elements










1.56.


The problems mentioned for the consolidated opening balance sheet (see paragraphs 1.44 to 1.46) led to the following deficiencies for the consolidated closing balance sheet. All Directorates-General audited (except Directorate-General for Education and Culture) could reconcile the data used in the calculations with the basic accounting data, except for some unexplained differences, which, although not material confirm a certain level of risk as identified above (see paragraph 1.45).












1.56.


Material errors identified in the Directorate-General for Education and Culture which resulted from the wrong treatment of cut-off elements have been corrected.








Off-balance sheet and notes










1.57.


The explanatory notes to the consolidated accounts contain more information than in the past (32) about the fact that some transactions are likely to be corrected at a later date by the Commission's departments or by the Member States. However, the notes do not identify the amount of expenditure which may be subject to verification and clearance of accounts procedures (see also paragraphs 1.63 to 1.65).












1.57.


In addition to the annual financial clearance of the paying agencies' accounts, the Commission has the right to make corrections under conformity decisions. The Commission has acted on the recommendation made in the Court's 2004 report concerning possible compliance corrections still to be made. For example, the Directorate-General for Agriculture and Rural Development has for the financial years 2001-2005 clearly set out in its Annual Activity Report 2005 (33) the corrections to be decided in future conformity decisions and this amount is disclosed as a contingent asset in the Commission's accountings. It is considered that the total amount to be recovered in the future is EUR 1 151 million, based on an average rate of financial correction of 0,95 % — see also the reply to paragraphs 5.56 and 5.62.








Consolidated economic outturn account










1.58.


A detailed reconciliation between budgetary outturn and economic outturn is indispensable for obtaining reasonable assurance concerning the reliability of the accounts. Except for the Commission this information only became available after the presentation of the final accounts. Nonetheless, the Court was able to use this data to reconcile the budgetary and economic outturn.






 




Legality and regularity of underlying transactions




The Court's approach










1.59.


Taking into consideration the requirements of Article 248(1) of the Treaty, the changing audit environment (which is extremely complex and has changed fundamentally due to the financial reform of the Commission) and the expectations of the DAS's ‘users’ (namely the discharge authority), the Court decided in 2002 (34) that its audit opinion would be the result of a consolidation of the specific assessments concerning own resources and each of the six operational chapters of the 2000 to 2006 financial perspective (35). These specific assessments, which aim to give the discharge authority the possibility of monitoring the quality of the management of the funds in each of the major fields of Community intervention (36), are based on four sources of evidence:










(a)


an examination of the way in which the supervisory and control systems set up both in the Community institutions and in the Member States and third countries work;










(b)


testing of samples of transactions for each major area by carrying out checks down to final beneficiary level;










(c)


an analysis of the annual activity reports and declarations by the Directors-General and of the procedures applied in drawing them up;










(d)


where possible, an examination of the work of other auditors who are independent of Community management procedures.






 










1.60.


The objective of the audit of supervisory and control systems is to assess the extent to which they manage the risks concerning the legality and regularity of underlying transactions. The testing of transactions seeks to obtain direct evidence as to legality and regularity and to provide indications on the origin, frequency, nature and impact of errors found. The results of the transaction testing are used to complement and contribute to the conclusions on the systems. Information from both sources is used to identify recommendations for corrective actions. In accordance with international audit standards, the Court also takes account of the ‘management representations’ contained in the annual activity reports and declarations by the Directors-General, as well as in the synthesis thereof which is adopted by the Commission. Finally, the work of other auditors (37) is reviewed in order to evaluate its potential relevance for the specific assessments.






 




Audit results 2005




Continuing need to achieve effectiveness of supervisory and control systems










1.61.


As in the past, the conclusions of the specific assessments to be drawn concerning the different DAS sources available are broadly consistent. In areas where, according to the Court's audit, supervisory and control systems are implemented that allow risk to be managed adequately, the Court's substantive testing does not identify material findings as regards the legality and regularity of underlying transactions (see paragraphs 4.26 to 4.30, 5.53, 9.19 and 10.20) and the Court's assessment of the declarations by Directors-General and authorising officers by delegation confirmed that no, or only minor, reservations had to be presented (see paragraphs 2.14 to 2.19).






 










1.62.


In areas where, according to the Court's evaluation, supervisory and control systems exist but their effectiveness in managing the associated risk has to be improved, the Court's substantive testing still tends to identify material findings as regards the legality and regularity of underlying transactions (see paragraphs 5.52 to 5.57, 6.38 to 6.41, 7.28 and, as regards implementing organisations 8.21 to 8.22). Furthermore, the Court's assessment of the declarations by Directors-General confirmed that major reservations were either presented or, in the Court's view, should have been presented (see paragraphs 2.14 to 2.19).












1.62.


The Commission has taken steps to manage the risks associated with shared management through audit work, application of action plans in Member States to rectify systems deficiencies, financial corrections, guidance on key controls, and improved reporting of audit results of national auditors. The Annual Activity Reports of the Structural Funds Directorates General report on these actions and provide indications of improvements made in the Member States' systems. It is inherent in the system of shared management that certain errors and deficiencies will only be corrected after reimbursement of the expenditure concerned. The Commission refers to its replies to the Court's observations at paragraphs 2.8, 2.25 and 2.26.




As outlined in the reply to paragraphs 2.18 and 2.19, the Directors General concerned considered that the operation of the systems in place provided a solid basis for reasonable assurance on the expenditure for which they are responsible, and only entered reservations where there appeared to be significant deficiencies posing a material risk to the Community budget.
As regards implementing organisations in external actions, please see the Commission's replies to paragraphs 8.20 and 8.21.




Multiannual nature of Community activities and error correction










1.63.


In the discussions concerning the DAS observations, it is often said that shortcomings identified by the Court at the level of underlying transactions only have a temporary impact and that the DAS does not take into account the multiannual nature of certain Community activities. Thus, it is argued that the Commission takes errors into consideration when clearing accounts in the EAGGF Guarantee section, when closing operational programmes in the Structural Funds, and when concluding audits relating to decentralised management.












1.63.


The Commission's argument is that under shared management there is a control cycle in relation to Community-funded expenditure which is carried out over a period of years. For Structural Funds this starts with first-level checks by the Member States and ends with the ex post audits of the Commission. The fact that the Court finds errors in transactions which are at a particular point in the control cycle does not signify that the control system is not functioning effectively. This is not, however, to deny the paramount importance of the checks on underlying transactions at source by management before expenditure is reported for reimbursement and of preventive measures such as guidance and information activities.














1.64.


In line with Article 53(5) of the Financial Regulation and Article 42 of the detailed rules for the implementation of the Financial Regulation (38), these decisions and corrective measures do indeed constitute important components of the Commission's supervisory and control systems. However, the weaknesses identified in the Court's audits show that ‘conformity decisions’ under the clearance of agricultural accounts, closure procedures for operational programmes under the Structural Funds and concluding audits relating to decentralised management cannot be regarded as mechanisms to ensure the prevention and timely identification and correction of errors (see paragraphs 5.56 to 5.57, 6.31 to 6.37, 6.41, 7.21 to 7.24 and 7.26 to 7.28).












1.64.


The objective of the conformity clearance of accounts decisions is to exclude from Community financing expenditure which has not been effected in compliance with Community rules. These decisions are addressed to Member States and protect the EU-taxpayer from the burden of financing undue expenditure. Under shared management the prevention, identification and correction of errors at the level of the final beneficiary is the responsibility of Member States. The clearance of accounts decisions encourage Member States to do their best to ensure that the error rate is kept at a tolerable level and that identified irregularities are recovered. The control systems are also combined with the application of dissuasive sanctions when errors are discovered by the Member States.




The Commission considers that in the area of agricultural expenditure the chain of controls performed by the Member States and the Commission provides adequate assurance that errors are detected and corrected (see reply to paragraphs 5.56 and 5.58).
For the Structural Funds, also, the closure procedure provides the final stage in the control cycle allowing for correction of errors at the point of final payment. However, the control system does not rely only on closure procedures; the risk to the budget of failures in first-level controls is addressed by the procedures for certification of expenditure, audit and financial corrections by Member States and Commission which operate during the implementation period.










1.65.


Additionally, decisions on financial corrections taken in the area of shared management, recovering from Member States which have not implemented and/or operated reliable systems, do not make the underlying transactions any less illegal/irregular, even if they may have a dissuasive effect. Furthermore, as the financial corrections applied result from systems weaknesses, they cannot directly be related to errors at the level of underlying transactions. The effect of imposing financial corrections is to shift the cost of the (disallowed) illegal/irregular transactions from the EU budget to national taxpayers.












1.65.


The conformity clearance process is not in itself a mechanism by which irregular payments to beneficiaries are recovered since it focuses on the system of controls established by the Member States. In case those controls discover irregularities it is the responsibility of the Member States, as clearly stated in Article 9(1) of Regulation (EC) No 1290/2005.




Whether the burden of a financial correction falls on the final beneficiary or is charged to the programme budget or is passed on to the national taxpayer depends on the reason for the correction. Member States are obliged to recover unduly paid amounts wherever possible and appropriate. The corrections guidelines provide that the Commission may launch infringement procedures if the Member States do not recover irregularities, even if a financial correction has been made. For errors detected in individual transactions where the beneficiary is at fault, the initiation of recovery proceedings from the beneficiary is expected. If a correction is due to lack of diligence in the Member State's performance of controls, which is often the reason for financial corrections, the fault is at the level of the authorities and not with the final beneficiary. In such a case, the financial burden of the correction can only be charged to the Member State budget.
In the Commission's view, such corrections repair the damage to the EU budget for errors in the legality and regularity of the transactions affected.






(1)  The ‘Final annual accounts of the European Communities’ make up Volume I of the annual accounts of the European Communities financial year 2005.

(2)  The accounting rules adopted by the Commission's Accounting Officer are inspired by International Public Sector Accounting Standards (IPSAS) issued by the International Federation of Accountants or, in their absence, International Accounting Standards (IAS)/International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board.

(3)  The ‘Consolidated financial statements’ comprise the balance sheet, the economic outturn account (including segment reporting), the cash flow table and the statement of changes in net assets.

(4)  The main new elements are pre-financing, accounts payable and cut-off.

(5)  See paragraphs 1.51 and 1.52 of the Court's Annual Report concerning the financial year 2004 and chapter 2 of the present Annual Report.

(6)  Council Regulation (EC, Euratom) No 1605/2002 of 25 June 2002 on the Financial Regulation applicable to the general budget of the European Communities (OJ L 248, 16.9.2002, p. 1).

(7)  Communication from the Commission — Modernisation of the Accounting System of the European Communities (COM(2002) 755 final of 17.12.2002).

(8)  See paragraph 1.8 of the Annual Report concerning the financial year 2002, paragraph 1.25 of the Annual Report concerning the financial year 2003 and paragraph 1.44 of the Annual Report concerning the financial year 2004.

(9)  For instance at the United Nations Headquarters and the Organisation for Economic Cooperation and Development or in Australia, Denmark, France, Spain, Sweden, the United Kingdom and the United States.

(10)  The new set of 15 accounting rules adopted by the Commission's Accounting Officer are based on the International Public Sector Accounting Standards (IPSAS) and for accounting transactions that are not yet covered by the IPSAS, on the relevant International Accounting Standards (IAS) / International Financial Reporting Standards (IFRS).

(11)  According to Article 59 of the Financial Regulation, each institution lays down in its administrative rules the staff of an appropriate level to whom it delegates the duties of the Authorising Officers for implementing revenue and expenditure, the scope of the powers delegated and the possibility to sub-delegate them. In the Commission, delegation is in general given to Directors-General and Heads of services.

(12)  Within each Directorate-General, the Resource Director is responsible to manage the budgetary and human resources available. He has specific responsibilities for matters concerning audit, internal control, financial management and related information systems.

(13)  ABAC Workflow is an IT-module which is the entry point for most budgetary and accounting data.

(14)  EuropeAid Co-operation Office, European Communities Personnel Selection Office, Office for Official Publications of the European Communities, Office for the Administration and Payment of Individual Entitlements, Directorates-General for Informatics, Education and Culture, Humanitarian Aid and External Relations (see also the Annual Report concerning the financial year 2004, paragraphs 1.38 to 1.42).

(15)  Directorates-General for Agriculture and Rural Development, Employment, Social Affairs and Equal Opportunities, Communication, Regional Policy and Research.

(16)  Strengthening of controls supporting accounting information, pre-financing, posting transactions in a timely manner, cut-off procedures, definition and formalisation of the Accounting Correspondent's role, legal entities, local IT systems, training, choice of object codes, culture change in an accruals based environment and validation of the opening balances.

(17)  Link between a recovery and the related commitment not mandatory in ABAC, invoices and supplier statements, accounting reporting from SAP and matching a guarantee to a corresponding framework contract upon entry in ABAC Guarantee.

(18)  The reservation of the Director-General of the Joint Research Centre concerning the lack of clarity on the status of some parts of the balance sheet and economic outturn and the quality of the data in some of the postings concerned is primarily of a technical nature.

(19)  This decision was based on the IPSAS ‘control concept’.

(20)  Although the Accounting Rule No 1 explains the different criteria to be followed for consolidation, the reasons for excluding the EDF from the consolidation scope are not disclosed.

(21)  OJ C 162, 5.6.2001, p. 1.

(22)  As concerns the long-term and short-term receivables, the Commission should obtain the figures for the European Agricultural Guidance and Guarantee Fund (EAGGF) debtor's ledger as at 31 December rather than indicating the figures as at the end of the EAGGF year (i.e. as at 15 October).

(23)  See paragraph 1.23 of the Annual Report concerning the financial year 2002, paragraphs 1.10(e), 1.14 and 1.15 of the Annual Report concerning the financial year 2003 and paragraph 1.17 of the Annual Report concerning the financial year 2004.

(24)  See paragraphs II(d) of the 2002 and III of the 2003 and 2004 Statement of Assurance.

(25)  The initial total amount of pre-financing obtained for the Commission before deduction of eligible expenditure was 64 600 million euro.

(26)  See paragraphs 1.30 to 1.32 of the Annual Report concerning the financial year 2004.

(27)  The audit on the Directorate-General for Education and Culture was conducted by the Commission's internal audit service under the supervision of the Court.

(28)  The initial gross amount of current payables before deduction of (the part of) invoices/cost statements already paid amounted to approximately 35 000 million euro, which was transferred into the new accounting system at the beginning of 2005.

(29)  See paragraphs 1.34 and 1.35 of the Annual Report concerning the financial year 2004.

(30)  To this amount, accrued charges deducted from short-term pre-financing representing some 6 400 million euro have to be added.

(31)  The Commission has eliminated the practice that has been criticised by the Court in past years in connection with the Communities' pension liabilities, whereby a parallel recognition of receivables and payables has the effect of neutralising the impact on the economic outturn, as it does not show the change from one year to another (see paragraphs 1.31 and 1.32 of the Annual Report concerning the financial year 2002, paragraph 1.10(h) of the Annual Report concerning the financial year 2003 and paragraph 1.20 of the Annual Report concerning the financial year 2004).

(32)  See paragraphs 1.10 and 1.11 of the Annual Report concerning the financial year 2002, paragraph 1.11 of the Annual Report concerning the financial year 2003 and paragraphs 1.12 and 1.13 of the Annual Report concerning the financial year 2004.

(33)  See Chapter 2 ‘Management of Internal Control Systems’, point 2.2.2.1 ‘Expenditure under the Guarantee section’

(34)  In February 2006, the Court approved a revision of the DAS approach which will be implemented for the first time for the financial year 2006.

(35)  Agriculture, structural measures, internal policies, external actions, administration and pre-accession strategy.

(36)  With regard to expenditure, the Financial Regulation distinguishes between the following cases (Article 53): the Commission implements the budget on a centralised basis (administrative expenditure and internal policies); the management of transactions is shared with the national authorities in the Member States (EAGGF-Guarantee and Structural Funds); the Commission decentralises the implementation of certain aspects of its operations to beneficiary countries after having carried out an ex ante check (pre-accession strategy) and the Commission may manage jointly certain operations with international organisations.

(37)  ‘Other auditors’ means any public or private person called upon to give an auditor's assessment of operations that are financed in whole or in part from the Community budget, but whose obligation does not stem from the Community regulations.

(38)  Commission Regulation (EC, Euratom) No 2342/2002 of 23 December 2002 laying down detailed rules for the implementation of Council Regulation (EC, Euratom) No 1605/2002 on the Financial Regulation applicable to the general budget of the European Communities (OJ L 357, 31.12.2002, p. 1).



CHAPTER 2
Commission internal control
TABLE OF CONTENTS
Introduction and audit scope
Audit Findings concerning the Commission's Management Representations
The Commission's Synthesis Report
Annual activity reports and declarations of Directors-General
Process of preparation
Declarations of Directors-General
Indicators
Audit Findings concerning Internal Control Standards
Overall conclusion and recommendations






THE COURT'S OBSERVATIONS


THE COMMISSION'S REPLIES




INTRODUCTION AND AUDIT SCOPE










2.1.


As in previous years, the Court has examined progress made by the Commission in implementing the financial aspects of its reform programme. In particular it has examined:










—


the annual activity reports by the Commission's Directors-General. These indicate how each Director-General has discharged his responsibilities and contain an assessment of the extent to which the expenditure for which he or she is responsible is legal and regular. The quality and reliability of these documents is thus of importance in permitting the Commission to satisfy itself that it has satisfactorily carried out its responsibilities for implementing the budget;










—


the Commission's ‘synthesis report’, which contains an overall assessment of the Commission's internal control system, drawing on the annual activity reports;










—


the Commission's system of internal controls.






 










2.2.


In 2005, the Commission continued with its efforts to embed risk management (1) into the existing planning and decision making processes, with the aim of developing a coherent (Commission-wide) approach and management culture in its Directorates-General.












2.2.


In 2005 a common methodological framework for risk management was adopted by the Commission, following the evaluation of the pilot exercises. The 2006 Annual Management Plan (AMP) process (launched in 2005) of the Commission's Directorates-General and Services contained for the first time an assessment of major risks for the Directorates-General's overall strategic objectives and a review of existing or placement of the necessary mitigating controls.














2.3.


On 17 January 2006 the Commission adopted an ‘action plan towards an integrated internal control framework’ (2), which took into account the results of the ‘gap assessment’ carried out by its services in 2005 for all management modes (3). The Court will evaluate the action plan when the relevant measures have been implemented and it is possible to assess their impact.












2.3.


Although the Commission appreciates the Court's results oriented approach, the Action Plan reflects the efforts made by the Commission to reinforce its internal control system in order to provide the Court of Auditors with sufficient audit evidence on the satisfactory management of the risk of error. The actions are to be implemented by Directorates-General and Services in close collaboration with Member States.




The Commission would welcome the Court's evaluation as soon as possible to determine whether the internal control framework, as improved by the planned actions, can provide adequate assurance, when properly applied.










2.4.


The Court examined the extent to which the management representations contained in the annual activity reports and declarations of the Directors-General, and in the Commission's synthesis, are confirmed by the Court’s audit findings and are relevant for the DAS. It also analysed the progress made in the implementation of the internal control standards and assessed the effectiveness of the procedures introduced and tools developed in order to ensure the legality and regularity of the transactions underlying the budgetary payments.






 




AUDIT FINDINGS CONCERNING THE COMMISSION'S MANAGEMENT REPRESENTATIONS




The Commission's Synthesis Report










2.5.


For the first time, the 2005 synthesis of the annual activity reports has been divided into two separate reports: one (4) dealing with the policy achievements during 2005 in terms of realising the Commission's strategic objectives, and the other (5) taking stock of the management of the Directorates-General and deciding on the measures that are necessary to address the major weaknesses in the supervisory and control systems. By adopting the latter, the Commission assumes its political responsibility for management by its Directors-General, on the basis of the assurances and reservations issued by them in their annual activity reports.






 










2.6.


In its 2005 Synthesis on the management achievements, the Commission considers that ‘Overall, … the internal control systems in place, with the limitations described in the 2005 annual activity reports, provide reasonable assurance on the legality and regularity of operations, for which the Commission is responsible under Article 274 EC. However, it acknowledges that further efforts are needed to solve a number of weaknesses, in particular those highlighted in the reservations of the delegated authorising officers.’






 










2.7.


In some respects, the assessments of the Commission are consistent with the analysis of the Court, in particular concerning reinforced guidelines of the annual activity reports (see paragraphs 2.11 and 2.12) and the need for developing indicators concerning the legality and regularity of underlying transactions and the functioning of key controls (see paragraphs 2.13 and 2.20), for continued efforts to ensure effectiveness of internal control (see paragraphs 2.21 to 2.23) and for further strengthening of accounting processes and systems to improve financial information (see paragraphs 1.5 to 1.58).






 










2.8.


However, in the areas of the common agricultural policy and structural operations the Court’s audit findings indicate that measures are needed, which go beyond those deemed necessary by the Director-General, in order to ensure that reasonable assurance in the declarations accompanying the annual activity reports is effectively underpinned by appropriate supervisory and control systems (see paragraphs 2.18 to 2.19).












2.8.


The Commission considers that the actions being implemented in the performance of its supervisory role already satisfactorily support the reasonable assurance expressed by the Directors General for the expenditure under their responsibility. As the audit work is carried out under a multi-annual strategy, the results enable the level of assurance on national systems to be built up year on year. The basis of the assurance will be further strengthened by the measures designed to achieve a higher level of compliance and effective control under the Action Plan towards an integrated internal control framework and by the improvements in the regulatory framework for the 2007-2013 programme period.














2.9.


The Court notes the emphasis that the Commission has placed on establishing an integrated internal control framework (see paragraph 2.3). Furthermore, it appreciates that the Commission updated the multi-annual objectives of its 2004 action plan (6), addressing the major cross-cutting issues identified in the financial year 2005 and recognising that most of the weaknesses identified can be eliminated only in the medium term (7).






 










2.10.


The Court considers that one of the most important objectives approved by the Commission is represented by the proportionality and cost-effectiveness of controls. In this context, the process of simplification of the spending programmes for the financial perspectives 2007 to 2013 (e.g. greater use of flat-rate and lump-sum payments, simplified rules on procurement and grants) and the use of audit certificates and assurance declarations from third parties responsible for budget implementation tasks could play a significant role.






 




Annual activity reports and declarations of Directors-General




Process of preparation










2.11.


The central departments of the Commission (8) drafted a circular (9) for the 2005 annual activity reports aiming to simplify and improve the preparation process and provide guidance on the materiality threshold of weaknesses. Furthermore, the peer review exercise (10) ensured an improvement as regards the content and impact of reservations on the reasonable assurance (materiality, scope and quantification).












2.11.


Through its ongoing efforts to improve the content of declarations and monitoring of compliance with the standards on which they are based, the Commission is endeavouring to make the annual activity reports and annual declarations an effective management tool and reliable indicator of its performance and of the strategy it uses for dealing with the risks identified so that the Court can use them as a basis for its assurance.














2.12.


The Court considers that the measures taken by the Commission strengthened the preparation process of the annual activity reports, particularly insofar as the establishment of clear guidelines for the assessment of significant system weaknesses (11) that supplement the basic principles on materiality are concerned (12). Nevertheless, the Court notes that these guidelines were not completely followed in some cases (see paragraph 2.15).












2.12.


The Commission believes that significant progress has been achieved in this respect in 2005, in particular through the agreement of a common approach on materiality by ‘family’, the emphasis in Part 2 of the annual activity reports on the bases of the declaration of assurance and the outline in Part 3 of the materiality criteria used and the combined impact of the reservations on the declaration of assurance.




See also the reply to point 2.15.










2.13.


Furthermore, the Court finds that there is still scope for improvement, especially insofar as the presentation of indicators having a direct link with legality and regularity is concerned. Despite the fact that relevant key figures and performance indicators (including legality and regularity) (13) should be presented by the Directors-General, there is no specific indication of which monitoring elements (indicators) should be used (14).












2.13.


In its guidelines, the Commission wanted to allow its services some flexibility in the choice of key figures and performance indicators.




Most of the services managing Community programmes presented legality and regularity indicators.
However, in the light of the 2004 Synthesis, there are ongoing harmonisation efforts to ensure a consistent approach by family and to make these indicators operational management tools specific to the nature of the activities.




Declarations of Directors-General










2.14.


In their declarations attached to the annual activity reports, the Directors-General state that the internal control procedures put in place provide reasonable assurance that the underlying transactions are legal and regular. In the event of material internal control weaknesses or irregularities, they qualify the declarations and issue reservations (15).






 










2.15.


The Court’s analysis of the declarations of the Directors-General for the financial year 2005 reveals that the definition of the materiality criteria, as well as their application for the formulation of the reservations should sometimes be further clarified. For example, in some cases (16) the selected (qualitative and/or quantitative) criteria, and in others (17) the financial impact of the reservations, could be better specified.












2.15.


The Commission believes that its services have followed the guidelines in the circular on annual activity reports and in communication COM(2003) 28, which included clarification of the methodology for the establishment of annual activity reports. Materiality is basically a matter of the authorising officer by delegation's judgment and commitment vis-à-vis stakeholders. The materiality of a weakness is examined from a quantitative and/or qualitative perspective. Where systemic weaknesses are found, qualitative factors can also give rise to the formulation of a reservation.




In the few cases mentioned by the Court, the criteria used and the factors behind the formulation of a reservation were outlined in Part 3 of the annual activity report and generally relate to qualitative criteria (even if, in quantitative terms, the estimated potential financial impact is less than the quantitative criteria).










2.16.


All the Directors-General stated that they had obtained reasonable assurance that the resources allocated to them had been used for the specified purposes, and that the internal controls which they had introduced ensured the legality and regularity of the underlying transactions. The Court notes that 21 of the 40 declarations contain one or more reservations.












2.16.


The formulation of reservations to the declaration of assurance by Directors-General is the logical conclusion of the reasoning in Parts 2 (bases of the declaration of assurance) and 3 (materiality criteria used, reservations and the combined impact of the reservations on the declaration of assurance), ensuring consistency between the annual activity report, the declaration and the reservations.




All authorising officers by delegation thus concluded that they were able to give reasonable assurance.










2.17.


The total number of reservations remained essentially unchanged from 2004 (32) to 2005 (31). The majority (18) concern weaknesses already identified in 2004 (18). The most important reservations in the context of the DAS are shown in 
Table 2.1
.












2.17.


The Commission is conscious that most reservations are recurring ones. Indeed, in its 2005 Synthesis it analysed the different types of recurring reservations (reservations whose underlying problem is being solved, in some cases with further efforts needed from third parties; reservations relating to structural problems; reservations relating to weaknesses affecting operations carried out outside headquarters).




In every case, the Commission will ensure that the Directors-General concerned take the necessary measures in 2006 to solve these problems.










2.18.


In comparison with 2004 (19), the Court notes in general an improvement in the quality of the assessment of the functioning of supervisory and control systems and of the overall impact of the relevant reservations on the assurance given in the declarations. However, the Court considers that some significant weaknesses singled out by its audits (20), should have been included as reservations in the declarations of the Directors-General (see 
Table 2.1
 and paragraphs 6.38 to 6.40 and 7.17).












2.18.


The Directorates-General concerned, which manage the bulk of the budget, consider that the operation of the systems in place to control expenditure provides a solid basis for their declaration of assurance. They entered reservations in their declarations where the information they had built up from their own and the Member States' audit work on the functioning of systems indicated significant deficiencies posing a material risk to the Community budget that could not be adequately managed through the normal corrective mechanisms of the control system. Where a risk was adequately managed, the Director-General considered that there was assurance and no reserve was necessary.




This was fully in compliance with the circular on the AAR for 2005 (SEC(2005) 1533). As recalled also in the 2005 synthesis report under point 2.2.: ‘The existence of a risk did not necessarily justify a reservation unless a problem had actually occurred during the year covered by the report or the control system was not able to prevent such events with material impact.’
The Commission particularly points to its replies to points 6.39. to 6.40 and 7.17.




Table 2.1 — Evolution of the evidence given by Directorates-General's annual activity reports for the Court's Statement of Assurance























Sector


Most important reservations of Directors-General
(included in the declarations)


2003


2004


2005


 


Impact of these most important reservations on the Director-General's assurance in the Court's view (21)



Evolution (23) 2004-2005


Other significant weaknesses revealed by the Court's audit and/or the Commission (not included in the declarations)


2003


2004


2005


 


Evidence given by the Annual Activity Report for the Court's audit conclusions (22)



Evolution (23) 2004-2005




2003


2004


2005


2003


2004


2005




Own Resources








—


Monitoring the application of preferential schemes






×


 


 


 


B


A


A


=


/


 


 


 


 


A


A


A


=










—


Import of Basmati rice






×


 


 










—



‘Hilton’ beef







×


×


×




Common agricultural policy








—


International Olive Oil Council






×


 


 


 


B


B


B


=








—


Insufficient account taken of the supervisory and control systems for the current financial year transactions






×


 


 


 


C


C


B (25)

C (26)



+










—



IACS in Greece







×


×


×








—


Limited scope of the Commission's monitoring action and backlog of incomplete checks as regards Regulation (EEC) No 4045/89






 


×




Structural measures








—


EAGGF-Guidance: management and control systems in the Member States (2000/2006)






×


×


 


 


C


B


B


+








—



Risks connected with the closure of the 1994-1999 programming period and/or significant weaknesses in the implementation of Regulation (EC) No 2064/97 (paragraphs 6.39 and 6.40)







×


×


×


 


C


C


C


=










—



ESF: management and control systems in the Member States (2000/2006)







×


×


×
(United Kingdom)








—



Management and control systems in the Member States (2000/2006) for several programmes (24) (paragraph 6.39)







 


 


×










—


IFOP: management and control systems in the Member States (2000/2006)






×


×
(Italy)


 


 


 


 


 










—



ERDF: management and control systems (2000/2006)







×
(Greece and Spain)


×
(Greece)


×
(United Kingdom and Spain)


 


 


 


 










—


URBAN and INTERREG management and control systems (2000/2006)






×


 


 


 


 


 


 










—



Cohesion Funds: management and control systems (2000/2006)







×
(Greece, Spain and Portugal)


×
(Greece)


×
(Spain)


 


 


 


 




Internal policies, including research








—


(Preliminary testing within the framework of indirect centralised management (Article 35 MERF)) — Insufficient assurance on management through National Agencies







×


 


×


 


B


B


B


=








—


Risks related to the systematic exceeding of the payment period in the area of research (24)







×


 


 


 


B


B


B


=










—



On-the-spot audits







×


×


×








—


Preliminary testing within the framework of indirect centralised management (Article 35 MERF) (24)







 


×


 










—



Error frequency (eligibility) in the cost declarations for research contracts







×


×


×
(5th Framework Programme)








—


Error frequency for public health area






 


×


 










—



Weaknesses in the European Fund for Refugee's management system







 


×
(United Kingdom and Luxembourg)


×
(United Kingdom)








—



Error frequency for 6th Framework Programme of research (24) (paragraph 7.17)







 


 


×




External actions








—


Partnership with a non-governmental organisation






×


 


 


 


B


A


A


+








—


Supervisory and control systems for the legality and regularity of underlying transactions at the level of implementing organisations need to be further improved to be fully operational






×


×


 


 


C


C


B


+










—


Non respect of contract procurement procedures by a Humanitarian Organisation






 


×


 


 


 


 










—



Legal status and liability of contractual partner in the framework of the implementation of EU contribution to UNMIK Pillar IV in Kosovo







 


 


×


 


 


 




Pre-accession strategy








—


ISPA: management and control systems






×


×
(Romania)


 


 


C


B


A


+








—


Risk that some candidate countries cannot fulfil their obligations regarding co-financing (24)







×


 


 


 


B


B


A


+










—


Phare: Risks inherent in the decentralised systems, omissions in the audit of systems and transactions






×


×
(Romania and Bulgaria)


 


 




Administrative expenditure








—



Implementation of internal control standards in the EU's delegations







×


×


×


 


A


A


A


=


/


 


 


 


 


B


A


A


=





Source: Court of Auditors.














2.19.


Despite the strengthened preparation process (see paragraphs 2.11 to 2.13), the Court considers that some annual activity reports (27) do not yet provide sufficient evidence for its Statement of Assurance (see paragraphs 2.15 and 2.18).












2.19.


The Directors-General and Heads of Service concerned have substantiated the bases of the declaration of assurance (Part 2 of the annual activity reports) and given an indication, by explicit arguments, of the impact of the reservations made on the reasonable assurance relating to the use of resources and the legality and regularity of the operations. They all concluded that they could give their assurance.




The Commission therefore finds that they could equally serve as an element, among others, to give the Court greater assurance than is reflected in the assessment in Table 2.1. For these reasons, all three Directorates-General quoted by the Court, which manage the major bulk of the budget, considered that their Annual Activity Reports clearly demonstrates the basis on which the Director-General's declarations of assurance are provided.




Indicators










2.20.


The Court notes that a certain number (28) of Directorates-General present legality and regularity indicators in their 2005 annual activity reports. However, the design and use of these monitoring elements by the Commission's services could be further improved to measure the quality of the supervisory and control systems, as well as the legality and regularity of the underlying transactions.












2.20.


Most of the services managing Community programmes presented legality and regularity indicators. They also outlined the bases of their assurance in Part 2 of their annual activity report.




The Commission is endeavouring to improve its monitoring indicators. Moreover, in the light of the 2004 Synthesis, there are ongoing efforts to harmonise legality and regularity indicators to ensure a consistent approach by family and to make these indicators operational management tools specific to the nature of the activities.




AUDIT FINDINGS CONCERNING INTERNAL CONTROL STANDARDS










2.21.


The Court examined the application of the internal control standards (29) by 14 (30) of the Commission's services, with the view to assessing not only the degree of implementation of the minimum requirements (baselines), but also to evaluate the extent to which they contributed to ensuring that transactions were legal and regular. The immediate direct impact of the internal control standards varies, depending on the management mode for the budget implementation. For example for agriculture and structural funds, where day-to-day management is carried out by national or regional authorities, the Commission's internal controls extend to supervision of management and control systems in the Member States.












2.21.


This is also the understanding behind the Commission's Action Plan towards an integrated internal control framework.














2.22.


The ‘overview on the state of internal control in the Commission DGs and services in 2005’ (31), presented by the Directorate-General for the Budget, shows that, for the 2005 financial year, the Directorates-General comply on average with 95 % of the baseline requirements. Given that the baseline requirements remained essentially unchanged (32), the Court notes a slight increase in compliance with the internal control standards, as compared with 2004 (93 %). The Court’s analysis of the implementation of internal control standards is generally consistent with the Commission's assessment and is presented in 
Table 2.2
.






 










2.23.


Despite this high level of compliance with the baseline requirements, the Court’s review of the annual activity reports and audit results reveals that in the majority (33) of Directorates-General audited, the effectiveness of some internal control components (34) could be further improved, with a view to contribute to an improvement in the legality and regularity of underlying transactions. This analysis is in line with the Commission's assessment presented in the ‘overview of the state of internal control’ and with the annual report of the Commission's Internal Audit Service (35).












2.23.


The Commission considers that the internal control structures of its services are in place but Directorates-General have constantly to fine-tune their systems for achieving efficient and effective management and controls. The particular areas being focused are objective and indicator setting, evolving a dynamic internal control strategy, continuity and staff competences in human resources management, reporting on accountability and enhancing ex-ante control.








Table 2.2 — The Court's analysis of the implementation of (compliance with) internal control standards (with a direct link to the legality and regularity of underlying transactions for the main Directorates-General) (situation as at 31 December 2005)






























Directorate-General or service


Execution of payment appropriations per policy area in 2005
(million euro)


Standard 11
‘Risk analysis and management’


Standard 12
‘Adequate management information’


Standard 14
‘Reporting improprieties’


Standard 17
‘Supervision’


Standard 18
‘Recording exceptions’


Standard 20
‘Recording and correction of internal control weaknesses’


Standard 21
‘Audit reports’


Standard 22
‘Internal audit capability’




2003


2004


2005


2003


2004


2005


2003


2004


2005


2003


2004


2005


2003


2004


2005


2003


2004


2005


2003


2004


2005


2003


2004


2005




Agriculture and Rural Development


52 737


A


A



A



A


A



A



A


A



A



B


A



A



A


A



A



A


A



A



A


A



A



A


A



A





EuropeAid


3 165


A


A



A



A


A



A



A


A



A



A


A



A



A


A



A



A


A



A



A


A



A



A


A



A





Budget


1 371


A


A



A



A


A



A



A


A



A



A


A



A



A


A



A



A


A



A



A


A



A



A


A



A





Competition


90


A


B



A



A


A



A



A


A



A



A


A



A



A


A



A



A


A



B



A


A



A



A


A



A





Education and Culture


1 003


B


A



A



B


A



B



A


A



A



B


B



B



A


A



A



A


A



A



A


A



A



A


A



A





Economic and Financial Affairs


357


B


B



A



B


B



A



A


A



A



A


A



A



A


A



A



A


A



A



A


A



A



A


A



A





Enlargement


1 903


A


A



A



A


A



A



A


A



A



A


B



B



A


A



A



A


A



A



A


A



A



A


A



A





Employment, Social Affairs and Equal Opportunities


9 756


A


A



A



A


A



A



A


A



A



A


A



A



A


A



A



A


A



A



A


A



A



A


A



A





Enterprise and Industry


305


A


A



A



A


A



A



A


A



A



A


A



A



B


A



A



A


A



A



A


A



A



A


A



A





Eurostat


111


B


B



A



B


A



A



A


A



A



B


B



A



B


B



B



B


B



B



A


A



A



A


B



A





Fisheries and Maritime Affairs


819


A


B



A



A


B



A



A


A



A



B


B



A



A


A



A



A


B



A



A


A



A



B


B



A





Information Society and Media


1 227


B


A



A



B


A



A



A


A



A



A


A



A



A


A



A



B


A



A



A


A



A



A


A



A





Regional Policy


19 982


A


A



A



A


A



A



A


A



A



A


A



A



A


A



A



A


A



A



A


A



A



A


A



A





Research


3 015


A


A



A



B


B



B



A


A



A



A


A



A



A


A



A



A


A



A



A


A



A



A


A



A





Assessment:
A: Compliance with baseline requirements
B: Partial compliance with baseline requirements

Source: Court of Auditors.








OVERALL CONCLUSION AND RECOMMENDATIONS










2.24.


In the financial year 2005, the Court notes a continued improvement in the Commission's internal control system. The action plan towards an integrated internal control framework is a step forward in the context of the roadmap exercise (36). The Court will evaluate its results when the relevant measures have been implemented and it is possible to assess their impact.












2.24.


Although the Commission appreciates the Court's results oriented approach, the Action Plan reflects the efforts made by the Commission to reinforce its internal control system in order to provide the Court of Auditors with audit evidence on the satisfactory management of the risk of error. The actions are to be implemented by Directorates-General and Services in close collaboration with Member States.




The Commission would welcome the Court's evaluation as soon as possible to determine whether the internal control framework, as improved by the planned actions, can provide adequate assurance, when properly applied.










2.25.


Despite the progress made by the Commission in strengthening the annual activity reports as an instrument to improve accountability and communication, the Court’s audits revealed significant weaknesses in the supervisory and control systems in several areas of the financial perspectives (37), which have not been taken into consideration in the (annual activity reports and) declarations of the Directors-General.












2.25.


The Directorates-General for structural measures based their assessments of the assurance obtained from management and control systems in the Member States on information from their own and Member States' audit work, taking into account the various instruments available to them to manage the risk of irregular payments.




The responsible Directorates-General have through their own audit activity identified deficiencies in certain Member States similar to those of the Court and in the exercise of their supervisory role are ensuring that the risk to Community funds is adequately addressed, including through the application of financial correction mechanisms where necessary. The Commission considers that this is an indicator of the effective operation of the supervisory role of the Commission.










2.26.


The Court recommends that the Commission continues its efforts to strengthen the supervisory and control systems of its Directorates-General focusing on the following areas:












2.26.


 














(a)


ensuring the full application of the guidelines on the annual activity reports from the central services, especially concerning the materiality and the impact of reservations on the declarations;












(a)


The Directorates-General concerned, which manage the bulk of the budget, consider that the operation of the systems in place to control expenditure provides a solid basis for their declaration of assurance. They entered reservations in their declarations where the information they had built up from their own and the Member States' audit work on the functioning of systems indicated significant deficiencies posing a material risk to the Community budget that could not be adequately managed through the normal corrective mechanisms of the control system. Where a risk was adequately managed, the Director-General considered that there was assurance and no reserve was necessary.














(b)


improving the effectiveness in the application of the internal control standards by analysing systematically the impacts achieved;












(b)


The Commission acknowledges that improvements in internal control will always be possible and further efforts are constantly being made in this area. The effectiveness of internal controls, however, relies largely on qualitative assessments which cannot always be reduced to simple indicators.














(c)


developing specific indicators regarding the effective functioning of key controls and the legality and regularity of underlying transactions in order to allow the assessment of improvements over time in supervisory and control system.












(c)


The Commission is currently working on the 2004 Synthesis action on objectives and indicators which aims at analysing and defining relevant objectives and indicators for legality and regularity of operations. In addition, the actions under the ‘Commission's action plan towards an integrated internal control framework’ [COM(2006) 9] should in future provide for improved presentation of the key controls used to support reasonable assurance.










(1)  The action is foreseen by the 2004 synthesis (multiannual objective No 3). See Annex 1 of the 2004 synthesis report (COM(2005) 256 final of 15.6.2005) and Memorandum to the Commission: ‘Towards an effective and coherent risk management in the Commission services’ (SEC(2005) 1327 of 20.10.2005) and the document ‘Risk management implementation guide’ of 15.11.2005.

(2)  See Communication from the Commission to the Council, the Parliament and the Court of Auditors COM(2006) 9 final and Communication to the Commission SEC(2006) 49 of 17.1.2006.

(3)  See Article 53 of the Financial Regulation (OJ L 248, 16.9.2002, p. 1).

(4)  Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions: Policy Achievements in 2005 (COM(2006) final 124 of 14.3.2006).

(5)  Communication from the Commission to the European Parliament, the Council and the European Court of Auditors (COM(2006) 277 final of 7.6.2006).

(6)  Annex 1 of the 2005 synthesis includes 15 measures related to the following categories: performance management and internal control, governance, financial management and reporting and human resources. Most of these actions are the follow-up of the multi-annual objectives included in the 2004 synthesis.

(7)  See also Annual Report of the Court of Auditors concerning the financial years 2003 and 2004, paragraph 1.67.

(8)  Secretariat-General, Directorate-General for Budget and Directorate-General for Personnel and Administration.

(9)  Note to Directors-General and Heads of Service — Circular on the annual activity reports for year 2005 SEC(2005) 1533 of 15.11.2005.

(10)  This is a process, organised by groups of Directorates-General, to improve consistency and coherence between reservations.

(11)  See part 3.1 and appendix 3 of the circular on the annual activity reports for year 2005. According to these guidelines, a system weakness is considered as material if it satisfies both qualitative and quantitative criteria. Specific implementing rules were further developed by the Directorates-General of the families of shared management and research, aiming to have common materiality criteria and quantification methodology, as laid down in multiannual objective No 6, established by the 2004 synthesis report (COM(2005) 256 final of 15.6.2005), Annex 1.

(12)  In particular, the existing guidelines establish the threshold as a function of the budget for the activity in question, i.e. 2 % of the value of the activity concerned (COM(2003) 28 final of 21.1.2003).

(13)  In part 1, section 1.2 of the relevant circular, it is foreseen that the scorecard of the service for the year 2005 should ensure a balance between impact, output, workload, management and legality and regularity indicators.

(14)  Appendix 6 of the circular on the annual activity reports for year 2005 foresaw the publication of a supplementary document on performance indicators. This procedure was suspended awaiting the results of the working group on standard objectives and indicators for horizontal activities.

(15)  The guidelines for the annual activity reports specify that reservations should not make the declaration meaningless and that, in extreme cases, the Director-General may not be able to provide the required assurance. In order to remedy weaknesses, action plans, including deadlines for implementation, should be drawn up.

(16)  Directorates-General for Communication, Education and Culture, Office for Infrastructures and Logistics in Brussels.

(17)  Directorates-General for Information Society and Media, Justice, Freedom and Security, External Relations.

(18)  See also Annual Report of the Court of Auditors concerning the financial years 2003 and 2004, paragraph 1.67.

(19)  In 2005, the analysis extended to the information included in the annual activity reports (and not only to the declarations). The assessments made in 2003 and 2004 have been adapted in view of presenting a comparable situation for 2003, 2004 and 2005.

(20)  Even though in some cases (management and control systems in the Member States in 2000 to 2006 for several programmes of structural measures and error frequency for the Sixth Framework Programme of Research) they were dealt with in the annual activity reports.

(21)  Impact of these most important reservations on the Director-General's assurance in the Court's view:

A: reasonable assurance that the internal control systems ensure the legality and regularity of the underlying transactions with no or insignificant qualifications
B: reasonable assurance with qualifications that the internal control systems ensure the legality and regularity of the underlying transactions (errors < 2 % or system weaknesses whose financial impact < 10 % of the budget concerned)
C: no assurance (errors > 2 % or system weaknesses whose financial impact > 10 % of the budget concerned)

(22)  Evidence given by the Annual Activity Report for the Court's audit conclusions:

In 2005, the analysis extended to the information included in the annual activity reports (and not only to the declarations). The assessments made in 2003 and 2004 have been adapted in view of presenting a comparable situation for 2003, 2004 and 2005.
A: sufficient evidence for the Court's DAS conclusions (clear and unambiguous)
B: sufficient evidence for the Court's DAS conclusions after corrections (with immaterial inaccuracies or missing information of minor importance)
C: insufficient evidence for the Court's DAS conclusions (with material inaccuracies or missing information of major importance, for example: negligence of the problems of shared management, cover of the previous financial year, lack of quantification, unusable information)

(23)  Evolution:

+ improvement
= constant
– regression

(24)  Although included in the Annual Activity Reports.

(25)  For CAP expenditure, where IACS is properly applied.

(26)  For CAP expenditure, which is not subject to IACS or where IACS is not properly applied.

Source: Court of Auditors.

(27)  Directorates-General for Agriculture and Rural Development, Employment, Social Affairs and Equal Opportunities, Regional Policy.

(28)  E.g. Directorates-General for Agriculture and Rural Development, Communication, Education and Culture, Employment, Social Affairs and Equal Opportunities, Enterprise and Industry, Environment, Information Society and Media, Justice, Freedom and Security, Regional Policy, Research, Health and Consumer Protection, Energy and Transport, EuropeAid Cooperation Office, Office for Infrastructures and Logistics in Brussels.

(29)  Standards Nos 11 ‘Risk analysis and management’, 12 ‘Adequate management information’, 14 ‘Reporting improprieties’, 17 ‘Supervision’, 18 ‘Recording exceptions’, 20 ‘Recording and correction of internal control weaknesses’, 21 ‘Audit reports’ and 22 ‘Internal audit capability’.

(30)  Directorates-General for Agriculture and Rural Development, Budget, Competition, Education and Culture, Economic and Financial Affairs, Enlargement, Employment, Social Affairs and Equal Opportunities, Enterprise and Industry, Fisheries and Maritime Affairs, Information Society and Media, Regional Policy, Research, EuropeAid Cooperation Office, Eurostat.

(31)  SEC(2006) 567 of 28.4.2006.

(32)  The number of baseline requirements increased from 71 to 75. Two of the baseline requirements selected for 2005 were strengthened in comparison with 2004.

(33)  Directorates-General for Agriculture and Rural Development, Budget, Competition, Education and Culture, Employment, Social Affairs and Equal Opportunities, Research, Regional Policy, EuropeAid Cooperation Office.

(34)  In particular, internal control standards 11 ‘Risk analysis and management’ and/or 17 ‘Supervision’.

(35)  In compliance with Article 86 of the Financial Regulation.

(36)  See Communication from the Commission to the Council, the European Parliament and the European Court of Auditors on a roadmap to an integrated internal control framework (COM(2005) 252 final of 15.6.2005) and Annual Report of the Court of Auditors concerning the financial year 2004, paragraph 1.85.

(37)  Common agricultural policy, structural measures and internal policies including research.



CHAPTER 3
Budgetary Management
TABLE OF CONTENTS
Introduction
Observations
Budget increased for the first full year of enlargement
Almost all of the budget used
Outstanding budgetary commitments continue to increase
Higher spending rate on structural operations required over the next three years
Decommitments under the year n + 2 rule have been limited
Conclusions and recommendations






THE COURT'S OBSERVATIONS


THE COMMISSION'S REPLIES




INTRODUCTION










3.1.


This chapter analyses issues arising from the implementation of the EU general budget in 2005 (1). Within the budget there are separate appropriations for commitments and payments. Appropriations for commitment represent the amounts for which the Union can enter into budgetary commitments in the current year in order to honour longer term legal commitments (or agreements) to spend. Appropriations for payment represent amounts that can be spent during the current year. In the case of ‘non-differentiated’ expenditure (such as much of agricultural spending) commitments and payments within the budget are equal and liquidated during the year.






 










3.2.


Most expenditure on structural operations and on internal and external policies takes the form of programmes managed over a number of years (e.g. 2000 to 2006 for the current Structural Funds programming period). In the case of this ‘differentiated’ expenditure, the legal obligations are reflected as budgetary commitments in yearly tranches over the life of the programmes. Since most budgetary commitments are not liquidated in the year in which they are made, but in subsequent years, there remains a ‘stock’ or balance of outstanding budgetary commitments. For more detailed information on the budget see 
Annex I
.






 




OBSERVATIONS




Budget increased for the first full year of enlargement










3.3.


2005 was the first full year of the enlarged Union. Total appropriations for commitments (116,6 billion euro) and payments (106,3 billion euro) were respectively 6,2 and 4,4 % higher than the 2004 final budget. The increase for commitments is proportionally larger because they can cover expenditure for more than one year (see paragraph 3.2), while payment appropriations are linked to absorption capacity. Overall, the commitment and payment appropriations remain below the financial perspective ceilings by 3,0 billion euro and 7,9 billion euro respectively.






 










3.4.


The eight amending budgets voted during the year resulted in an overall 0,6 billion euro reduction in both appropriations for commitments and payments, mainly in agriculture and structural operations.






 




Almost all of the budget used










3.5.


The budgetary outturn for 2005 is given in 
Diagrams III and IV
 of 
Annex I
:










—


utilisation rates for both commitments and payments — at 99 and 96 % respectively — were at a similar high level to 2004 (98 and 95 %),










—


2,7 billion euro of unused payment appropriations were not cancelled but carried over from 2005 to 2006, a similar level to the carryover from 2004 to 2005 (2,8 billion euro) (2),










—


the budgetary surplus (3) for the year totalled 2,4 billion euro, a small reduction compared with 2,7 billion euro in 2004.






 




Outstanding budgetary commitments continue to increase










3.6.


Outstanding budgetary commitments (4) increased by 9,1 billion euro, or 8 %, to 119 billion euro (see 
Table 3.1
). 94 % of the increase was related to structural operations, with 4 billion euro for the EU-15 programmes and 3 billion euro for the EU-10. Almost 3 billion euro of the increase for structural operations related to the Cohesion Fund. Outstanding budgetary commitments for differentiated expenditure as a whole represented 2,4 years of payments at the current spending rate (2,2 years in 2004).












3.6.


An increase in outstanding budgetary commitments (RAL) related to structural operations in EU-10 was to be expected as budgeted commitments are normally somewhat higher than payments in the early years of programming.








Table 3.1 — Change in balance of outstanding commitments 2005

















 


By type



Total



Agriculture


Structural operations


Internal policies


External actions


Administration


Reserves


Pre-accession strategy


Compensation


Rounding




Non-Differentiated appropriations


Differentiated appropriations




Commitments brought forward




Balance brought forward


1 313


108 834



110 147



1 452


73 285


13 450


12 313


808


0


8 840


0


–1




Payments


–1 072


–42 852



–43 924



–1 394


–31 184


–4 415


–3 306


– 673


0


–2 953


0


1




Decommitments


–47


–2 245



–2 293



–5


–1 304


– 410


– 405


–35


0


– 133


0


–1




Cancellations


– 191


0



– 191



–47


–1


–24


–18


–96


0


–5


0


0




Commitments made in 2005




Commitments made


55 589


60 689



116 278



48 928


42 490


9 548


5 516


6 355


140


1 994


1 305


2




Payments


–54 311


–6 600



–60 911



–47 071


–1 580


–3 556


–1 707


–5 518


– 140


–32


–1 305


–2




Cancellations


–26


0



–26



0


–2


–12


–6


–5


0


–1


0


0




Rounding


–1


0



0



0


0


0


0


0


0


0


0


0





Commitments outstanding at end 2005




1 254




117 826




119 080



1 863


81 704


14 581


12 387


836


0


7 710


0


–1





Source: 2005 annual accounts.














3.7.




Graph 3.1
 shows the value of outstanding budgetary commitments on differentiated expenditure since 1994, and the steady increase in both absolute and relative terms. The increase is due to:










—


the cumulative effect of underspending between 1999 and 2003 which resulted in 40 billion euro of payment appropriations being cancelled (5), and










—


a growing budget — partly due to enlargement — in which appropriations for commitment are generally higher than those for payments.












3.7.


A significant increase in the absolute level of RAL was to be expected, as it is a natural consequence of the changed commitment and payment rules for the Structural Funds for the 2000 to 2006 period.








Higher spending rate on structural operations required over the next three years










3.8.


Due to the nature of the budgetary process the balance of outstanding budgetary commitments does not reflect the full extent of the European Communities' legal commitments (see paragraph 3.1). At the end of 2005, 48,4 billion euro of legal commitments remained uncommitted at the budgetary level. As such, total outstanding legal commitments represented 3,4 years' of payments. This should be viewed in the light of the various time limits for making payments within the different budgetary areas.












3.8.


The indicators used in paragraphs 3.8 to 3.11 should be interpreted with care. The ratio of ‘outstanding legal commitments’ relative to payments in a given year, is not by itself a useful indicator for the reasons cited by the Court.





















3.9.


The majority of the balance of outstanding budgetary commitments concerns structural operations. At the end of 2005, outstanding budgetary commitments for the Structural Funds 2000 to 2006 programming period were 67 billion euro, representing 2,3 years' expenditure at the 2005 spending rate, a slight increase over 2004. Legal commitments not yet transformed into budgetary commitments total 39 billion euro. Accordingly, total outstanding legal commitments for the Structural Funds 2000 to 2006 programming period at the end of 2005 were 106 billion euro. This represents 3,6 years' payments at the 2005 spending rate, compared with the nearly five years' worth of payments in 2004. The fall is partly due to the higher level of payments in 2005 compared with 2004, and more particularly a natural consequence of 2005 being one year nearer the end of the programme payment cycle (see 
Graph 3.2
).






 

















3.10.


The amount of expenditure needed to liquidate the outstanding legal commitments for Structural Funds should be viewed in the context of the time limit of end of 2008 (6) for beneficiaries to incur expenditure. In order to meet this deadline Member States will have to increase further their current high level of spending. This will be difficult to ensure as spending tends to reduce towards the end of the programming cycle as projects are finalised. Furthermore, from 2007 spending should start on the 2007 to 2013 programming cycle, but the need to complete the current cycle risks delaying the start and subsequent implementation of the new programmes (7).












3.10.


Member States and the Commission are aware that vigilance is needed to ensure that the switch between cycles is made smoothly, both in terms of ensuring programme implementation, and in tackling the additional workload relating to the establishment of new programmes. The closure of the 2000-2006 programmes is already being prepared by the Commission and Member States.




The Commission will propose budgets that match the expected level of eligible payment claims, whether these claims arise from the 2000 to 2006 period, or the 2007 to 2013 programming period. Expenditure will not necessarily reduce in the final years of the current programme period. Part of the balance for programmes for the current period will be paid in the years 2007 to 2011 and will therefore overlap with the following period (8).
In the current period — unlike in 1994 to 1999 — the n + 2 rule provides a powerful incentive to Member States to ensure that implementation proceeds at a sufficently high rate, as funds not implemented in good time are decommitted.










3.11.


Spending was less than expected for the Cohesion Fund largely due to lower than planned spending in the new Member States. An amending budget reduced the payment appropriations by 0,9 billion euro or 30 % and outstanding budgetary commitments increased from 9,7 billion euro in 2004 to 12,5 billion euro at the end of 2005. As a result, total outstanding legal commitments for the Cohesion Fund were 18,6 billion euro which represents 8,5 years' of payments at the 2005 spending rate. However, in contrast to the Structural Funds, there is no general legal deadline by which payments must be made.












3.11.


Enlargement in May 2004 brought a significant addition to the total stock of outstanding legal commitments, while the impact of new programmes on payments is necessarily limited at the start-up of programmes.








Decommitments under the year n + 2 rule have been limited










3.12.


The year n + 2 rule applies to the Structural Funds and provides for the cancellation of commitments when no payment claim is made within the two years following the year the commitment is made and is intended to prevent an excessive accumulation of outstanding budgetary commitments (9). In 2005, only 286 million euro of outstanding budgetary commitments were cancelled following application of the n + 2 rule. This was slightly higher than in 2004 (245 million euro) but still represented just 0,9 % of the commitment tranches more than two years old and therefore potentially subject to cancellation (and 0,4 % of the total balance of outstanding budgetary commitments).












3.12.


The payments on account made at the beginning of the programming period, which represented 7 % of the total EU-15 2000 to 2006 envelope of each programme, provide a relatively long term protection against n + 2 de-commitments as advance payments reduce the level of reimbursements needed to avoid automatic de-commitments.




This protection weakens over time, and may lead to growing n + 2 de-commitments in the years ahead (see the Commission's reply to point 2.24 of the Court’s 2004 Annual Report). EU-10 will be subject to the n + 2 procedure for the first time at the end of 2006.










3.13.


In practice the year n + 2 rule may encourage Member States to make claims as soon as they have made the underlying payments to final beneficiaries rather than when expenditure has actually been incurred by these beneficiaries. The risk is that Member States will submit claims of ineligible or anticipated (rather than actual) expenditure in order to prevent cancellations. Such practices may diminish the effectiveness of the year n + 2 rule.












3.13.


The Commission is aware of the risk and checks for abuses when it carries out its own audits.














3.14.


Most of the cancellations under the n + 2 rule relate to the European Social Fund. Moreover, in practice new commitments from the performance reserve (10) were — as in 2004 — in some cases allocated to the programmes from which commitments were cancelled, thereby partly negating the effect of the procedure (11).












3.14.


As appropriations cannot be shifted between Objectives (amounts fixed at the Berlin European Council in 1999 and in the Structural Funds Regulation), competition for the Performance Reserve is limited to programmes of one Member State within one Objective.




There is only one Objective 3 SPD in the Netherlands, so there was no option in this case but to commit the reserve to this programme. However, the allocation was made to the better performing priorities of the programme (see the Commission's reply to point 2.25 of the Court’s 2004 Annual Report).




CONCLUSIONS AND RECOMMENDATIONS










3.15.


The high rate of spending in 2005 and active management of the budget built upon the improved budgetary performance of 2004. In particular the large spending programmes continued at the expected levels, although absorption difficulties were encountered in the EU-10, particularly the Cohesion Fund. Despite the high spending rate, outstanding budgetary commitments increased by 8 % to an all time high of 119 billion euro, or 2,4 years’ worth of spending.












3.15.


Some increase in outstanding budgetary commitments is to be expected as a consequence of the increase of the budget of differentiated commitments for multiannual programmes to reflect enlargement.














3.16.


For the Structural Funds (which represents the major proportion of differentiated expenditure and the outstanding commitments) the high level of spending needs to be further increased to ensure that the deadline for beneficiaries to incur expenditure (end of 2008) is met for the 2000 to 2006 programmes. This will be particularly difficult as spending tends to reduce as the programmes end. There is, therefore, a risk that subsequent closure of the current programmes will delay the start and implementation of the 2007 to 2013 programmes as in the past.












3.16.


Expenditure will not necessarily reduce in the final years of the current period. Available evidence on execution trends of the programmes of the current programming period does not suggest any significant deceleration. Member States and the Commission are aware that vigilance is needed to ensure that the switch between cycles is made smoothly, both in terms of ensuring programme implementation, and in tackling the additional workload relating to the establishment of new programmes. The closure of the 2000 to 2006 programmes is already being prepared by the Commission and Member States.














3.17.


Effective budgetary management requires a realistic and appropriate budget taking into account the expected profile of payments, particularly the absorption capacity of Member and beneficiary States. This was not the case for the first three years of the current programming period. Commitments on major spending programmes are made in equal tranches which do not reflect the timing or profile of payments. The low level of spending at the beginning of programmes resulted in a build up of outstanding budgetary commitments, and commitments are only liquidated many years after they are made.












3.17.


In terms of execution of the available payment appropriations 2005 was a very good year, which partly reflects realistic and appropriate budgeting.




The Commission budgets commitments in line with the agreement reached by Member States on the Financial Perspective and with the terms of the Structural Fund Regulations.










3.18.


This situation is caused by constant and smoothly increasing annual commitment and payment budgets. The Commission based the latter on the expectation that when programming cycles overlap the lower demand for payment at the start of the new period will be compensated for by payments from the end of the old period (12). When this is not the case (such as 2000 to 2003) there is considerable underspending. As a result there is a risk that significant levels of spending will continue far beyond the 2000 to 2006 financial perspective period.












3.18.


The Commission's budgets are based on a detailed analysis of the requirements for each programme period.




Under the current regulatory framework (and the one being discussed by the legislative authority for 2007 to 2013) significant levels of spending associated with one period’s programmes continue for some years into the next one. The Commission will monitor the situation closely to reduce the risk of repetition of problems at the start of the new programme cycle.










3.19.


For the Structural Funds the year n + 2 rule has resulted in little cancellation of commitments to date. Its effectiveness as a budgetary management tool may be compromised if Member States make claims based on ineligible or anticipated payments in order to prevent commitments being cancelled.












3.19.


The level of de-commitments is not in itself a proper indicator of the effectiveness of the n + 2 rule, precisely because the rule also has an effect on promoting budget execution.




The Commission fully agrees that the n + 2 procedure needs to be implemented rigorously.










3.20.


The Court recommends that the Commission makes a careful analysis of the forthcoming completion of the current structural operations spending programmes and the effect this will have on the start of the next. Furthermore, the Commission will have to ensure for the Structural Funds the effective application of the year n + 2 rule with the consequence that it will have to cancel a significant value of budgetary commitments unless Member States succeed in increasing the rate of eligible spending even further.












3.20.


The Commission agrees with the recommendation.




The Commission will continue to ensure the effective application of the n + 2 rule.










3.21.


For the 2007 to 2013 programming period, the Commission should:










—


ensure that programmes are adopted quickly and are based on reasonable assumptions,










—


review critically Member States' payment forecast, and










—


ensure that annual budgeting over the life of the period is consistent with realistic assumptions about the rate of spending.












3.21.


The Commission agrees with the recommendation.










(1)  Detailed information on budgetary implementation for 2005 can be obtained from the Commission document entitled ‘Report on budgetary and financial management — Financial year 2005.’ See http://ec.europa.eu/budget/publications/fin_manag_account_en.htm

(2)  For more explanation on the carry over of appropriations, see point 7.3 of 
Annex I
.

(3)  The budgetary surplus — which differs from the economic outturn — is a reflection of the extent to which the budget has not been spent. It is not a reserve which can be accumulated and used in future years to finance expenditure. The unused revenue that the surplus represents is offset against the own resources to be collected for the following year.

(4)  See paragraph 3.2.

(5)  See paragraph 2.12 of the Court's 2003 Annual Report.

(6)  Early or mid 2009 in certain cases.

(7)  In the past, closure has been a difficult period in the programming cycle: ‘The administrative and financial constraints connected with completion of the 1994 to 1999 programmes contributed largely to the delays in starting up programmes for the 2000 to 2006 period.’ COM(2002) 528 final, page 4.

(8)  The final date for eligibility of expenditure under the 2000 to 2006 programmes is normally the end of 2008, in line with the n + 2 rule. However, the final 5 % balance of a programme can only be paid after Member States have submitted satisfactory closure documents, for which the deadline is early 2010. In practice this means that some payments will be made in 2010 and 2011.

(9)  Commission reply to paragraph 2.23 of the Court's 2004 Annual Report. See also the Commission's reply to paragraph 2.48 of the Court's 2003 Annual Report: ‘The “N + 2” rule should result in a stabilised level of outstanding commitments over the next few years…’.

(10)  4 % of the appropriations allocated to each Member State were placed in reserve for distribution to the best performing programmes in three tranches from 2004 to 2006.

(11)  For example, in the case of 79 million euro decommitted from a programme following the year n + 2 rule in the Netherlands, 24 million was allocated to the same programme from the Performance Reserve.

(12)  See Commission reply to paragraph 2.16 of the Court’s 2003 Annual Report: ‘The overlap of programme cycles for multiannual programmes tends to smooth the pattern of payments over time. For example, at the beginning of a new Structural Fund programme period, payments made in respect of programmes of the previous period normally compensate for the still low level of payments under current programmes before they reach cruising speed.’



CHAPTER 4
Revenue
TABLE OF CONTENTS
Introduction
Specific assessment in the context of the Statement of Assurance
Scope of audit
Legality and regularity of underlying transactions
Functioning of supervisory and control systems
Commission supervisory and control systems
Supervisory and control systems in Member States
Conclusions and recommendations
Follow-up of previous observations
Traditional own resources: B-account adjustment






THE COURT'S OBSERVATIONS


THE COMMISSION'S REPLIES




INTRODUCTION










4.1.


The revenue in the budget of the European Union consists of own resources and other revenue. As shown in 
Table 4.1, Graph 4.1
 and 
Graph 4.2
 own resources are by far the main source of financing for budgetary expenditure (94,3 %).






 




Table 4.1 — Revenue for the financial years 2004 and 2005











(million euro)




Type of revenue and corresponding budget heading


Actual revenue in 2004


Development of the 2005 budget


Actual revenue in 2005


% change (2004 to 2005)




Initial budget


Final budget




 


(a)


(b)


(c)


(d)


e = [(d) – (a)]/(a)




1



Traditional own resources (net of 25 % collection costs)




12 307,1




123 633,0




13 944,0




14 063,1



14,3




— Agricultural duties (Chapter 10)


1 313,4


819,5


1 119,4


1 350,8


2,8




— Sugar and isoglucose levies (Chapter 11)


401,6


793,6


793,8


695,1


73,1




— Customs duties (Chapter 12)


10 592,1


10 749,9


12 030,8


12 017,2


13,5




2



VAT resource




13 912,1




15 313,5




15 956,0




16 018,0



15,1




— VAT resource from the current financial year (Chapter 13)


13 679,3


15 313,5


15 556,0


15 618,9


 




— Balances from previous years (Chapter 31)


232,8


0,0


400,0


399,1


 




3



GNI resource




68 982,0




77 583,0




70 935,4




70 860,6



2,7




— GNI resource from the current financial year (Chapter 14)


69 214,2


77 583,0


68 884,1


68 811,6


 




— Balances from previous years (Chapter 32)


– 232,2


0,0


2 051,3


2 049,0


 




4



Balances and adjustments




– 148,0




0,0




0,0




– 130,6



–11,8




— UK correction (Chapter 15)


– 149,3


0,0


0,0


– 120,3


 




— Final calculation of UK correction (Chapter 35)


1,3


0,0


0,0


–10,3


 




5



Other revenue




8 458,7




1 040,5




4 848,6




6 279,5



–25,8




— Surplus from previous financial year (Chapter 30)


5 693,0


0,0


3 262,7


3 262,7


–42,7




— Miscellaneous revenues (Titles 4 to 9)


2 765,7


1 040,5


1 585,9


3 016,8


9,1





Grand Total




103 511,9




106 300,0




105 684,0




107 090,6




3,5






Source: Budgets and amending budgets for 2005; Annual Accounts of the European Communities, 2005.




























4.2.


There are three categories of own resources: traditional own resources (2) (customs duties, agricultural duties, and sugar levies) (13,3 %), own resources calculated on the basis of value added tax (VAT) collected by Member States (14,9 %), and own resources derived from the Member States' gross national income (GNI) (3) (66,1 %).






 




SPECIFIC ASSESSMENT IN THE CONTEXT OF THE STATEMENT OF ASSURANCE




Scope of audit




Traditional own resources










4.3.


The main risks to the collection of traditional own resources are evasion of duty by the taxpayer, whether by misrepresentation or simply by smuggling; miscalculations or failures to establish duty because of undetected errors or weaknesses in customs authorities' systems; and errors or omissions in Member States' accounting for the duty established.






 










4.4.


The Court's audit of the accounts cannot cover undeclared imports and imports that have escaped customs surveillance. However, its audit work included an evaluation of supervisory and control systems, both at the Commission and in Member States, to assess whether they gave reasonable assurance of completeness. It consisted of a review of the organisation of customs supervision and of the national systems for accounting for traditional own resources in eight Member States (4) (see paragraph 4.22); an examination of the effectiveness of the mutual assistance arrangements (paragraphs 4.10 to 4.12); an examination of the Commission's accounts for traditional own resources; and an analysis of the flow of duties in order to gain reasonable assurance that the amounts recorded were complete and correct.






 




VAT and GNI own resources










4.5.


The VAT and GNI own resources reflect macroeconomic statistics whose underlying data cannot be audited directly. For this reason, the VAT/GNI audit took as its starting point the receipt by the Commission of the macroeconomic aggregates prepared by the Member States (either as forecasts or as final figures) and sought to assess the Commission's system for handling the data until they are ultimately included in the final accounts. The audit thus covered the establishment of the annual budget and its implementation in respect of the payments by Member States. In addition, the Court continued its review of supervisory and control systems in relation to the compilation of national accounts at Statistical Offices in Member States.






 




Legality and regularity of underlying transactions




Traditional own resources










4.6.


Minor errors were found in customs declarations (the underlying transactions for traditional own resources) but these have no material effect on the accounts. However, certain traditional own resources transactions, which should have been made available to the Commission without delay were incorrectly withheld and entered in separate accounts (the B accounts).












4.6.


The Commission requires Member States to pay interest for any delays discovered in making traditional own resources available.














4.7.


As in previous years the Court's audit and the Commission's inspections (see paragraph 4.9) found systematic problems with the B accounts in a number of Member States (5). Some errors are related to the conditions for entry in the accounts. In Member States whose B accounts represent 34 % of the balance, customs debts that are partly secured are nevertheless entered in full in the B accounts, leading to delay in making the secured part available to the Commission. Other errors arise because Member States have not adapted their accounting systems so as to record the appeal or recovery accurately, or because there is insufficient internal control over the compilation of reports. 22,7 million euro of potential duties remain under discussion between the Commission and Germany as a result of such a problem.












4.7.


The Commission agrees with the Court’s findings. The practice of including unchallenged amounts in the B account because the guarantee held may be insufficient is incorrect. It is also contrary to the advice the Commission has given Member States. The Commission will take all appropriate measures including infringement proceedings against this incorrect practice.




Germany initially made corrections totalling 40 million euro in its B account balance. The Commission continues to require that the financial consequences of the correction be reliably identified. So far this has been done for just under half the corrections and 387 415 EUR made available. Germany has been requested to produce further evidence for the remainder (approximately 22,7 million EUR), the Commission will then take the appropriate action.




VAT and GNI own resources










4.8.


The Court's audit did not reveal any material irregularities in respect of the payments of VAT and GNI own resources by Member States.






 




Functioning of supervisory and control systems




Commission supervisory and control systems




Traditional own resources










4.9.


The Court has reviewed the inspections carried out by the Commission (6) and has taken the results into account. As in previous years the Commission's methodology and documentation were found to be respectively soundly-based and good. The inspections found that the own resources collection systems were generally satisfactory, but confirmed the continued poor reliability of the B accounts in some Member States (see paragraph 4.7).






 




Mutual assistance in customs matters










4.10.


An important aspect of the supervisory and control systems is coordination of action between Member States and the Commission to protect the financial interests of the Community against fraud and irregularities (7). Weaknesses in these systems would put the completeness of collection of duties at risk. Specific provisions on mutual assistance in the customs and agricultural sectors are given in Council Regulation (EC) No 515/97 (8). The European Anti-Fraud Office (OLAF) provides the Commission's support for this cooperative task.






 










4.11.


There are still inconsistencies in Member States' reporting of mutual assistance cases, and very long delays, sometimes exceeding five years, at the administrative investigation stage which could result in loss of revenue since time-barring generally applies after three years. This finding is consistent with the observation in the Court's recent audit of the management of OLAF (9), that there were no rules for consistent monitoring of progress on mutual assistance cases in the Member States.












4.11.


The investigation phase may be both complex and time-consuming. Where Member States are shown to have been dilatory in pursuing evidence of irregularity and revenue is consequently lost, the Commission requested those countries to pay for the duties forgone together with interest on the delay in making them available.




Nonetheless the Commission had already carried out an evaluation of the handling of Mutual Assistance (MA) messages between Member States. This identified the need for a more modern procedure for facilitating the capture, transfer and analysis of information by the Member States and reducing the timeframe for reaction. Action is now underway to migrate all the current AFIS (Anti-Fraud Information System) modules to new web technology. In addition, the Commission and Member States have agreed to integrate developments to the e-MA communication system in this process.










4.12.


The Taxation and Customs Union Directorate General (DG TAXUD) has recently introduced a RIF (Risk Information Form) system for exchanging control- and risk-related information between the Member States' customs services. 90 % of the RIF data fields are also on the standard mutual assistance communication, and the information obtained from these two systems is used in many cases by the same services in the Member States, including investigation/intelligence and control services. Even if a potential risk has been reported using a RIF, the regulation requires a parallel message to OLAF using the mutual assistance procedure in cases of breaches of customs legislation.












4.12.


Council Regulation (EC) No 648/2005 introduced a general requirement for a Community Customs Risk management framework. The RIF exchange is an integral part of the framework and the Commission's experience is that RIF information is presently fulfilling a key aim of reaching a wider range of front-line control officers.




OLAF and TAXUD are already and will continue cooperating to obtain maximum synergy between AFIS and RIF taking into account the differences between first phase control requirements and anti-fraud related actions.




VAT own resource










4.13.


The Commission succeeded in maintaining the frequency and quality of its on-the-spot inspections during the financial year 2005 in the enlarged European Union.






 










4.14.


The number of outstanding reservations (10) in respect of Member States' VAT statements remains high. With 37 reservations lifted and 41 new reservations set, the number increased to 111 at the end of the year 2005 and its breakdown between the Member States concerned is given in 
Table 4.2
. Their financial impact has not been estimated by the Commission.












4.14.


The Commission places reservations where it disagrees with the Member State's figures or method, or where it requires evidence to justify the figures or method used, or where the Member State presents no figures. For these reasons their financial impact is seldom easy to estimate with accuracy. Moreover, the Commission would not want such estimation to discourage Member States from performing the sometimes difficult work of producing accurate data and appropriate methods of calculation. The Commission will nonetheless reexamine this question.








Table 4.2 — VAT reservations as at 31 December 2005










Member States (11)



Number of reservations outstanding at 31.12.2004


Reservations set in 2005


Reservations lifted in 2005


Number of reservations outstanding at 31.12.2005


Oldest year to which reservations apply




Belgium


4


5


3


6


1989




Denmark


1


0


0


1


1991




Germany


17


8


8


17


1999




Greece


13


0


0


13


1997




Spain


3


6


3


6


1999




France


9


4


6


7


1993




Ireland


1


9


0


10


1998




Italy


12


0


1


11


1995




Luxembourg


3


1


3


1


1997




Netherlands


2


1


2


1


2001




Austria


3


5


0


8


1995




Portugal


5


0


0


5


1996




Finland


6


1


0


7


1995




Sweden


21


1


11


11


1995




United kingdom


7


0


0


7


1995





Total




107




41




37




111



 














4.15.


The Court notes that the lifting of a reservation largely depends on appropriate action being undertaken by the Member State in question. For certain reservations an infringement procedure can be started at the European Court of Justice. Apart from this there is at present no effective instrument for ensuring that Member States provide adequate information within clearly defined deadlines, so enabling the Commission to decide on the lifting of outstanding reservations within reasonable timescales.












4.15.


Reservations are a device for keeping weak elements in VAT statements open for correction after the statutory time-limit of four years. The Commission considers that in those cases where the Member States apply either VAT or own resources legislation incorrectly, the infringement procedure may provide a remedy. For other cases, the Commission will examine the possibility and opportuneness of introducing, for instance into Council Regulation (EC) No 1553/89, an instrument of the kind suggested by the Court.








GNI own resource










4.16.


As regards the GNI own resource, there was still insufficient verification by the Commission of the underlying national accounts that form the basis for the figures forwarded in the GNI questionnaires (12). During 2005 Commission inspections as part of supervisory and control systems were limited to desk checks (13) in respect of the quality and consistency of data in the annual GNI questionnaires submitted by Member States.












4.16.


In autumn, the Commission verifies the annual GNI questionnaires, using the same standardised checklist for all Member States, drawing extensively on Commission experts’ knowledge of the countries’ practices, and requesting additional information from the Member States, if necessary. The GNI questionnaires are submitted to the GNI Committee for examination. This approach makes the data adequate for provisional use in the budgetary calculations, taking account of existing reservations for Member States.




To complement this desk verification, the Commission will resume control missions to Member States after the new inventories are available and analysed in 2008, with more emphasis on the sources and methods used and on the reservations. Resource constraints must be taken into account in this exercise.










4.17.


In its Annual Report concerning the financial year 2004 (14) the Court drew attention to some weaknesses in the quality reports submitted by Member States. A review of the quality reports submitted in 2005 showed that most of these weaknesses had been addressed. However, there was still no reporting on the results of investigations of the quality of GNI and its components carried out by Member States.












4.17.


The Commission has urged Member States to step up their efforts in reporting the results of their investigations of GNI quality (see reply to 4.30(c)).














4.18.


At the end of the 2005 financial year there were 63 outstanding specific reservations (15) in total (the majority for years 1995 to 2001), with an unequal spread between the EU-15 Member States, both in respect of the number of reservations and the action taken to have them lifted, see 
Table 4.3
.






 




Table 4.3 — GNI reservations as at 31 December 2005









Member States (16)



Number of reservations outstanding at 31.12.2004


Reservations set in 2005


Reservations lifted in 2005


Number of reservations outstanding at 31.12.2005 (17)





Belgium


3


—


—


3




Denmark


5


—


—


5




Germany


1


3


1


3




Greece


7


—


—


7




Spain


5


—


—


5




France


8


—


—


8




Ireland


4


—


—


4




Italy


4


—


—


4




Luxembourg


1


8


1


8




Netherlands


4


—


2


2




Austria


4


—


3


1




Portugal


4


—


—


4




Finland


3


—


—


3




Sweden


0


—


—


0




United kingdom


6


—


—


6





Total




59




11




7




63















4.19.


The Commission will have to put in place a further reservation applicable to all EU-15 Member States in respect of the inclusion of illegal activities in GNI, to allow adjustments to be made in the aggregates concerned, going back to the year 2002 (18).












4.19.


The Commission notified a reservation covering illegal activities to the Member States in July 2006.








Financial Intermediation Services Indirectly Measured (FISIM)










4.20.


Since 2005 new rules on the allocation of FISIM within the European system of national and regional accounts (ESA 95) apply (19). The objective is to achieve a more accurate intra-Community comparison of GNI levels of Member States. According to Eurostat (20), the application of these new rules would result in a significant increase of GNI which varies across Member States and years, but roughly ranges between 0,5 and 2 %.






 










4.21.


In cases where modifications to the ESA 95 result in significant changes in the GNI, the Council is required to decide whether these modifications shall apply for the purpose of own resources on the basis of a proposal made by the Commission (21). Although the decision setting new rules for the allocation of FISIM within ESA 95 had already been taken in 2002, the Commission has not yet presented any proposal for FISIM allocation for own resources purposes. Such an allocation would have an impact on the incidence of the financial burden on the Member States.












4.21.


Statistical changes adopted by the EU in order to improve the methodology of ESA and achieve a more accurate comparison of economic activity among Member States should apply also to own resources payments, once agreed changes are applied in a uniform manner across Member States. The Commission will therefore present a proposal to include allocated FISIM for GNI own resources when it considers that all Member States are able to implement this adjustment in a uniform manner.








Supervisory and control systems in Member States




Traditional own resources










4.22.


The systems for customs supervision and for accounting for traditional own resources were generally found to be functioning correctly. However, an examination of Community transit found that many Member States (22) did not have effective systems for starting enquiries on time when there was doubt about the arrival of consignments, and there were also considerable delays in later stages of the enquiry and recovery procedures. As a result duties were frequently collected late in such cases. In several Member States (23) customs control of goods in temporary storage (24) was not sufficient to ensure that the time-limits and other rules in the Community Customs Code were observed. In one Member State (25) the intervals between customs audits of economic operators could routinely exceed three years, thus putting traditional own resources at risk because of time-barring.












4.22.


All the Court’s comments will be followed up with the relevant Member States.




For transit under the paper-based system there were frequent queries regarding the proper discharge of movements of goods — which often took a very long time to resolve. With 2005's full implementation of the New Computerised Transit System (NCTS) a much-improved framework is now in place. Fewer queries about the full and timely discharge of movements may be expected and those that do arise are likely to be resolved more speedily. The Commission is currently examining the application of the transit provisions in Member States. The initial findings suggest that accounting delays affecting traditional own resources relate to movements managed under the old rather than the new system and that present trends are encouraging. In addition, a separate review of the enquiry procedure is underway.
Customs controls increasingly happen inland via audit-based examinations of commercial records scheduled on the basis of a risk analysis. The Member State concerned intends to revise its strategy to minimise the risk of time-barring.




GNI own resource










4.23.


In its Annual Report concerning the financial year 2004, the Court noted that there were significant differences between Member States as regards the existence and implementation of certain elements of supervisory and control systems at Statistical Offices with respect to the compilation of national accounts. In 2005 the examination was extended to six more Member States (26) and a number of weaknesses were identified in the following areas:










(a)


the performance of a formal and structured risk analysis in respect of the process of national accounts compilation (27);










(b)


the existence of agreements or equivalent arrangements between national accounts departments and units providing basic statistical data, which set out the conditions for the delivery and the quality of data (28);










(c)


the systematic production of ‘quality reports’ accompanying statistical surveys (29);










(d)


the performance of internal audits on the process of statistical data collection and compilation (30).












4.23.


See reply to 4.25.














4.24.


In 2005 the European Statistics Code of Practice (31) was adopted, providing basic principles for enhancing the quality of statistical products (including national accounts). During 2005 National Statistical Offices had to perform a self-assessment on their compliance with the basic principles of this code. These self-assessments will be complemented and validated by peer reviews taking place in 2006 and 2007 and co-ordinated by the Commission.






 










4.25.


The Court remains of the view that the differences in the existence and implementation of supervisory and control systems could lead to varying degrees of reliability, comparability and exhaustiveness of national accounts.












4.25.


The Commission uses a standardised tool to verify the reliability, comparability and exhaustiveness of all Member States’ GNI data used for own resources, including detailed descriptions of sources and methods (GNI inventories) with annual updates in the form of the quality reports. The Commission considers that this approach is essential for the validation of the reliability, comparability and exhaustiveness of GNI data.




The implementation by Member States of supervisory and control systems in respect of national accounts compilation could further reinforce this assurance. The Commission will therefore actively promote the sharing of good organisational practices among Member States.




Conclusions and recommendations










4.26.


Taking into account the scope of the audit (see paragraph 4.3) and with the exception of the B-account matters noted in paragraphs 4.6 to 4.7, the Court found that in all material respects the systems for customs supervision were satisfactory, the accounts recording traditional own resources were reliable and the underlying transactions were legal and regular.






 










4.27.


As regards traditional own resources, the Court recommends that:












4.27.


 














(a)


in order to improve the effectiveness of mutual assistance and reduce the risk of time-barred claims, OLAF and DG TAXUD should streamline both reporting and monitoring systems and work towards a more integrated approach, for example by means of an inter-DG action plan (paragraph 4.12) and,












(a)


OLAF and DG TAXUD are already cooperating on a more integrated approach to streamlining reporting and monitoring systems, see reply to 4.12.














(b)


in the light of the continued problems with the B accounts, the Commission should consider in due course whether the current Regulation specifies the requirements with sufficient clarity, whether there is scope for providing guidance on best practice, and whether the procedures can be simplified in order to reduce the level of errors (paragraph 4.7).












(b)


In 2004, the Commission obtained Council approval of regulatory amendments to the B account arrangements. There is a transitional period for the changes ending in 2009. The effect of these changes should be evaluated before any further alterations are embarked upon. In the meantime the Commission will continue to inform Member States about the correct use of B accounts and the implications of Court of Justice judgments affecting the accounting treatment of traditional own resources.














4.28.


Taking into account the scope of the audit as set out in paragraph 4.5 the Court found that, on the basis of data supplied by Member States, the VAT and GNI resources in all material respects were correctly calculated, collected and entered in the Community accounts by the Commission.






 










4.29.


In respect of the Commission's controls on the systems underlying the calculation of the VAT own resource, the Court:












4.29.


 














(a)


notes that reservations impact on the correctness of Member States' VAT statements, especially given the high number (111), and recommends that, where possible, the Commission quantify the impact of these reservations in consultation with the Member States (see paragraph 4.14);












(a)


Wherever there is a reservation, the Commission continues its discussion with the Member State until a solution is found, which is then presented to the Advisory Committee on Own Resources. The Commission will examine the possibility of ranking reservations according to their potential financial importance, while at the same time continuing discussions with national authorities in order to achieve the definitive solution.














(b)


recommends that the Commission introduces an instrument for ensuring that reservations are lifted within reasonable timescales (see paragraph 4.15).












(b)


The Commission will examine the possibility and opportuneness of introducing into Council Regulation 1553/89 the practice with regard to reservations and setting out the procedure for their implementation (see reply to paragraph 4.15).














4.30.


The Court's audit work on the GNI own resource has identified weaknesses that could impact on the quality of the data on which establishment of Member States' GNI contributions is based. The Court recommends that the Commission:












4.30.


 














(a)


perform more verification checks on selected national accounts aggregates (see paragraph 4.16);












(a)


The approach outlined in the reply to paragraph 4.16 makes the data adequate for provisional use in the budgetary calculations, taking account of existing reservations for Member States.
The Commission is currently discussing with the Member States in the GNI Committee ways in which more direct verification in the sense indicated by the Court might be carried out, as well as the scope and appropriate timing for these checks.
Resource constraints must be taken into account in these control exercises.














(b)


further encourage Member States to undertake actions allowing reservations to be lifted (see paragraphs 4.18 to 4.19);












(b)


At the GNI Committee meeting on 3 and 4 July 2006 the Commission further encouraged Member States to accelerate work aimed at having their reservations lifted.














(c)


formulate more precise guidelines in respect of the reporting on results of investigations on the quality of GNI and its components (see paragraph 4.17);












(c)


The GNI Committee meeting on 3 and 4 July 2006 addressed the issue of GNI quality investigations at national level. The Commission in particular urged Member States to step up their efforts in reporting the results of their investigations of GNI quality.














(d)


review the implementation in Member States of supervision and controls in respect of the national accounts compilation and to encourage implementation of best practices (see paragraphs 4.24 to 4.25);












(d)


The Commission will actively promote the sharing of good organisational practices among Member States, even though the organisational aspects of national statistical offices fall under the responsibility of Member States.














(e)


present a proposal for FISIM to be included in the GNI used for the calculation of own resources (see paragraphs 4.20 to 4.21).












(e)


The Commission will present a proposal to include allocated FISIM for GNI own resources when it considers that all Member States are able to implement this adjustment in a uniform manner which is expected to occur in 2008 (see reply to paragraph 4.21).








FOLLOW-UP OF PREVIOUS OBSERVATIONS




Traditional own resources: B-account adjustment










4.31.


Entitlements without security, and those which have been challenged and might be subject to change, need not be made available to the Commission until payment is received, provided that they are entered by the Member States in separate accounts (the B accounts). To recognise the uncertainty of recovery, the Commission enters in its balance-sheet a write-down, based since 2004 on estimates provided by the Member States.






 










4.32.


For 2004, because most of the Member States had not provided information about the methods they used to make their estimates, the Court was unable to confirm the amount of the write-down (32). The Court has reviewed the 2005 calculation as a whole, together with the checks made by the Commission, and although some Member States have not yet fully developed procedures to ensure the consistency of their estimations, the Court finds the total adjustment (33) reasonable.






 






(1)  Contains surplus from previous financial year and miscellaneous revenue.

(2)  The traditional own resources are collected by Member States on behalf of the European Union, retaining 25 % to cover collection costs.

(3)  In contrast to traditional own resources, the VAT and GNI own resources are contributions resulting from the application of uniform rates to Member States' harmonised VAT assessment bases or to the Member States' GNI, calculated according to Community rules.

(4)  Belgium, the Czech Republic, Germany, Ireland, Luxembourg, Malta, the Netherlands, and the United Kingdom. In addition, the traditional own resources accounting systems were reviewed in Italy, Poland and Sweden.

(5)  Belgium, the Czech Republic, Germany, Ireland, Italy, Greece, Spain, Finland and the United Kingdom.

(6)  Article 18 of Council Regulation (EC, Euratom) No 1150/2000 of 22 May 2000 implementing Decision 94/728/EC, Euratom on the system of the Communities' own resources (OJ L 130, 31.5.2000, p. 1), as amended by Regulation (EC, Euratom) No 2028/2004 (OJ L 352, 27.11.2004, p. 1).

(7)  Article 6(5) of Regulation (EC, Euratom) No 1150/2000.

(8)  Council Regulation (EC) No 515/97 of 13 March 1997 on mutual assistance between the administrative authorities of the Member States and cooperation between the latter and the Commission to ensure the correct application of the law on customs and agricultural matters (OJ L 82, 22.3.1997, p. 1), as last amended by Regulation (EC) No 807/2003 (OJ L 122, 16.5.2003, p. 36).

(9)  Special Report No 1/2005 (OJ C 202, 18.8.2005).

(10)  Reservations relate to the use of reliable quantitative data and an acceptable methodology in the production of VAT statements by Member States and make it possible for corrections to be made to these statements after the four year time limit set in Community legislation.

(11)  No reservations have been set for the ten new Member States as they submitted their first VAT statements in 2005.

(12)  Document based on a common model by which the National Statistical Offices communicate the GNI figures to Eurostat each year. These figures serve as a basis for the calculation of the GNI own resource.

(13)  With the exception of a mission to Germany.

(14)  See Annual Report concerning the financial year 2004, paragraphs 3.36 to 3.37.

(15)  Reservations in respect of the GNI resource relate to sources and methods used by Member States for the compilation of national accounts aggregates and make it possible to adjust GNI aggregates after the four year time limit set in Community legislation.

(16)  As yet no reservations are in place for any of the ten new Member States as their ESA 95 inventories do not have to be submitted until the end of 2006.

(17)  Austria, Belgium, Denmark, Germany, Greece, France, Ireland, Italy, the Netherlands, Spain and Portugal have submitted revised figures for some of the outstanding reservations to enable the Commission to take a decision.

(18)  See Annual Report concerning the financial year 2004, paragraphs 3.43 to 3.44 and the corresponding Commission replies.

(19)  Commission Regulation (EC) No 1889/2002 of 23 October 2002 on the implementation of Council Regulation (EC) No 448/98 completing and amending Regulation (EC) No 2223/96 with respect to the allocation of financial intermediation services indirectly measured (FISIM) within the ESA (OJ L 286, 24.10.2002, p. 11).

(20)  ‘Changes to National Accounts in 2005’, Eurostat paper dated 14 February 2006.

(21)  Article 2(7) of Council Decision 2000/597/EC, Euratom of 29 September 2000 on the system of the European Communities' own resources (OJ L 253, 7.10.2000, p. 42).

(22)  Belgium, Germany, Spain, France, Italy, Latvia, Hungary, Poland, Slovenia and Sweden.

(23)  The Czech Republic, Germany, Malta and the United Kingdom.

(24)  Goods that have arrived and been included on a summary customs declaration, but which are awaiting the formalities necessary for them to be assigned a definite customs-approved treatment or use (such as release for free circulation).

(25)  The United Kingdom. Under the Community Customs Code additional customs duty cannot normally be charged more than three years after the original customs debt was incurred.

(26)  Austria, Belgium, Finland, the Czech Republic, the Slovak Republic and Sweden.

(27)  This element was not fully implemented in any of the Member States visited.

(28)  This element was fully implemented in Belgium, the Czech Republic, Austria, the Slovak Republic and Sweden.

(29)  Occurred in Austria, the Slovak Republic, Finland and Sweden.

(30)  This element was fully implemented in the Czech Republic and Sweden.

(31)  COM(2005) 217 final, 25.5.2005.

(32)  See Annual Report concerning the financial year 2004, paragraphs 3.21 to 3.22.

(33)  The write-down entered in the balance-sheet is 759,2 million euro.



CHAPTER 5
The common agricultural policy
TABLE OF CONTENTS
Introduction
Specific assessment in the context of the Statement of Assurance
The audit scope
Integrated Administration and Control System (IACS)
Area aid
The Integrated Administration and Control System (IACS) in the New Member States
Animal premiums
Olive oil
Rural development
EU-15
Temporary Rural Development Instrument for new Member States
Export refunds

Ex-post scrutiny of subsidies paid to traders and processors
The Commission's clearance of accounts
Certifying bodies
Conformity clearance
Audit of the Commission's Clearance of Accounts units
Conclusions and recommendations
Follow-up of previous observations
Rural development: support for less-favoured areas
The organisation of the system for the identification and registration of bovine animals in the European Union
Special Reports issued since the last Annual Report






THE COURT'S OBSERVATIONS


THE COMMISSION'S REPLIES




INTRODUCTION










5.1.


This chapter deals with the Court’s audit of heading 1 (Agriculture) of the 2000 to 2006 Financial Perspectives. It comprises expenditure on regulating and supporting agricultural markets and on direct income support for farmers. Expenditure in 2005 on the common agricultural policy (CAP) (1) totalled 48 466 million euro (2004: 43 579 million euro) (for details see 
Graphs 5.1
 and 
5.2
).






 
























5.2.


Under the Treaty, the European Commission has overall responsibility for implementing the EU budget. Virtually all agricultural expenditure is carried out under shared management (EAGGF-Guarantee). This means that payments to final beneficiaries (farmers, private companies, traders, associations or public entities) are made by Paying Agencies approved by the Member States. Less than 1 % of expenditure is managed directly by the Commission.






 










5.3.


The expenditure declared by the Member States is subject to several control systems:










(a)


control of the correctness of the farmer's claims under the Integrated Administration and Control System (IACS) (4);










(b)


sector-specific controls, e.g. for olive oil and rural development;










(c)


physical checks on subsidised exports of agricultural goods (5);










(d)


post-payment scrutiny of commercial documents on the premises of traders and processors of agricultural goods (6);










(e)


the clearance procedure, which covers all of the expenditure declared as far as the completeness and accuracy of the annual accounts are concerned (the financial decision) and, on a multi-annual basis, the legality and regularity of the expenditure (conformity decisions).






 




SPECIFIC ASSESSMENT IN THE CONTEXT OF THE STATEMENT OF ASSURANCE




The audit scope










5.4.


In order to obtain assurance as to the legality and regularity of the transactions underlying the Community's accounts, the Court audited the main supervisory and control systems (see paragraph 5.3) and tested a random sample of payments drawn from the expenditure of 25 paying agencies in EU-15 (which were collectively responsible for 66 % of CAP expenditure) (see 
Table 5.1
) and 20 payments under the Single Area Payments Scheme (SAPS) (7) in the New Member States.






 




Table 5.1 — Paying agencies by expenditure declared in 2005











No


Member State


Paying agency


Amounts declared in million euro (8)



% of total


Qualified certificates


Disjoined accounts (9)





1


France


ONIC


4 535,37


9,36


×


 




2


Italy


AGEA


3 832,32


7,91


×


×




3


United Kingdom


RPA


2 952,11


6,09


 


 




4


Greece


OPEKEPE


2 756,08


5,69


 


 




5


France


OFIVAL


2 401,35


4,95


 


 




6


Spain


Andalucía


1 817,00


3,75


 


 




7


Ireland


DAF


1 805,72


3,72


 


 




8


Denmark


EU-direktoratet


1 223,61


2,52


 


 




9


Poland


ARiMR


1 193,04


2,46


 


 




10


Austria


AMA


1 192,37


2,46


 


 




11


France


ONIOL


967,48


2,00


 


 




12


Spain


Castilla-León


956,40


1,97


 


 




13


Sweden


SJV


954,42


1,97


 


 




14


Finland


MMM


901,48


1,86


 


 




15


Spain


Castilla-La Mancha


882,45


1,82


 


 




16


Germany


Niedersachsen


881,09


1,82


 


 




17


Portugal


INGA


801,25


1,65


 


 




18


Hungary


ARDA


553,72


1,14


 


×




19


Belgium


BIRB


525,63


1,08


 


 




20


Germany


Nordrhein-Westfalen LWK


524,04


1,08


 


 




21


Czech Republic


SAIF


424,82


0,88


 


 




22


Netherlands


Dienst Regelingen


375,61


0,77


 


 




23


Spain


Cataluña


368,39


0,76


 


 




24


Germany


BLE


307,41


0,63


 


 




25


United Kingdom


NAWAD


297,38


0,61


 


 




26


France


ONIFLHOR


276,03


0,57


×


 




27


Belgium


Région Wallonne


256,67


0,53


×


 




28


Lithuania


NMA


235,90


0,49


 


 




29


Slovakia


APA


205,56


0,42


×


 




30


Poland


ARR


166,46


0,34


 


 




31


Netherlands


PT


74,33


0,15


 


 




PAs covered by DAS 2005



Subtotal
 (10)




34 645,52




71,47



 


 




32


Germany


Bayern Landwirtschaft


1 176,61


2,43


×


 




33


France


CNASEA


813,81


1,68


×


 




34


United Kingdom


SERAD


644,32


1,33


 


 




35


Spain


Extremadura


633,95


1,31


 


 




36


Italy


AVEPA


560,02


1,16


 


 




37


Spain


Aragón


535,47


1,10


 


 




38


Germany


Baden-Württemberg


474,29


0,98


×


 




39


Italy


AGREA


444,56


0,92


 


 




40


Italy


Region Lombardie


436,96


0,90


 


 




41


Germany


Mecklenburg-Vorpommern


429,65


0,89


 


 




42


Netherlands


PZ


416,27


0,86


 


 




43


Germany


Brandenburg


412,50


0,85


 


 




44


Germany


Sachsen-Anhalt


404,81


0,84


 


 




45


Spain


FEGA


389,87


0,80


 


 




46


Germany


Schleswig-Holstein


382,16


0,79


 


 




47


Germany


Hamburg-Jonas


374,01


0,77


 


 




48


France


FIRS


355,04


0,73


 


 




49


Germany


Sachsen


345,39


0,71


 


 




50


France


ONILAIT


329,50


0,68


 


 




51


United Kingdom


DARD


323,06


0,67


×


 




52


Netherlands


HPA


291,47


0,60


 


 




53


Germany


Thüringen


291,31


0,60


 


 




54


France


ONIVINS


270,71


0,56


 


 




55


Belgium


ABKL


252,20


0,52


 


 




56


Italy


ENR


248,50


0,51


 


 




57


Germany


Hessen


242,77


0,50


 


 




58


Italy


ARTEA


204,07


0,42


 


 




59


Germany


Rheinland-Pfalz


194,53


0,40


 


 




60


Spain


Valencia


173,04


0,36


 


 




61


Spain


Galicia


151,41


0,31


 


 




62


France


ODEADOM


129,73


0,27


×


 




63


Spain


Navarra


128,59


0,27


 


 




64


Spain


Canarias


121,23


0,25


 


 




65


Spain


Murcia


108,91


0,22


×


 




66


Slovenia


AAMRD


106,65


0,22


 


 




67


Italy


SAISA


99,10


0,20


 


 




68


Latvia


RSS


98,86


0,20


 


 




69


Portugal


IFADAP


91,52


0,19


×


×




70


Spain


Asturias


81,25


0,17


 


 




71


Estonia


PRIA


67,32


0,14


 


 




72


Spain


País Vasco


61,34


0,13


 


 




73


Spain


Madrid


57,94


0,12


 


 




74


Netherlands


PVE


52,83


0,11


 


 




75


Netherlands


DLG


46,07


0,10


 


 




76


Luxembourg


Ministère de l'Agriculture


45,07


0,09


×


×




77


Spain


La Rioja


43,77


0,09


 


 




78


Austria


ZA Salzburg


43,31


0,09


 


 




79


Spain


Cantabria


39,45


0,08


×


 




80


Cyprus


CAPO


38,61


0,08


 


 




81


Spain


Baleares


32,51


0,07


 


 




82


Germany


Bayern Umwelt


26,60


0,05


×


×




83


Italy


ARBEA


25,78


0,05


×


 




84


Germany


Saarland


21,57


0,04


 


 




85


United Kingdom


FC


13,45


0,03


 


 




86


France


OFIMER


8,98


0,02


 


 




87


Italy


FINPIEMONTE


8,72


0,02


 


 




88


Germany


Hamburg


7,41


0,02


 


 




89


Malta


MRAE


7,33


0,02


 


×




90


United Kingdom


CCW


4,58


0,01


 


 




91


Germany


Nordrhein-Westfalen LfEJ


4,35


0,01


 


 




92


Germany


Bremen


2,28


0,00


 


 




93


Spain


FROM


1,91


0,00


×


 




94


Ireland


DCMNR


1,45


0,00


 


 




95


France


SDE


0,22


0,00


 


 




 


 



Subtotal




13 830,96




28,53



 


 





TOTAL




48 476,48




100,00



 


 





Source: Summary report of the Commission on the financial clearance of the EAGGF Guarantee Section accounts for 2005.








Integrated Administration and Control System (IACS)










5.5.


IACS is the key management and control tool for area aid, animal premiums and the new single area payment scheme. It comprises a computerised database of holdings and aid applications, and systems for identifying parcels of agricultural land and identifying and registering animals.






 










5.6.


The Court analysed the inspection statistics of IACS for all Member States and audited its implementation in a number of old Member States as well as in five (11) of the eight new Member States that have opted for SAPS and in the two new Member States (12) that have opted for the traditional direct aid schemes (see 
Annexes 5.2
 and 
5.3
).






 




Area aid










5.7.


The Court analysed the IACS inspection results of Member States for the 2004 area declarations (for payments in 2005) (see 
Table 5.2
). For all Member States together, 40 % of the applications checked contained errors. These errors represent 2,1 % of the area verified by the paying agencies. For EU-15 this latter percentage has increased from 1,8 % in 2003 to 2,2 % in 2004, which thereby exceeded the 2 % materiality threshold (13) set at Commission level. In the new Member States it was lower: 2,0 % in 2004. The errors identified by the paying agencies, through their control of a minimum of 5 % of claims received, are corrected before the payment is made to the farmer. For the 14 Member States that have implemented IACS satisfactorily, their random checks showed an error rate of 1,95 %.












5.7.


The Commission has not set a 2 % materiality level that could be considered as an acceptable error rate for expenditure. The key element for reservations in the Annual Activity Report, to which the Court apparently makes reference, is the presence of significant deficiencies in the management and control systems. The threshold of 2 % (expressed in financial terms applied per ABB activity and not excluding other specific thresholds) is only used in case of significant deficiencies not compensated by financial correction procedures. The Commission considers that the results of random checks provide a reasonable estimate of the likely error in claims paid, as stated by the Court in its 2004 Annual Report.








Table 5.2 — Area Aid, forage areas and other crops — Results of IACS field inspections and remote sensing in 2004, relating to claims paid in 2005

















Member States


Applications submitted


Applications checked


Applications with errors




Number


Area (ha)


Average size (ha)


Number


%


Area (ha)


%


Average size (ha)


Number


%


Area (ha)


%




Belgium


39 821


1 000 289,72


25


3 815


9,6


133 656,40


13,4


35


1 584


41,5


1 273,33


1,0




Denmark


47 391


2 329 078,35


49


2 506


5,3


136 454,12


5,9


54


852


34,0


1 185,91


0,9




Germany


298 771


14 050 886,00


47


17 798


6,0


1 093 602,00


7,8


61


7 873


44,2


6 278,00


0,6




Greece


318 947


3 995 969,16


13


39 169


12,3


1 018 459,45


25,5


26


9 379


23,9


25 872,12


2,5




Spain


420 001


17 456 253,40


42


44 212


10,5


1 895 096,68


10,9


43


18 793


42,5


61 788,13


3,3




France


401 827


23 977 233,71


60


27 365


6,8


1 975 055,48


8,2


72


12 212


44,6


11 231,17


0,6




Ireland


130 508


4 727 823,77


36


8 892


6,8


363 336,38


7,7


41


1 441


16,2


1 468,96


0,4




Italy


599 095


7 219 935,24


12


42 540


7,1


819 002,00


11,3


19


20 212


47,5


51 457,19


6,3




Luxembourg


1 935


121 623,00


63


113


5,8


7 200,00


5,9


64


118


104,4


251,66


3,5




Netherlands


44 996


657 563,25


15


3 154


7,0


50 283,43


7,6


16


1 160


36,8


2 450,47


4,9




Austria


137 677


2 538 918,68


18


8 649


6,3


184 400,41


7,3


21


5 115


59,1


4 169,18


2,3




Portugal


130 854


1 825 638,94


14


7 641


5,8


431 406,95


23,6


56


5 904


77,3


22 391,65


5,2




Finland


67 090


2 086 152,39


31


4 290


6,4


160 238,86


7,7


37


2 088


48,7


1 105,08


0,7




Sweden


59 058


2 763 403,94


47


3 793


6,4


206 888,21


7,5


55


2 429


64,0


6 550,03


3,2




United Kingdom


131 410


14 101 732,67


107


7 091


5,4


907 565,00


6,4


128


4 335


61,1


6 898,37


0,8





Total 2004 EU-15




2 829 381




98 852 502,22




35




221 028




7,8




9 382 645,37




9,5




42




93 495




42,3




204 371,25




2,2





Total 2003 (14)



2 840 153


98 843 983,00


35


230 170


8,1


11 309 077,00


11,4


49


97 729


42,5


199 740,00


1,8




Total 2002


2 894 917


97 955 796,00


34


248 572


8,6


11 656 029,00


11,9


47


94 717


38,1


198 079,00


1,7




Total 2001


2 935 273


98 275 675,00


33


299 716


10,2


11 638 423,00


11,8


39


105 099


35,1


240 786,00


2,1




Czech Republic


18 759


3 529 134,84


188


1 344


7,2


454 565,96


12,9


338


831


61,8


3 765,64


0,8




Estonia


18 954


818 453,31


43


1 068


5,6


259 394,41


31,7


243


548


51,3


1 855,02


0,7




Cyprus


39 025


173 372,00


4


1 992


5,1


33 691,00


19,4


17


1 770


88,9


5 400,00


16,0




Latvia


69 847


1 338 352,28


19


5 220


7,5


366 043,87


27,4


70


2 667


51,1


11 539,71


3,2




Lithuania


238 068


2 550 554,55


11


17 413


7,3


352 572,07


13,8


20


7 418


42,6


6 603,17


1,9




Hungary


208 809


5 002 586,57


24


11 205


5,4


549 871,90


11,0


49


1 763


15,7


9 442,44


1,7




Malta


4 981


5 152,14


1


1 011


20,3


1 940,72


37,7


2


481


47,6


201,36


10,4




Poland


1 400 401


13 689 068,96


10


78 618


5,6


1 235 809,26


9,0


16


23 061


29,3


21 207,68


1,7




Slovenia


77 049


166 113,00


2


5 093


6,6


16 725,25


10,1


3


5 232


102,7


8 944,87


53,5




Slovakia


12 399


1 831 840,09


148


1 704


13,7


528 587,61


28,9


310


1 042


61,2


8 133,01


1,5





Total 2004 EU-10




2 088 292




29 104 627,74




14




124 668




6,0




3 799 202




13,1




30




44 813




35,9




77 092,90




2,0






TOTAL




4 917 673




127 957 129,96




26




345 696




7,0




13 181 847,42




10,3




38




138 308




40,0




281 464,15




2,1






NB 1: Remote sensing involves the use of satellite or aerial photography to check IACS applications.

NB 2: Test performed in year N are relevant to payments made in year N + 1.

Source: IACS statistics submitted by Member States to DG AGRI.














5.8.


For on-site inspections, areas not found in the claims inspected (15) (see 
Graph 5.3
) include both the results of checks on claims selected randomly and those selected on the basis of risk analysis. As in previous years, in certain Member States, risk-based transactions proved to have a lower rate of error than randomly selected transactions, which is contrary to what may be expected. Although the Commission has addressed the problem by adopting Regulation (EC) No 118/2004 (16) the effects will not be seen until 2006.












5.8.


The Commission's audits have shown that certain Member States recorded remote sensing controls as random controls, although the farmers had been selected on a risk basis within the zone. Hence, there is a distorted view of the statistics. As regards the difference in results between the two types of selection, filtering out the bias resulting from this incorrect reporting, the Commission's analysis shows that only in Denmark and to a lesser extent Ireland, the results of the random selection are higher than those of the risk based selection (no account is taken of GR).














5.9.


Like last year, some 40 % of the payments tested by the Court were found to contain overdeclarations of the area claimed for the fields measured. Around one in three payments was affected by relatively small errors of measurement and a small number of cases were affected by larger errors.












5.9.


The Commission has received the cases only recently and therefore is not in the position to comment on the findings.





















5.10.


The Court’s findings in Greece indicate that there has been no significant improvement since last year:












5.10.


 














(a)


the quality of inspections is low and findings are poorly or not at all documented, reporting of results is unreliable and is not always based on genuine inspections;










(b)


in certain local authorities in Greece, the techniques used when measuring parcels lead to a higher technical tolerance than the maximum allowed (5 %). The financial impact of this practice cannot be quantified;












(a) and (b)


In 2005, the Commission continued with its enhanced audit programme and other supervisory measures for Greece. 8 audit missions were carried out on IACS or IACS related measures, among a total of 13 missions. Where deficiencies were found, these are followed up by clearance of accounts procedures.
At the initiative of the Commission, the Greek authorities have set up an action plan targeting the deficiencies, in order to ensure that the main IACS components are enhanced and used effectively. This action plan covers the deficiencies mentioned by the Court. The Commission is continuously monitoring the correct implementation of the plan.














(c)


farmers’ unions control the input of all data into the computer system. None of the data in the system are secure and they can be and are modified by the farmers’ unions at any time before payment. The computer system does not record when and why changes to the original data are made. Many of these changes are irregular but cannot be precisely quantified;












(c)


The Commission has repeatedly criticised the role of the farmer's unions in the claim procedure, and formally required the authorities in June 2004 to implement a new procedure. The Greek authorities have included this in their action plan for implementation in 2006.
The Court's observation is valid only until the end of claim year 2004 (financial year 2005). For claim year 2005, the Greek authorities have introduced an audit trail allowing to track all the changes to the original data.














(d)


overdeclarations of the areas claimed by farmers continued to be detected by the Court.






 










5.11.


The area claimed and for which aid is paid to the farmer may be higher or lower than the area measured by the inspection as long as it lies within a certain technical tolerance. In Slovenia, however, if the area is overclaimed, the 4 % tolerance is incorrectly applied, leading to overpayments.












5.11.


The Commission services already detected this point during their enquiry in March 2005 and informed the Member State by letter in September 2005. This point and other findings are subject to clearance of accounts procedures.








The Integrated Administration and Control System (IACS) in the New Member States










5.12.


A key element of IACS is the Land Parcel Identification System (LPIS) containing a register of all agricultural land. Of the seven new Member States visited by the Court, four have chosen to use production blocks as the reference parcel (17) in the LPIS. The other three have defined the reference parcel as the cadastral parcel.






 










5.13.


The Court’s audit has shown that amongst the Member States audited which apply the Single Area Payment Scheme (SAPS) and have chosen to use production blocks as reference parcels, only in the Czech Republic does the LPIS contain eligibility data for agricultural parcels. In the others the LPIS only contains eligibility data for the reference parcels. These Member States did however not require the application to be supported with particulars and accompanied with documents that enable each agricultural parcel to be located and measured (18) so that the information available to the authorities was not sufficient to ensure that every agricultural parcel can be reliably identified. This failure affected the ability and effectiveness of the checks to detect and prevent errors.












5.13.


In so far as agricultural parcels fall within the reference parcel or block and the total eligible area of the reference parcel is not exceeded, the eligibility of the agricultural parcel is in principle established.




The Commission performed on-the-spot audits in each of the new Member States in the period 2004 to 2005 and, although establishing weaknesses in some Land Parcel Identification System (LPIS), it is reasonably satisfied with the degree of implementation in the first years. However, the functioning of the cross-checks depends on the quality of the data recorded in the system for the identification of agricultural parcels, and so in the framework of their audits the Commission has underlined the need for a reduction in block sizes and outlined ways in which this might be achieved. From the most recent exchanges, it is apparent that significant improvements are underway, thanks to these recommendations.










5.14.


As a consequence, overdeclarations and/or double declarations of agricultural parcels go undetected as long as the reference parcel is not overclaimed. Parcels not claimed or claimed partly only by one farmer can compensate for double or overdeclarations made by another farmer so that the real extent of overdeclarations and/or double declarations inside a reference parcel cannot be correctly established. Therefore, aid reductions and penalties are either not applied or applied at too low a level (19). For example, in Hungary and Slovakia this led to arbitrary reductions and sanctions being imposed in cases of reference parcel overclaims, where it was not possible to attribute the responsibility for the overclaim to any particular farmer. In none of the Member States visited was there an obligation to inspect all claimed parcels within the production block.












5.14.


The risks outlined by the Court are inherent to LPIS based on physical blocks, both in the new and old Member States, and have to be countered by limitations on block size. The use of sketch maps and other graphic material further reduce the risks, but in cases of doubt it is necessary to inspect all parcels within a block, which is recommended practice.




The Commission considers that LPIS based on physical blocks, when properly applied, is the most appropriate tool which facilitates the identification of boundaries on the spot (being generally more easily identified than with cadaster based LPIS).










5.15.


During on-the-spot inspections, overdeclarations and underdeclarations of parcels can be off-set against each other as long as the cadastral area is not exceeded. In Poland, the area measured in excess of the cadastral area of a parcel was used for off-setting area deficits found on other parcels. The financial impact of this error cannot be quantified.












5.15.


This problem has been identified by the Commission and is being followed up.










(a)


The Commission will follow it up during the bilateral meeting with the Member States.










(b)


This will be followed up during the Commission services' enquiry.














5.16.


Further problems were found in:










(a)


Hungary: inspection results were not or not correctly taken into account for the calculation of the SAPS payment (20);










(b)


Poland: national top-up payments (21) are made under more restrictive conditions than SAPS payments. When national criteria were not met, SAPS payments were reduced in the same way as national payments even though SAPS criteria were met. This is not in line with EU legislation. Moreover, the administrative cross-checks allow a tolerance for differences found between the claimed area and the eligible area registered in the LPIS, which is only permitted for parcels controlled on the spot;






 










5.17.


In 5 Member States (22), evaluation of risk factors applied was not carried out or not documented for claim year 2004 and not applied to claim year 2005 (relevant for financial year 2006).












5.17.


As part of the general plan to improve statistics and their use, the Commission services since 2005 have during meetings with the Member States urged the latter to evaluate the risk analysis.














5.18.


Under SAPS if the total aid payable in a Member State exceeded the national financial envelope the aid per hectare had to be reduced by an equivalent proportion. The Member States had to inform the Commission of the rate of reduction by 30 November 2004. The Czech authorities were not able to substantiate the figure for the total area claimed that was used to calculate the reduction of the aid by 1,63 %. Hungary and Lithuania did not communicate the final reduction coefficient by the deadline.












5.18-5.19.


The Commission will follow up the observations of the Court.














5.19.


According to the regulations, SAPS aid is to be paid once, between 16 October 2004 and 30 April 2005. Hungary made two payments. There is no legal basis for this practice.






 










5.20.


From the sample of 20 SAPS transactions randomly selected by the Court, five overpayments were found, with a significant level of error. Four of these were due to overdeclarations by the claimants and the fifth was included in an amendment to the claim after the regulatory deadline.












5.20.


The Commission will examine the findings of the Court of Auditors.








Animal premiums










5.21.


The Commisssion's statistics for animal premiums show the number of animals claimed by farmers which inspectors found not to exist or not to be eligible for subsidy. For the largest scheme, the suckler cow premium (see 
Table 5.3
 and 
Graph 5.4
), Member States inspected 14,9 % of the animals claimed, finding 1,8 % of these to be missing or ineligible. Overall, this percentage for cattle shows small variations from Member State to Member State. However, for Italy, Malta and Slovenia it is very high (for the suckler cow premium in Italy, 11,4 % and in Slovenia, 48,2 %, and for the special beef premium in Malta, 11,8 %, in Italy, 21,8 % and in Slovenia, 56,2 %).












5.21.


While it can be agreed that the Italian statistics show a relatively high percentage of reductions, the percentage of farmers involved has decreased markedly in 2004, suggesting that problems are concentrated on fewer farmers. The issue will be pursued with the Italian authorities with a view to better identifying the reasons for this high percentage.




Checks regarding Malta and Slovenia have already revealed that the statistics are unreliable and the Commission has requested revised statistics.




Table 5.3 — IACS inspections for suckler cow premium — Results of on-the-spot checks in 2004, relating to claims paid in 2005

















Member State


Claims inspected


Inspected claims partially rejected


Inspected claims fully rejected


Animals inspected


Inspected animals rejected




Total number of claims submitted


Number


%


Number


%


Number


%


Total number of animals claimed


Number


%


Number


%




Belgium


14 886


707


4,7


6


0,8


3


0,4


395 197


30 885


7,8


58


0,2




Denmark


8 650


1 047


12,1


5


0,5


3


0,3


109 355


25 066


22,9


18


0,1




Germany


32 899


3 508


10,7


227


6,5


81


2,3


641 781


87 995


13,7


1 125


1,3




Greece


10 849


3 728


34,4


201


5,4


22


0,6


209 825


125 424


59,8


1 179


0,9




Spain


59 800


5 195


8,7


293


5,6


44


0,8


1 758 858


311 213


17,7


4 188


1,3




France


117 249


13 958


11,9


1 024


7,3


217


1,6


4 214 721


548 148


13,0


2 181


0,4




Ireland


61 840


4 698


7,6


421


9,0


19


0,4


1 104 521


132 916


12,0


603


0,5




Italy


55 850


8 443


15,1


212


2,5


288


3,4


763 119


122 665


16,1


13 954


11,4




Luxembourg


491


62


12,6


4


6,5


0


0,0


23 288


4 959


21,3


12


0,2




Netherlands


4 549


648


14,2


16


2,5


30


4,6


73 105


10 015


13,7


141


1,4




Austria


92 616


6 563


7,1


408


6,2


79


1,2


403 022


69 724


17,3


876


1,3




Portugal


24 849


2 792


11,2


91


3,3


41


1,5


364 386


59 322


16,3


345


0,6




Finland


1 666


225


13,5


29


12,9


4


1,8


41 499


6 714


16,2


126


1,9




Sweden


9 809


590


6,0


2


0,3


1


0,2


152 363


10 661


7,0


8


0,1




United Kingdom


43 778


5 457


12,5


410


7,5


33


0,6


1 709 788


235 665


13,8


1 499


0,6





Total EU-15




539 781




57 621




10,7




3 349




5,8




865




1,5




11 964 828




1 781 372




14,9




26 313




1,5





Malta


0


0


0,0


0


0,0


0


0,0


0


0


0,0


0


0,0




Slovenia


27 813


2 832


10,2


825


29,1


45


1,6


98 537


13 556


13,8


6 534


48,2





Total EU-2




27 813




2 832




10,2




825




29,1




45




1,6




98 537




13 556




13,8




6 534




48,2






Total 2004 — EU-17




567 594




60 453




10,7




4 174




6,9




910




1,5




12 063 365




1 794 928




14,9




32 847




1,8






Total 2004 — EU-15




539 781




57 621




10,7




3 349




5,8




865




1,5




11 964 828




1 781 372




14,9




26 313




1,5






Total 2003 — EU-15
 (23)




522 146




66 340




12,7




4 596




6,9




1 683




2,5




11 998 677




2 060 855




17,2




25 052




1,2






Total 2002 — EU-15




539 093




78 087




14,5




6 056




7,8




2 933




3,8




11 934 249




2 230 816




18,7




45 408




2,0






NB 1: A claim is fully rejected when a difference of more than 20 % is found between the number of animals declared and that determined to be eligible, or when the difference is the result of irregularities committed intentionally.

NB 2: Test performed in year N are relevant to payments made in year N + 1.

Source: IACS statistics submitted by Member States to DG AGRI.





















5.22.


For the sheep and goat premiums the number of overclaimed animals decreased from 8,2 % in 2003 to 6,3 %. Italy and Slovenia report significantly higher levels of error for sheep and goat premiums (10 % and 24,1 % respectively) than the other Member States (1,2 %). The Court found problems in Greece, Spain, France, Netherlands and the United Kingdom. The flock registers are poorly maintained. The registers cannot be relied upon to confirm that the retention period requirements have been met or to reconcile the claim with the number of sheep found on inspection.












5.22.


As regards the findings for Italy and Slovenia, reference is made to the response to point 5.20.




Commission audit missions to Greece, Spain, France, the Netherlands and other Member States in 2005 have all identified weaknesses as regards farmers' keeping of flock registers and these findings are being considered in the clearance-of-accounts procedures.










5.23.


In Malta, aid reductions and penalties applicable to bovine and ovine premiums were systematically calculated incorrectly.












5.23.


This will be followed up under clearance procedure after receipt of the details of the Court's finding.














5.24.


In general, the national statistics for animal premiums are still less reliable than the equivalent statistics for area aid applications. The risk of overpayment is higher because of the frequent animal movements and the complex conditions of the animal premium schemes. Overall, the Court’s own testing does not provide evidence which significantly differs from the IACS statistics.






 




Olive oil










5.25.


The Court has examined nine olive oil production aid payments in Spain, Greece and Italy (24) — these Member States have declared some 2 000 million euro. All of the transactions contained either an overpayment and/or one or more formal errors and the two cases in Italy were found to be irregular. The results indicate that there are serious weaknesses in control over the production aid scheme and also more generally with the reliability of the olive cultivation Geographical Information System (GIS). This system of aerial photographs is used to verify the existence of olive tree parcels.












5.25.


Along with checks on mills, the olive GIS is one element in the system of checking production aid for olive oil. It is compulsory only as from the 2003/2004 marketing year. Commission audits conducted in the context of the clearance of accounts procedure since 2003 have established similar shortcomings in the Member States audited by the Court, concerning the updating of the olive GIS, the application of sanctions to the mills and the use of the olive GIS to control the yields or apply the regulatory sanctions to the producers over-declaring the number of olive trees. Member States have been informed and the clearance of Accounts procedure is currently ongoing. Financial corrections will be applied if a risk for the EAGGF is confirmed.














5.26.


The GIS should have been fully operational from the 2003/2004 marketing year. The Commission was initially responsible for certifying the completion of the GIS but changed the Regulation so that Member States had to declare when the system was completed. Despite the fact that they have confirmed completion, the Court has found that in all Member States the failure to update the GIS data (the alphanumerical database, the real number of olive trees, new plantings and the production potential) clearly demonstrates that the GIS can still not be considered fully operational. This has significant implications because the olive cultivation GIS will be merged with IACS and be used as a basis for the calculation of payment entitlements and for the management and control of the new Single Payment Scheme (SPS) (25) (olive growers will be paid on an area basis).












5.26.


The deficiencies in the olive GIS are also known to the Commission, which shares the concerns of the Court about the implementation of the reform. Recommendations have been made to the Member States during the clearance of accounts procedures. When the expenditure for the new schemes is made, the risk to the EAGGF will be evaluated and may give rise to financial corrections.














5.27.


The average yield for the production zone is fixed by the Commission every year. It is difficult for the Commission to verify that the Member States use these averages appropriately to check the eligibility of the production claimed and do not make irregular payments (see for example Italy paragraph 5.25).












5.27.


The compliance with the average yield is not a condition of eligibility for the aid but it is a means to control the reality of the production of olive oil. If production above the average yield is not justified the farmer can be excluded for a part of his aid.




In its audits, the Commission has asked Member States to prove the effectiveness of their controls on yields and has applied financial corrections to Italy based, among other reasons, on the absence of this control. In Spain and Greece the Commission has criticised:






—


the approach based on only one criteria, not supported by any thorough analysis,










—


the apparent lack of effectiveness of this approach because most of the production under control was finally considered eligible.








Rural development




EU-15










5.28.


EAGGF-Guarantee rural development expenditure amounted to 6 311 million euro in 2005 (13 % of CAP spending). This covers spending on agri-environmental schemes, compensatory amounts for farming in less-favoured areas, forestry, investments, and support for young farmers and farmers who are intending to retire.






 










5.29.


Most entitlements to rural development support are dependent on observance of (often complex) commitments entered into by the beneficiaries, such as observance of good farming practices, and are calculated on the basis of the number of hectares used. The Court’s audit found a high incidence of errors because farmers did not meet their commitments or the key eligibility conditions were not checked by the authorities.












5.29.


The Commission will examine in detail the problems identified by the Court when the replies from the Member States have been received.








Temporary Rural Development Instrument for new Member States










5.30.


The new Member States have a specific rural development regime (26), to support the four so-called ‘accompanying measures’ (27), and some specific rural development measures (28) (payments in 2005 amounted to 1 069 million euro).






 










5.31.


The financially most important measure in Poland is Less-Favoured Areas, for which 225,8 million euro was paid in 2005. One of the eligibility conditions for this measure is that farmers must apply usual good farming practices. The Polish rural development programme sets out verifiable standards for this, which are checked on the spot as part of the 5 % controls. These verifications found a high level of non-compliance with the standards; 3 281 farms (9,6 % of the farms checked) had one or more infringements.






 










5.32.


In accordance with Polish laws, in the case of a first infringement, the farmer only receives a warning and is not sanctioned. This was the case for all farmers, thus no recoveries or sanctions were applied. This is not in accordance with EU law: infringements of an eligibility condition of the Council Regulation (29) should lead to reductions in the amounts payable. The total value of payments affected was 0,8 million euro.












5.32.


This problem has already been identified by the Commission, and a clearance of accounts procedure is already underway and may result in financial corrections.








Export refunds










5.33.


Export refunds paid to exporters of EU agricultural products cover the difference between EU internal and world market prices and allow surplus EU production to be disposed of on world markets (30). In 2005 refunds accounted for some 3 billion euro, or 7,5 % of CAP expenditure. Member States are required to physically check 5 % of exports to ensure that they are correctly described and entitled to the export refund claimed. They also have to carry out checks at the point of exit from the EU where this is different from the place at which the goods were presented for physical check (substitution checks). The Commission monitors the quality and number of these checks.






 










5.34.


Given the time needed to finalise clearance procedures, the weaknesses found by the Commission during audits in Member States in 2004 (31) have not yet been the subject of a final decision on whether or not a financial correction should be imposed. In 2005 problems were found relating to prior warning in Belgium.












5.34.


Two enquiries have meanwhile been closed without a financial correction (Poland, Lithuania). For the remaining enquiries, where deficiencies have been identified, clearance of accounts procedures are under way (Ireland, Italy, Netherlands, France, Spain, Germany, United Kingdom) and may result in financial corrections.














5.35.


The Court’s audit of physical and/or substitution checks in 11 Member States from 2004 to 2006 concluded that:












5.35.


 














(a)


the fundamental requirement that exporters should not have tacit prior warning of such checks at the point of loading had not been systematically complied with (Belgium, Denmark, Germany, France, Italy, Netherlands, United Kingdom);












(a)


The Commission services have noted during their on-the-spot enquiries that the timing of physical checks can become too predictable. This is why Member States were reminded at the March 2005 meeting of the Trade Mechanisms Committee that they should vary the time of arrival when carrying out physical checks at exporter's premises and a document on this point (D(2005) 12998) was discussed in the Trade Mechanisms Committee of June 2005. Consideration is being given to ways of making this obligatory.














(b)


there were significant weaknesses in the verification of ingredients used in the manufacture of ‘Non-Annex I’ goods such as biscuits, confectionery, whisky, etc. on which refunds are paid (Belgium, Germany, France (32), Italy (32), United Kingdom (32));












(b)


The Commission services will examine the Court's findings and Member State replies and take appropriate action.














(c)


excessive numbers of physical checks had been carried out on consignments for which the refund claim was less than 200 euro (33). According to the rules, these transactions should be excluded unless they are to prevent fraud and abuse;












(c)


The Commission services verify this aspect as a routine part of their audits on physical checks. While some Member States carry out checks on exports below the minimum size thresholds, the Commission services have found no evidence that they do so to the detriment of the minimum requirement of checks on exports above the thresholds.














(d)


substitution checks are not carried out at the point of exit from the EU on significant numbers of consignments which have been customs-sealed despite not having been physically checked at the point of loading (34). In particular, Denmark (35) and the Netherlands allowed authorised exporters to affix customs seals themselves;












(d)


Article 10(2) of Regulation (EC) No 2090/2002 provides that no substitution check shall be carried out if the customs office of export has sealed the means of transport. However, in the Trade Mechanisms Committee of March 2002, the Commission stressed that an authorised trader's seal cannot replace the customs office's seal.
The Commission services are studying the Court's proposal to exclude from the population for substitution checks only the consignments which were subject to a physical check. The Commission will examine the Court's findings concerning Denmark and the Netherlands and the replies of these Member States and, if necessary, investigate further.














(e)


as the physical presence of customs officials at the point of taking goods under customs control at the customs office of exit from the EU has been replaced by computerised inventory systems in the United Kingdom and certain French ports, the necessary checks that customs seals have not been broken or removed are no longer carried out.












(e)


Article 10(2)(a) of Regulation (EC) No 2090/2002 does not require the 100 % check on the customs seals. The Commission considers that systematic seal checks by customs at the entrance to ports are useful, but can be compensated if the information and assurance available to customs services from other sources is sufficient.














5.36.


The Court concludes that significant improvements are required in these areas before it can derive assurance that the system of physical checks on export refund consignments is operating satisfactorily. Furthermore, the Court is not in a position to confirm that checks have been carried out in the required number in respect of the 2005 EAGGF year and have been verified and potential corrections made, as this information is not made available to the Commission until after 30 April 2006.












5.36.


The Commission takes the view that the system of physical and substitution checks is already operating sufficiently well to contribute to providing reasonable assurance for the underlying transactions. However, in order to further improve the system, the Commission intends to amend the legislation on physical checks in order to make the pattern of checks less predictable and to reduce the risk of substitution.




As regards the other weaknesses identified by the Court, the Commission will examine the Court's findings and the replies from the Member States and, if necessary, take appropriate action.





Ex-post scrutiny of subsidies paid to traders and processors










5.37.


Member States are required (36) to carry out annual programmes of post-payment checks of commercial documentation for a range of CAP subsidies, including export refunds, processing and transformation subsidies, processing of cotton, olive oil and tobacco and some rural development expenditure. Member States must satisfy themselves that transactions have taken place and been executed correctly, and must take steps to recover sums lost as a result of irregularity or negligence.






 










5.38.


The Commission's monitoring includes a supervision and coordination role to ensure that Members States’ risk analysis and control programmes are appropriate. It further includes analysis of the relevant reports and other documents Member States provide and may include visits to Member States in order to check the implementation of the Regulation on the spot. The Court found that during 2005 the Commission:












5.38.


 














(a)


made progress in monitoring and analysing documents submitted but still cannot provide full and comparable information on the transactions checked and the value of irregularities detected and recovered. It has made regulatory changes to improve the reporting of the results of post-payment checks, although the effects of these changes are not yet known;












(a)


The Commission welcomes the Court's acknowledgment of the efforts made in order to improve the reporting by Member States on post-payment checks, as well as of the efforts made to improve monitoring and analysis of documents submitted.
The Commission considers that it already receives sufficient information regarding transactions tested and irregularities detected.
The reporting has been further improved by the introduction of Regulation (EC) No 40/2006, permitting the potential level of irregularities to be estimated for all categories of expenditure.














(b)


had again carried out specific missions to three Member States to examine the implementation of the Regulation. These missions did not cover all risks or a sufficient number of Member State checks to enable the assessment of compliance with the Regulation and the quality of the scrutinies carried out. Three further audits included an assessment of the new Member States’ readiness to apply the Regulation and 19 conformity audits included a review of at least one post-payment check as part of the work carried out. These conformity audits do not yet follow a standard methodology or reporting format for the scrutinies checked, which hampers comparability and a meaningful analysis;












(b)


The Commission considers that the number of post-payment checks reviewed in 2005 was sufficient and in line with the objectives of the audits.
In 2006, the Commission has already carried out 3 specific missions on post-payment checks according to Regulation (EC) No 4045/89 in Italy, Denmark and the Netherlands. Further missions are scheduled for the autumn 2006. The conformity units have continued in 2006 to check the application of Regulation (EC) No 4045/89 as part of their missions covering specific sector related issues.














(c)


has started an exercise to assess the extent of the backlog of planned checks in certain Member States (highlighted in previous Court reports). Initial results have confirmed the failure of four Member States to complete the minimum number of post-payment checks required but as yet no remedial action has been taken;












(c)


The Commission has, in fact, already assessed the extent of the backlog. Remedial action has been initiated through missions to two Member States where the backlog is most serious. The two Member States in question have been requested to develop action plans to resolve the backlog. Such action plans including a clear calculation of the number of outstanding scrutinies versus available resources and including clear deadlines are to be communicated to the Commission and their implementation will be closely followed-up.














(d)


is not able to fully measure the success or otherwise of the Regulation in terms of detecting and recovering irregular payments (37)
 (38).












(d)


The Commission considers that it can measure the success of the Regulation in detecting potentially irregular payments.














5.39.


As a follow-up to its work in 2003 the Court re-visited seven Member States to assess the progress made. Whilst the Court’s follow-up found that improvements had been made in the overall quality of checks examined, weaknesses persisted in the recovery of irregularities detected by the checks, and there was a failure to complete the planned post-payment checks on time. In two Member States there was a persistent failure to complete the minimum number.












5.39.


The Commission welcomes the Court's acknowledgment of the improvements made.




Recovery of irregular payments is not the responsibility of those carrying out post-payment checks but of the paying agencies.
As regards the persistent delays in the execution of controls in two Member States, the Commission has initiated remedial action, as described in the response to point 5.38 (c).










5.40.


According to the Regulation, post-payment checks on 2005 transactions will be carried out in the period July 2006 to July 2007. These checks can cover more than the transactions for the year 2005. The results will be reported to the Commission by 1 January 2008 at the latest. The Commission will then review them and may decide to exclude expenditure. For this reason the Court cannot derive assurance as to the EAGGF transactions for the year 2005.












5.40.


The Commission considers that assurance can be derived from the post-payment checks because the system of controls, as such, is operational. Moreover, Regulation (EC) No 4045/89 provides for an ex-post control system within the comprehensive system for the management and control of agriculture expenditure, as described in detail in the response to point 5.59. It is an additional level of control to the pre-payment checks (which for the majority of measures already provide sufficient assurance).














5.41.


The Court’s findings at the Commission and in the Member States show that, while the system of post-payment checks is improving, the backlog of checks not carried out in certain Member States limits the assurance that can be gained as to the legality and regularity of payments made in previous years in these Member States.












5.41.


Whilst the Commission welcomes the Court's acknowledgment of the improvements made, it considers that assurance can be gained as to the legality and regularity of payments made.




The comprehensive system for the management and control of agricultural expenditure, as described in the response to point 5.59, provides reasonable assurance as to the effective management of the risk of error in the legality and regularity of the underlying transactions in agriculture.
Regulation (EC) No 4045/89 provides for an ex-post control system which is actually an additional level of controls to the pre-payment checks.




The Commission's clearance of accounts










5.42.


One of the elements considered by the Commission to be of major importance for an adequate control of shared management in the agricultural domain is the audit work carried out by the clearance of accounts units, which leads to the financial and conformity clearance decisions taken by the Commission.






 










5.43.


The annual Financial Decision taken by the Commission is based on the work and the certificates of certifying bodies. These certificates include a statement of whether the accounts are true, complete and accurate and whether the paying agencies have the capability to ensure that compliance of payments with Community rules is checked. The Commission's annual clearance decision is limited to the accounts and is dealt with in Chapter 1. The decision to exclude expenditure not in compliance with Community rules is taken at a later stage (see conformity decisions). Until then expenditure has a provisional character (see also paragraphs 1.57 and 1.64 to 1.66 of the present report).












5.43.


Notwithstanding the clearance of accounts process, the Commission considers that the expenditure does not have a provisional character.








Certifying bodies










5.44.


The reports of certifying bodies may bring to light problems in the management and control systems of paying agencies but they cannot be relied upon to provide assurance as to the legality and regularity of payments made to farmers and traders (39), as claims for EU aid are usually not checked on the spot by the certifying body. As indicated in the Court’s opinion on the single audit model, such coverage would represent a stronger and clearer chain of accountability for CAP spending. It would provide increased assurance to the Commission as to the legality and regularity of transactions.












5.44.


The Commission takes the view that there is a comprehensive system for the management and control of agricultural expenditure, as described in detail in the response to point 5.59, already provides reasonable assurance as to the effective management of the risk of error in the legality and regularity of the underlying transactions in agriculture. In order to improve and reinforce the overall system for providing reasonable assurance even further, the Commission is prepared to implement the Court's recommendation that the certifying bodies should do more work to verify and validate inspection's statistics and post-payment checks. To this end, the certifying bodies will be required in the new guideline on reporting to review more in detail the administrative capacity of the paying agency as regards on-the-spot checks. They will have to gain assurance as to whether the system (for on-the-spot checks) in place has operated satisfactorily by reviewing in detail elements like accuracy of control statistics, instructions and manuals, human resources, training and competencies of controllers, agreements with delegated bodies, monitoring and supervision systems in place by the paying agency, application of sanctions etc.














5.45.


With respect to the paying agencies’ internal control systems the Court’s analysis of the reports of 31 paying agencies (40) has shown that most of the major deficiencies found by the certifying bodies related to payment checks and procedures, accounting (including debtors) and delegation of functions (41); four paying agencies were found with four or more major deficiencies relating to different accreditation criteria (42). The Commission places reliance on the work of the certifying bodies by reviewing their reports and certificates but does not evaluate the work of the certifying bodies on the spot on a systematic basis (43).












5.45.


In the new Commission Regulation (EC) No 885/2006, the requirements for monitoring paying agencies have been significantly strengthened by obliging Member States to keep their paying agencies under constant supervision and to establish a system for the exchange of information on possible cases of non-compliance. A procedure has to be put in place to deal with such cases, including the obligation to draw up a plan to remedy any identified deficiencies within a determined time limit. Expenditure effected by paying agencies whose accreditation is maintained by their Member State although they have failed to implement such a remedial plan within the determined time limit will be subject to the conformity clearance procedure provided for in Article 31 of Regulation (EC) No 1290/2005.




Although a systematic review of the work of the certifying bodies was introduced by the end of 2005, the Commission has visited on-the-spot and reviewed the work of certifying bodies since the introduction of the new clearance of accounts procedure in 1996.
The 2006 mission programme, which is based on a detailed risk-analysis, includes 5 missions to certifying bodies. The missions are targeted towards those bodies where certain problems have been identified. In addition, 7 paying agencies are to be visited.




Conformity clearance










5.46.


Conformity decisions have the objective of excluding expenditure from Community financing where the Commission has found it has not been in compliance with Community rules. The procedures in place are not designed to ensure that this objective is achieved at the level of payments made to final beneficiaries (farmers and traders). These decisions are in most cases flat-rate corrections for weaknessess in the control systems rather than an assessment of the impact of the individual irregular payments. Therefore, irregular payments are unlikely to be recovered through the clearance of accounts procedure. In order to obtain reliable information on the legality and regularity of payments to final beneficiaries the Director-General would need:










(a)


either to make arrangements for certifying bodies to extend their work to final beneficiaries, through extending their sample tests to the level of farmers or by doing more work to verify and validate IACS inspections statistics and post-payment checks; or










(b)


to require his/her own staff, on the basis of an appropriate sampling method, to verify the legality and regularity of transactions for the year at the level of final beneficiaries.




In the spirit of the Court’s opinion on the single audit, the Commission should, where possible, take into account the management and control systems already in place, such as IACS.








5.46 and 5.47.


As the Court correctly points out, the objective of the conformity clerance is to exclude expenditure from Community financing which has not been effected in compliance with Community rules, thus shielding the Community budget from expenditure that should not be charged to it. In contrast, it is not a mechanism by which irregular payments to beneficiaries are recovered, which according to the principle of shared management is the sole responsibility of the Member States, as clearly stated in Article 9(1) of Regulation (EC) No 1290/2005.




The Commission considers, that on the basis of this definition, the objective of the conformity clearance is achieved by its current approach, which is to audit Member States' management and control systems and, in case of deficiencies, applying financial corrections which, if the loss for the EAGGF cannot be quantified, can take the form of a flat rate. The effectiveness and efficiency of such an approach has been recognised by the Court itself in point 6.35 of its present report.
Moreover, as the Court itself points out in point 6.35, financial corrections are an important means to improve the Member States' management and control systems and thus to prevent or detect and recover irregular payments to final beneficiaries. The conformity clearance thereby indirectly contributes to the legality and regularity of the transactions at the level of the final beneficiaries.
The level of irregularities is already estimated in certain expenditure areas. For example, for area aids, the error estimated on the basis of around 47 000 random controls carried out by Member States is 1,95 %. This constitutes a very big and representative sample. In line with the single audit approach it would not appear cost-effective that the Commission should select a separate sample to verify the legality and regularity of expenditure. It is more cost-effective that the Commission relies on the work performed by the paying agencies and concentrates its audit work on verifying the systems in place in the Member States to control expenditure.
In order to improve and reinforce the overall system for providing reasonable assurance, the Commission is prepared to implement the Court's recommendation that the certifying bodies should do more work to verify and validate inspection's statistics and post-payment checks (see reply to paragraph 5.44).
Whether the burden of a financial correction is passed on to the national budget or the final beneficiary depends on the reason for the correction.










5.47.


The financial corrections are not means by which irregular payments to beneficiaries are recovered, which is the responsibility of the Member States. The cost of these corrections is borne by the Member States and do not, in most cases, directly affect those who have received the subsidy (farmers and traders).






 










5.48.


The conformity decisions usually relate to several years of expenditure and are taken a few years in arrears. Thus, corrections made in the conformity decisions taken in 2005 relate to CAP payments to final beneficiaries made in years before 2005. The expenditure to be excluded for the year 2005 will only be decided during the coming years. At the end of 2005, clearance was not complete for any year later than 1998.












5.48.


The Commission would like to finish with the past and the most longstanding cases still pending were closely examined when the audit work programme relating to agricultural expenditure for 2006 was drawn up. The situation in June 2006 is that 97 % of the audits carried out in 2001 (which allow financial corrections back to 1999) and 94 % of the audits carried out in 2002 (which allow financial corrections back to 2000) have been closed. The still outstanding financial corrections for the years 1999 and 2000 are estimated at a maximum of, respectively, 41 and 126 million euro. For the audits carried out in 2003 and 2004, the closure rates are, respectively, 83 % and 84 %.




For the financial years 2001 to 2005, the corrections to be decided in future conformity decisions is clearly set out in the Annual Activity Report 2005. This information is also disclosed as a contingent asset in the Commission's accounting system.
However, the multi-annual nature of the conformity clearance process referred to by the Court does not affect the assurance which can be derived from that process for the financial year 2005. Since the Commission's audits cover the Member States' management and control systems, they do not only provide information on the expenditure audited, but indirectly also on future expenditure covered by the systems in question.




Audit of the Commission's Clearance of Accounts units










5.49.


In 2005 the Court carried out an audit of the Commission's Clearance of Accounts units which included the allocation of staff and an assessment of a sample of conformity audits carried out in 2004 and 2005 respectively (44).






 










5.50.


The audit revealed the following main weaknesses:












5.50.


 














(a)


the Commission was unable to evidence that it systematically takes account of its central risk analysis when allocating staff to the various measures it has to audit;












(a)


As regards the conformity audit work (excluding direct expenditure), the current division into three different units broadly reflects the main categories of aid measures under the CAP: traditional market mechanisms, direct income support under the IACS and rural development measures. The allocation of personnel to the different units was done in a way to ensure that for each of the three main areas of aid measures under the CAP a sufficient amount of conformity audit work can be carried out.
The directorate's central risk analysis is in the first instance a tool for the selection of the aid measures to be audited. Moreover, there are many other factors to be considered in the allocation process which are subject to specific risk analysis such as, for example, audits on Regulation (EC) No 4045/89, certification of accounts, Sapard accreditation, administrative and monitoring activities as well as experience and availability of staff. The result has been, over several years, movements of resources between teams and units and the evaluation of the allocation of personnel is an ongoing process.














(b)


for six of the conformity audits examined not all relevant risks and key controls had been covered and this without adequate justification;












(b)


The Commission's audit work in the field of agricultural expenditure, which in 2004 and 2005 included, respectively 177 and 163 on-the-spot missions, is based on available human resources and a risk analysis. On this basis the responsible directorate selects certain risks and key controls to be checked, which are considered most appropriate for the enquiry in question. Such a scope limitation is a perfectly normal and accepted audit practice. In three of the six cases raised by the Court, the scope limitation was explicitly provided for in the Mission Planning Memorandum. In the other three cases the scope limitation was due to circumstances outside the auditors' control.














(c)


for five of the audits examined no use was made of detailed audit programmes or the use was not adequately evidenced.












(c)


The Commission is of the opinion that its audit work is generally well documented and provides sufficient evidence of the audit work carried out and the conclusions to be drawn.
However, the Commission is always committed to further improve the documentation of its audit work. In this context, reference is made to the implementation of the IAC recommendations in 2005 (see next point).














5.51.


These findings limit the conclusions that can be drawn as to the proper functioning of Member States’ control systems and the assurance that can be gained from conformity audits. The Court confirms the conclusions set out in the report, finalised in 2004 (45), of the Commission's Internal Audit Capability for Agriculture. There was no disagreement on these conclusions in the final report transmitted to the Director-General for Agriculture.












5.51.


The Commission remains convinced that the conformity audits are a key element in the overall system for the management and control of agricultural expenditure, as described in detail in the response to point 5.59, and that its audit work is of sufficient quality to contribute to the assurance derived from that system. However, improvement of procedures is an ongoing process and the follow-up report to the IAC final report, to which the Court refers, confirms that significant improvements have been observed in 2005.








Conclusions and recommendations










5.52.


As in previous years, drawing on all available sources of evidence, the Court found that CAP expenditure, viewed as a whole, was still affected by a material level of error which are not detected or prevented by the supervisory and control systems. Different degrees of risk and weaknesses attach to the main categories of CAP expenditure.












5.52.


The Commission takes the view that for the agricultural expenditure managed and controlled by the IACS the situation is satisfactory, the risks identified by the Court being concentrated on the other CAP measures. At the moment, IACS covers some 67 % of EAGGF Guarantee expenditure. The CAP reforms of 2003 and 2004 reduce the overall risk even further by extending the expenditure covered by IACS to around 89 % by 2013.




The Commission, where necessary in collaboration with the Member States concerned, will analyse the errors found by the Court, some of which may lead to a clearance of accounts financial correction.
The systems in place allow the risk of error in the legality and regularity of the underlying transactions to be managed in an effective manner. Where the systems are not applied properly, the Commission makes financial corrections in the context of the clearance of accounts procedures. This is demonstrated by the Court's own findings on the application of IACS.










5.53.


CAP expenditure managed and controlled by IACS amounts to 25 500 million euro in EU-15 and 1 400 million euro in the New Member States. IACS, where properly applied, is an effective control system for limiting the risk of error or irregular expenditure. However, this is not the case in Greece. In the New Member States audited by the Court systems are not yet reliable: in particular the information recorded in LPIS together with the information requested in the aid applications was found insufficient to systematically ensure the correct identification of agricultural parcels. This failure affects the efficiency of administrative controls and of on-the-spot inspections and measurement tolerances are wrongly applied.












5.53.


The Commission shares the Court's opinion that IACS is an effective control system to limit the risk of irregular expenditure.




The Commission continued in 2005 with its enhanced audit programme and other supervisory measures in Greece and, at the initiative of the Commission, the Greek authorities have set up an action plan targetting the deficiencies (see reply to paragraph 5.10.). Some of the Court's observations regarding the new Member States' LPIS are accepted, but the weaknesses are considered to be relatively minor given the overall successful implementation of IACS. Furthermore, the teething problems raised by the Court are being dealt with in the course of the routine audits of agricultural expenditure, under which all new Member States have been subject to on-the-spot audits at least once in the period 2004 to 2005.










5.54.


The IACS inspection results address the legality and regularity of payments to farmers but these are insufficiently verified and validated by an independent body. The work of the certifying bodies cannot be relied upon to provide assurance on claims by farmers and traders because claims for EU aid are not usually checked on the spot.












5.54.


The Commission considers that it has a comprehensive system for the management and control of agricultural expenditure, as described in detail in the response to point 5.59 and which includes, in particular, the IACS, already provides reasonable assurance as to the effective management of the risk of error in the legality and regularity of the underlying transactions in agriculture.




However, in order to improve and reinforce the overall system for providing reasonable assurance even further, the Commission is prepared to implement the Court's recommendation that the certifying bodies should do more work (see reply to paragraph 5.44).










5.55.


Continuing control weaknesses in the olive oil sector, rural development and export refunds mean that related payments run the risk of being illegal/irregular. The Court’s own testing has proved that these risks are real. This is particularly evident in the case of olive oil, where the unreliability of the Geographic Information System calls into question the basis for the future single payment to olive growers.












5.55.


The deficiencies in the olive GIS are also known to the Commission, which shares the concerns of the Court about the implementation of the reform. The Commission has issued recommendations to the Member States during the clearance of accounts procedures. When the expenditure for the new schemes is made, the risk for the EAGGF will be evaluated and may give rise to financial corrections.














5.56.


Although clearance systems and post-payment checks have the objective of excluding expenditure which does not comply with Community rules, at present they fail to do so at the level of payments to final beneficiaries. The level of irregular payments financed by the CAP is not known or estimated by the Commission (46). It is therefore not clear whether the proportion of irregular payments recovered by such systems is satisfactory.












5.56.


The Commission considers the clearance of accounts system to be an effective and efficient tool for excluding expenditure from Community financing which does not comply with Community rules. This has been confirmed by the Court itself in point 6.35 of its present report.




The Commission considers the total financial corrections in respect of a given year, together with the sanctions imposed on final beneficiaries at national level, to give a valuable estimate of the overall level of irregular payments.










5.57.


The Commission's conformity decisions are not complete for any year later than 1998. Since these decisions for 2005 expenditure will be taken in the future, the expenditure is provisional and assurance as to the legality and regularity of the transactions underlying the Community accounts can only be provided once a full clearance procedure is in place and applied.












5.57.


The Commission would like to finish with the past and the most longstanding cases still pending were closely examined when the audit work programme relating to agricultural expenditure for 2006 was drawn up. The situation in June 2006 is that 97 % of the audits carried out in 2001 (which allow financial corrections back to 1999) and 94 % of the audits carried out in 2002 (which allow financial corrections back to 2000) have been closed. The still outstanding financial corrections for the years 1999 and 2000 are estimated at a maximum of, respectively, 41 and 126 million euro. For the audits carried out in 2003 and 2004, the closure rates are, respectively, 83 % and 84 %.




For the financial years 2001 to 2005, the corrections to be decided in future conformity decisions is clearly set out in the Annual Activity Report 2005. This information is also disclosed as a contingent asset in the Commission's accounting system.
Despite the fact that for the financial years 2001 and subsequent financial correction procedures are still under way, the Commission takes the view that it already has sufficient information to have reasonable assurance of the legality and regularity of agricultural expenditure (see reply to paragraph 5.59 for details).
Moreover, the multiannual nature of the conformity clearance process does not affect the assurance which can be derived from that process for the financial year 2005. Since the Commission's audits cover the Member States' management and control systems, they do not only provide information on the expenditure audited, but indirectly also on future expenditure covered by the systems in question.










5.58.


The Commission should continue to support the respective Member State's authorities in order to ensure that IACS is fully implemented in Greece and that the weaknesses found in the new Member States are remedied.






 










5.59.


The Commission should ensure that supervisory and control systems provide assurance as to the legality and regularity of the transactions at the level of the final beneficiary and should seek to ensure that irregular payments are recovered. It should estimate the value of irregular payments:










(a)


either by making arrangements for the certifying bodies to extend their work to final beneficiaries, through extending their sample tests to the level of farmers or by doing more work to verify and validate IACS inspection statistics and post-payment checks;










(b)


or by requiring its own staff, on the basis of an appropriate sampling method, to verify the legality and regularity of transactions for the year at the level of the final beneficiaries.












5.59.


The Commission considers that it has sufficient information to have reasonable assurance of the legality and regularity of agricultural expenditure and to ensure that irregular payments are recovered.




A comprehensive system of management and controls exists and relies on four levels:






(a)


compulsory administrative structure at the level of Member States, centred around the establishment of paying agencies and an authority at high level which is competent for issuing and withdrawing the agency's accreditation. The decision for issuing the accreditation is based on a detailed review by an external audit body;










(b)


detailed systems for controls and dissuasive sanctions to be applied by those paying agencies, with common basis features and special rules tailored to the specificities of each aid regime;










(c)


ex-post controls through certified audit bodies and special departments (checks under Regulation (EC) No 4045/89);










(d)


clearance of accounts through the Commission (both annual financial clearance and multiannual conformity clearance).




These four levels establish a comprehensive system for the management and control of agricultural expenditure and provide the Commission with reasonable assurance as to the effective management of the risk of error in the legality and regularity of the underlying transactions in agriculture.
The level of irregularity can already be estimated for the financially most important measures, especially IACS. The Commission is working on improving the quality of data for other measures.
In order to improve and reinforce the overall system for providing reasonable assurance, the Commission is prepared to implement the Court's recommendation that the certifying bodies should do more work to verify and validate inspection's statistics and post-payment checks (see reply to paragraph 5.44).










5.60.


As indicated last year, the Commission should make post-payment checks a more valuable tool in the identification of irregular CAP payments by addressing the deficiencies in the data requested from Member States, notably by reporting on the value of transactions tested and irregularities detected by budget line.












5.60.


The Commission has already taken action to further improve the reporting on post-payment checks by modifying the legal framework. The improvements relating to the value of transactions tested and irregularities by budget line have been included in the amendments to Regulation (EC) No 4/2004, introduced by Regulation (EC) No 40/2006 which has been published on 10 January 2006.














5.61.


The Commission should investigate why, for IACS checks on areas, tests performed on a random basis continue to show a higher level of error than those selected on the basis of risk analysis.












5.61.


The Commission's audits have shown that certain Member States recorded remote sensing controls with the random controls although they have selected the farmers on a risk basis within the zone. Hence, there is a distorted view of the statistics. As regards the difference in results between the two types of selection, filtering out the bias resulting from this incorrect reporting, the Commission's analysis shows that only in DK the results of the random selection are higher than those of the risk based selection (no account is taken of GR). This is subject of verification.




To enhance a more accurate reporting, the Commission has already taken further action (see paragraph 5.8).










5.62.


The Commission is recommended to improve the checks on CAP spending in those areas where significant shortcomings persist.












5.62.


The Commission is committed to address continuing shortcomings still existing, such as the application of IACS in Greece. The CAP reforms of 2003 and, for Mediterranean products, of 2004 reduce the overall risk by extending the expenditure covered by IACS to 89 % by 2013.














5.63.


As requested by the Council (47), the Commission should distinguish on the one hand between expenditure which has been verified (and has been the subject of corrections, where necessary) for which it can give reasonable (or no) assurance and, on the other hand, expenditure which is subject to further verification (and possible correction at a later stage) (see also paragraphs 1.57 and 1.64 to 1.66 of the present report).












5.63.


The Commission is of the opinion that it would not be appropriate to distinguish, as the Court suggests, between expenditure which has already been verified and expenditure which will be the subject to further verification. Given the multi-annual nature of the conformity clearance process, such a distinction would be largely arbitrary; it would also prejudice the Member States' right of defence in the context of the clearance of accounts procedure.




Moreover, in its annual accounts, the Commission makes the necessary disclosure for the amounts which it still expects to be recovered through the clearance of accounts process.




FOLLOW-UP OF PREVIOUS OBSERVATIONS




Rural development: support for less-favoured areas










5.64.


The Court’s Special Report No 4/2003 concerning rural development dealt with support for less-favoured areas. The main observations and recommendations were taken up in the discharge procedure for the 2002 budget by the European Parliament (48) and focused on:










(a)


the need for the Commission to submit to Parliament a comprehensive evaluation report in respect of this measure;










(b)


the need for the Commission to adapt and update the definition of ‘good farming practices’ and to ensure that the Member States apply this condition consistently;










(c)


the need for the Commission to undertake a comprehensive and thorough review of the current classification of all less-favoured areas.






 










5.65.


In its report on the follow-up to the 2002 discharge procedure (49), the Commission announced that it was preparing a specific evaluation study of this measure and that the results would be available in late 2005. The contract to carry out this evaluation study was signed in December 2005 and the report is planned to be finalised by the end of 2006 and published in early 2007.






 










5.66.


The new Regulation on support for rural development for the period 2007 to 2013 (50) includes the measures for less-favoured areas, and the discharge authority's other two requests were addressed in this framework.






 










5.67.


The condition that farmers in less-favoured areas must apply usual good farming practices in order to receive compensatory allowances will no longer exist as an eligibility criterion. Instead, such farmers will have to comply, on the whole holding, with the mandatory requirements as regards environment and animal welfare which have been known as ‘cross-compliance’ since the 2003 CAP reform.






 










5.68.


The areas eligible for payments under the ‘payments to farmers in areas with handicaps, other than mountain areas’ category will be determined on the basis of soil productivity and climatic conditions, thus breaking the link with socio-economic criteria. The concept of natural handicap payments to farmers in mountain areas (and those areas north of the 62nd parallel) has been retained.












5.68.


Following Council Regulation (EC) No 1698/2005 concerning the next programming period, the areas eligible for ‘payments to farmers in areas with handicaps, other than mountain areas’ must be affected by significant natural handicaps (notably a low soil productivity or poor climate conditions) and specific handicaps, where land management should be continued in order to conserve or improve the environment, maintain the countryside and preserve the tourist potential of the area in order to protect the coastline.














5.69.


However, with the exception of the cross-compliance requirement, the entry into force of all other changes to the less-favoured areas measure has been postponed until 1 January 2010 and will require the adoption of a Council regulation based on a proposal from the Commission. Thus the current criteria for determining the areas to be classified as less-favoured will remain in force at least until 2010.












5.69.


Concerning the definition of less-favoured areas, the Commission proposal COM(2004) 490 final for the future rural development framework contained a proposition for a reclassification of the ‘intermediate category’ of LFAs. However, the proposal faced strong opposition in particular in the Council.




As part of the final compromise on the proposal, adopted as Regulation (EC) No 1698/2005, it was agreed to endeavour further in-depth analysis on the issue before taking a final decision on the reclassification.




The organisation of the system for the identification and registration of bovine animals in the European Union










5.70.


The Court’s Special Report No 6/2004 examined the bovine identification system, which aims to guarantee the traceability of beef and veal animals and is used to check eligibility for the various cattle premiums. The Court found weaknesses in the system introduced by the Community legislation, and in particular found that the traceability of intra-Community cattle movements was not assured since the legislation made no provision for the harmonisation or exchange of information between Member States’ databases.












5.70-5.72.


In 2004 the Commission has set up the TRACES system which is able to trace animal movements within the EU and from the outside. TRACES consolidates and simplifies the existing traceability systems for the trade of animals. It became compulsory for all Member States from 1 January 2005 and complies with most of the requests from the Member States and of the recommendations given by the Court in the Special Report No 1/2000 related to classical swine fever.




Following the conclusions of the Council on the Special Report No 6/2004 of the Court the Commission has developed further guidance in close cooperation with the Member States. On 14 February 2005 the Commission finalised the working document on benchmarking of bovine databases, which has been welcomed by the Member States and which is in use to further develop the national databases.
Furthermore, on 26 January 2005, the Commission has presented its Report to the Parliament and the Council on the possibility of introduction of electronic identification for bovine animals (COM(2005) 9). This report contains different options for legislative proposals, which were discussed at Council level in the Special Committee on Agriculture on 7 March 2005. With the preparation of an appropriate legislative proposal the Commission intends to consider also the exchange of information between national databases.










5.71.


As part of the 2003 discharge procedure, the Council (51) sought greater harmonisation between databases in the Member States. The European Parliament (52) invited the Commission to submit a legislative proposal to ensure compatibility between the national databases, and to provide guidance on exchanges of data.






 










5.72.


The Commission accepted the main findings of the Court’s Special Report No 6/2004. It accepted (53) the proposal to organise exchanges of information and developed a working document for benchmarking the national databases. While keeping the situation under review, the Commission has not proposed further legislation.






 










5.73.


The Court examined the implementation of the Slaughter Premium Scheme in the context of the follow-up of the Court’s Special Report No 6/2004. The slaughter premium scheme is one of the premium schemes relying on the bovine identification system (54). The premium is paid for the slaughter or export from the EU of adult cattle and calves.






 










5.74.


The design of the scheme facilitates adequate control over payments in respect of animals which are slaughtered in the Member State of payment. However checks relating to the minority of animals (1,2 % on average in the regions examined) which are slaughtered in one Member State and for which a premium is paid in another are not as rigorous. The transfer of information between Member States relating to such cases is incomplete and does not ensure that all eligibility criteria for the premium are verified before payment. Germany and the Netherlands paid the premium in some cases where confirmation of slaughter from other Member States had not been received before payment. For the Member States visited, only Ireland and the United Kingdom (for animals slaughtered in Northern Ireland) had arranged to exchange information automatically between the relevant databases.












5.74.


Community legislation lays down the general principles of management of the slaughter premium for animals which have been the subject of intra-Community trade after the retention period (Article 35(3) of Regulation (EC) No 2342/1999). The slaughterhouse of the Member State in which the animal is slaughtered must issue a certificate containing the information to be submitted in support of the application for the premium.




As a general rule, Member States assist one another to ensure effective controls on the authenticity of the documents submitted and the accuracy of the information. The Member State where payment is made must transmit regularly to the Member State where the slaughter takes place a summary of the slaughter certificates received from the latter Member State. The implementation of these principles is the responsibility of the Member States.
The implementation of the reform of direct payments introduced by Council Regulation (EC) No 1782/2003, applicable from 2005, modified the conditions for applying for the premium for animals which have been the subject of intra-Community trade.
The fact that 17 Member States have decided to implement the decoupled single payment scheme without maintaining the slaughter premium has contributed to make the information on the trade of animals for slaughter less important.










5.75.


The Court’s examination of the Slaughter Premium Scheme showed that weaknesses in the bovine identification system identified in the Special Report continue to exist, especially relating to cattle traded between the Member States.












5.75.


Once the situation as regards implementation of the reform has been stabilised, the conditions for applying the slaughter premium in intra-Community trade must be examined from both the standpoint of trade between Member States which apply the ‘coupled’ slaughter premium and that of trade between these Member States and those which have decoupled this premium.








SPECIAL REPORTS ISSUED SINCE THE LAST ANNUAL REPORT










5.76.


The Court has published two special reports relevant to agriculture in the last twelve months:










(a)


Rural Development Investments: Do they effectively address the problems of rural areas? (Special Report No 7/2006);










(b)


Growing Success? The effectiveness of the European Union support for fruit and vegetables producers’ operational programmes (Special Report No 8/2006).




They can be found on the Court’s website (www.eca.europa.eu).


 






(1)  EAGGF-Guarantee only. For EAGGF-Guidance see Chapter 6.

(2)  Others: production, processing or consumption aid paid to producers or organisations of producers or processors and administrative expenditure.

(3)  Intervention: public and private storage, fruits and vegetables withdrawal arrangements, compulsory and voluntary distillation.

(4)  Council Regulations (EEC) No 3508/92 (OJ L 355, 5.12.1992, p. 1) and (EC) No 1782/2003 (OJ L 270, 21.10.2003, p. 1) covering animal premiums and area aid.

(5)  Council Regulation (EEC) No 386/90 (OJ L 42, 16.2.1990, p. 6).

(6)  Council Regulation (EEC) No 4045/89 (OJ L 388, 30.12.1989, p. 18) covering payments above a specified threshold of export refunds, processing and transformation subsidies, cotton, olive oil, tobacco and some RD measures.

(7)  The SAPS replaces all direct aid with a single payment. It involves payment of a uniform amount per hectare of agricultural land. Eight of the ten new Member States (excluding Malta and Slovenia) apply it.

(8)  Conformity corrections declared and amounting to 174,4 million euro (Spain) and 0,21 million euro (Netherlands) are not included because they cannot be allocated to individual paying agencies.

(9)  Accounts disjoined from the Financial Decision.

(10)  The Court examined the reports and certificates of these 31 paying agencies in respect of which a sample of transactions was selected for testing.

Source: Summary report of the Commission on the financial clearance of the EAGGF Guarantee Section accounts for 2005.

(11)  The Czech Republic, Lithuania, Hungary, Poland and Slovakia.

(12)  Malta and Slovenia.

(13)  ‘The materiality criteria used in DG AGRI’ (for reservations and their combined impact on the declaration) ‘are those recommended by the Commission in the Communication COM(2003) 28 of 21 January 2003 on the “Guidelines for assessment of materiality for deficiencies in Member States management and control systems under shared management for the purposes of Annual Activity Report” agreed in 2005 between the structural funds’ Directorates General. In qualitative terms the materiality of a deficiency is judged on […]. In quantitative terms the materiality threshold used is the 2 % level recommended at Commission level’. DG AGRI Annual Activity Report 2005 (March 2006), paragraph 3.1. Materiality criteria used.

(14)  The Commission has readjusted these data in 2004.

NB 1: Remote sensing involves the use of satellite or aerial photography to check IACS applications.

NB 2: Test performed in year N are relevant to payments made in year N + 1.

Source: IACS statistics submitted by Member States to DG AGRI.

(15)  Expressed as a percentage of the areas claimed by the inspected farmer.

(16)  OJ L 17, 24.1.2004, p. 7.

(17)  ‘Agricultural parcel: shall mean a continuous area of land on which a single crop group is cultivated by a single farmer’ (Commission Regulation (EC) No 796/2004 (OJ L 141, 30.4.2004, p. 18), as last amended by Regulation (EC) No 1187/2006 (OJ L 214, 4.8.2006, p. 14), Article 2(1a));
‘Reference parcel: shall mean a geographically delimited area retaining a unique identification as registered in the GIS in the Member State's identification system…’ (Commission Regulation (EC) No 796/2004, Article 2(26));
‘The identification system for agricultural parcels … shall operate at reference parcel level such as cadastral parcel, or production block…’ (Commission Regulation (EC) No 796/2004, Article 6(1)).
A production block has in practice often natural boundaries and may be made up of a number of cadastral parcels.

(18)  As required for claim year 2004 by Article 4 of Commission Regulation (EC) No 2419/2001 (OJ L 327, 12.12.2001, p. 11), as last amended by Regulation (EC) No 118/2004 (OJ L 17, 24.1.2004) and as required by Article 6 of Regulation (EC) No 796/2004 for claim years after 2004.

(19)  In the absence of any information the financial impact of this failure cannot be established.

(20)  In a sample of 30 inspection reports analysed, representing claim payments totalling 23 800 euro, overpayments and underpayments totalling 3 122 euro due to inadequate analysis of inspection reports were found. The differences add up to 13 % of payments.

(21)  Regulation (EC) No 1782/2003, Article 143c.

(22)  The Czech Republic, Hungary, Slovakia, Slovenia and Malta.

(23)  The Commission has readjusted these data in 2004.

NB 1: A claim is fully rejected when a difference of more than 20 % is found between the number of animals declared and that determined to be eligible, or when the difference is the result of irregularities committed intentionally.

NB 2: Test performed in year N are relevant to payments made in year N + 1.

Source: IACS statistics submitted by Member States to DG AGRI.

(24)  One transaction was also audited in Portugal. No significant errors were detected.

(25)  Council Regulation (EC) No 864/2004 (OJ L 161, 30.4.2004, p. 48).

(26)  Commission Regulation (EC) No 27/2004 (OJ L 5, 9.1.2004, p. 36).

(27)  Agri-environment, early retirement, afforestation and compensatory payments for less-favoured areas and areas subject to environmental constraint.

(28)  Semi-subsistence farms undergoing restructuring, producer groups, compliance with Community standards, technical assistance, complements to direct payments.

(29)  Council Regulation (EC) No 1257/1999 (OJ L 160, 26.6.1999, p. 80).

(30)  Regulation (EEC) No 386/90.

(31)  Annual Report concerning the financial year 2004, paragraph 4.12.

(32)  A posteriori verification of recipes under Commission Regulation (EC) No 1520/2000 (OJ L 177, 15.7.2000, p. 1).

(33)  Analysis of data reported to the Commission under Commission Regulation (EC) No 2390/1999 (OJ L 295, 16.11.1999, p. 1) shows that all EUR-15 Member States (with the exception of Greece and Spain, which did not provide the data, and Luxembourg, which had an insignificant number of transactions) had to varying extents carried out checks on such consignments.

(34)  Affixing customs seals to consignments which have not been subject to a physical check does not contravene current legislation.

(35)  Denmark abandoned this procedure from 1 February 2006.

(36)  Regulation (EEC) No 4045/89.

(37)  Regulation (EEC) No 4045/89, in the first ‘whereas’ in the preamble, links the Regulation to the Member States’ duty to ‘deal with irregularities and to recover sums lost as a result of irregularities or negligence’.

(38)  The current system is that only irregularities over 4 000 euro are subsequently reported to OLAF under Council Regulation (EC) No 595/91 (OJ L 67, 14.3.1991, p. 11).

(39)  The critical aspect in checking the legality and regularity of the transactions is the existence and accuracy of the information declared by the beneficiaries, much of which can only be verified by physical inspection at the level of the final beneficiary.

(40)  The reports of the 31 certifying bodies from which transactions were tested (see 
Table 5.1
).

(41)  The Commission has addressed the latter aspect by an enquiry started in 2002. Even though it found widespread weaknesses in the management of delegated bodies by AGEA (Italy) which have persisted, the Commission does not intend to impose a financial correction. Furthermore, no separate Article 8 letter pursuant to Commission Regulation (EC) No 1663/95 (OJ L 158, 8.7.1995, p. 6) has been sent to date in order to follow up the results of the mission to France carried out in 2003.

(42)  AGEA (payment checks and procedures, debtors, computer security, internal audit, delegated bodies), OPEKEPE (payment checks and procedures, debtors, internal audit, delegated bodies), ARDA (payment checks and procedures, accounting, computer security, delegated bodies), ONIFLHOR (written procedures, debtors, computer security, delegated bodies). The paying agencies concerned declared some 7 418 million euro which are to be further analysed by the Commission.

(43)  In 2005 only the certifying body for OPEKEPE was evaluated on the spot. In addition, as part of the Commission's review of accreditation ten missions were carried out to new Member States.

(44)  The selection of the ten conformity audits was made at random, taking into consideration materiality. This procedure resulted in a selection of conformity audits in the field of arable crops (3), animal premiums (2), rural development (2), export refunds (1), olive oil (1) and fruit and vegetables (1).

(45)  ‘The audit put in evidence risks that may affect the capacity of these Teams to perform effectively the assigned activities to provide the Director General, as AOD in the context of shared management, with the satisfactory assurance that management and control systems put in place by the Member States ensure the legality and regularity of underlying transactions.’

(46)  In order to estimate the level of irregularities, an appropriate sampling method should be clearly defined (Opinion of the Court No 2/2004 on the single audit model, paragraph 48) and the legality and regularity of expenditure should be verified at the level of the final beneficiary (Opinion of the Court No 1/2005 on the financing of the CAP, paragraph 24).

(47)  Council document 5971/06 ADD1 — Discharge to be given to the Commission in respect of the implementation of the budget for the financial year 2004.

(48)  European Parliament resolution accompanying the decision concerning discharge in respect of the implementation of the general budget of the European Union for the 2002 financial year (Commission) (SEC(2003) 1104-C5-0564/2003-2003/2210(DEC)).

(49)  COM(2004) 648 of 30 September 2004 and the working document which accompanied it.

(50)  Council Regulation (EC) No 1698/2005 (OJ L 277, 21.10.2005, p. 1).

(51)  Council document 5665/05 ADD 2 of 17 February 2005 — ‘Discharge to be given to the Commission in respect of the implementation of the budget for the financial year 2003 — Council’s conclusions on the Court of Auditors’ special reports — Annex 9’.

(52)  European Parliament resolution containing the comments which are an integral part of the decision on the discharge for implementing the general budget of the European Union for the financial year 2003, Section III — Commission (SEC(2004) 1181 — C6-0012/2005-2004/2040(DEC) — SEC(2004) 1182 — C6-0013/2005-2004/2040(DEC)).

(53)  Commission staff working document SEC(2005) 1193 of 26 September 2005.

(54)  The Court examined its implementation by the Commission and in selected Member States (Germany (North Rhine-Westphalia), Spain (Aragon), France, Ireland, Italy, the Netherlands and the United Kingdom (England)).

ANNEX 5.1
Evolution of key observations — Agriculture









 


2004


2005




Observations


Replies of the Commission


Observations


Recommendations




IACS



Area aid schemes



 


 


 




For some Member States risk based transactions proved to have a lower rate of error than randomly selected transactions (4.37).


This is largely due to some Member States’ reporting of remote sensing controls as ‘random’, when in fact they are also at least partly risk-based.


As in previous years, in certain Member States risk-based transactions proved to have a lower rate of error than randomly selected transactions (5.8).


The Commission should investigate why, for IACS checks on the areas, tests performed on a random basis continue to show a higher level of error than those selected on the basis of risk analysis.





Animal Premium Schemes



 


 


 




Statistics for animal premiums are still less reliable than the equivalent statistics for area aid applications (4.39).


Statistics for (the six) animal premium schemes are more varied than those for arable crops.


In general, the national statistics for animal premiums are still less reliable than the equivalent statistics for area aid applications (5.24).


 




More than seven years after the deadline for full implementation IACS in Greece can still not ensure compliance with legality and regularity for area aid and animal premium payments (4.8).


 


The DAS findings concerning IACS in Greece indicate that there has been no significant improvement since last year (5.10).


The Commission should ensure that IACS is fully implemented in Greece.




Subsidies paid on the basis of quantities produced


Transactions concerning olive oil show a number of deficiencies:


 


 


 










(a)


in Greece some claims could not be verified as the parcels declared were not at the location indicated;










(b)


Greece still did not have a functioning olive oil GIS for the period relevant to payments made in 2004;










(c)


in Greece cases were found of producer organisations failing to make the necessary checks, for example on the disposal of olive oil;












(a)-(c)


The Commission has made similar findings in the framework of the clearance of accounts audits.






The Court has found that in all Member States the failure to update the GIS data (the alphanumerical database, the real number of olive trees, new plantings and the production potential) clearly demonstrates that the GIS can still not be considered fully operational (5.25-5.26).


The Commission is recommended to improve the checks on CAP spending in those areas where significant shortcomings persist.










(d)


in Andalusia, incorrect calculations for the application of sanctions for olive growers who had declared more olive trees than recorded in the GIS (4.44).












(d)


Previous Commission clearance missions in several Autonomous Communities of Spain have also shown that a tolerance is systematically wrongly added when calculating the sanctions in case of over-declaration of trees. These cases are closely followed up by the Commission.








Other expenditure


The Court examined the Commission's monitoring of Regulation (EEC) No 4045/89 checks:


 


 


 










(a)


the existing regulation does not require coordination bodies to present statistics in a format which permits meaningful analysis;












(a)


The Commission considers the reports provided by Member States to provide valuable information, although it accepts that reporting in respect of Regulation (EEC) No 4045/89 could be improved. It will introduce a proposal to amend Commission Regulation (EC) No 4/2004 to this effect.






The Commission still cannot provide full and comparable information on the transactions checked and the value of irregularities detected recovered. It has made regulatory changes to improve the reporting, but the effects are not yet known (5.38).


The Commision should improve the format of the reporting of the results of all supervisory systems.










(b)


in 2003 the Court concluded that only one in three post-payment checks for eleven Member States was wholly satisfactory. The Commission's response in 2004 has been to visit three Member States, the first visits since 2001;












(b)


The Commission considers that due to the complexity of post-payment checks, there might often be a margin for improvement without putting into question the value of the checks carried out.
In 2004, DG AGRI carried out three missions on the application of Regulation (EEC) No 4045/89 to cover the general aspects, i.e. the annual report, risk-analysis and control programme. In 2005, six further missions are ongoing.






As a follow-up to its work in 2003 (examining the Commission's monitoring of 4045/89 checks) the Court re-visited seven Member States to assess the progress made. Whilst the Court's follow — up found that improvements had been made in the overall quality of checks examined, weaknesses persisted in the recovery of irregularities detected by the checks, there was a failure to complete the planned post-payment checks on time and in two Member States a persistent failure to complete the minimum number (5.39).


 










(c)


the delays in completion of Member States' annual programmes of post-payment checks persist. At the end of 2004 almost 40 % of the checks planned had not been completed.
Given that the data does not provide for analysis by amount or by type of expenditure, it is not possible to draw conclusions on the significance and cause of the variation in the reported frequency of irregularity (4.10).
(see also paragraph 4.51).












(c)


The Commission acknowledges that there have been delays in the completion of post-payment checks in certain Member States. However, the number of scrutinies planned by most Member States exceeds significantly the minimum number required. On this basis the shortfall is less than 40 %.






The Commision has started an exercise to assess the extent of the failure to complete the planned checks in certain Member States (highlighted in previous Court reports). Initial results have confirmed the failure of four Member States to complete the minimum number of post-payment checks required but as yet no remedial action has been taken (5.38).


 





Checks on export refunds:



 


 


 




The Commission was unable to provide information on the value of transactions physically checked and the value of irregularities detected. During 2004 the Commission adopted a regulation requiring Member States to report this information with effect from the 2005 report. The Court hopes that this regulation will effectively remedy these deficiencies (4.13 and 4.52-4.53).


Following the Court's recommendation, the Commission responded by adopting Regulation (EC) No 1454/2004, which stipulates that, as from 2005, the value of transactions checked as well as irregularities exceeding the amount of 200 euro have to be communicated by Member States.


The weaknesses found by the Commission during audits in Member States in 2004 have not yet been the subject of a final decision on whether or not a financial correction should be imposed (5.34).


 




Rural development


Most entitlements to rural development support are dependent on respect of commitments entered into by the beneficiaries, such as respect of good farming practices. The Court's Special report on agri-environment measures concludes that the verification of such expenditure poses particular problems and that it can rarely lead to reasonable assurance at a reasonable cost (4.48).


The control of agri-environment measures is, due to its complexity, resource intensive both in technical and financial terms. Therefore, a more exhaustive check of the AEM would lead to disproportionate additional costs and would bring only limited value added as to the minimisation of the risk. See also reply to paragraphs 4.98 and 4.99.


The Court continues to find high incidence of errors because farmers did not meet their commitments or the key eligibility conditions were not checked by the authorities (5.29).


 






ANNEX 5.2
IACS monitoring elements — classic aid schemes

Source: Court of Auditors, review of paying agencies' IACS system (abstract).













Member State


Area Aid


Animal premiums




Administrative procedures and controls to ensure correct payment


Risk analysis and selection procedures for inspections


Inspection methodology and reporting of individual results


Preparation and reliability of statistics on inspections and results


Administrative procedures and controls to ensure correct payment


Risk analysis and selection procedures for inspections


Inspection methodology and reporting of individual results


Preparation and reliability of statistics on inspections and results




Malta


 


4


2


9


6


 


 


9




Slovenia


1/3/7


4/5


2


10


8


5


11


10














 


A


Works well, few or minor improvements required




 


B


Works, but improvements are necessary




 


C


Does not work as intended













1


The information contained in the LPIS together with the information that the Member States request in the aid applications do not systematically assure the correct identification and location of every agricultural parcel claimed within the reference parcel. This affects the quality of administrative and on the spot controls and the application of reductions and penalties (see footnote 3 of Annex 5.3).




2


Inspection results (e.g. permanent features) were not recorded in the Land Parcel Identification System to avoid over-declarations in coming years.




3


The control service was not in a position to fulfil its responsibilities.




4


The evaluation of risk factors applied was not carried out and/or not documented.




5


The analysis of significant discrepancies found during the inspections has not or not sufficiently been carried out and/or in the case of significant irregularities the control rate was not increased in the same year (Article 18(2) of Regulation (EC) No 2419/2001).




6


Special premium and slaughter premium was granted from Community funds for bovine animals that had been slaughtered prior to the accession to the European Union. Aid reductions and penalties applicable to bovine and ovine premiums were systematically calculated incorrectly. For claimed bovines only proportional aid reductions but no penalties were applied and for unclaimed cattle penalties applied were too high. For ovine premiums the administration systematically calculated too small a reduction.




7


If the area claimed exceeds the area measured by more than the measurement tolerance, the area accepted for payment is considered to be the area measured increased by the tolerance margin of 4 %.




8


Special premium and slaughter premium was granted from Community funds for bovine animals that had been slaughtered prior to the accession to the European Union. Because of late publication of the administrative procedures a number of applications were incorrectly completed. There was no electronic data exchange with the slaughterhouses as regards slaughter and special beef premium. Direct aid payments made to natural persons after 1 January 2005 were not made in full but reduced by a 4 % advance on income tax.




9


Minor unexplained differences between the number of inspections and/or inspection results reported to the Commission and the underlying data transmitted to the auditors and/or minor delays in transmitting statistics to the Commission.




10


Significant unexplained differences between the number of inspections and/or inspection results reported to the Commission and the underlying data transmitted to the auditors and/or substantial delays in transmitting statistics to the Commission.




11


The minimum control rate of 10 % of applications received was not achieved for the bovine premium scheme.






ANNEX 5.3
IACS monitoring elements – single area payment scheme (SAPS)

Source: Court of Auditors, review of paying agencies' IACS system (abstract).









Member State


Administrative procedures and controls to ensure correct payment


Risk analysis and selection procedures for inspections


Inspection methodology and reporting of individual results


Preparation and reliability of statistics on inspections and results




Czech Republic


2


4/5


13


14




Hungary


1/2/3/9/7


4


13


15




Lithuania


1/2/3


12


6


14




Poland


1/2/3/8/10/11


5


13


15




Slovakia


1/3


4


13


 














 


A


Works well, few or minor improvements required




 


B


Works, but improvements are necessary




 


C


Does not work as intended













1


The information contained in the LPIS together with the information that the Member States request in the aid applications do not systematically assure the correct identification and location of every agricultural parcel claimed within the reference parcel. This affects the quality of administrative and on the spot controls and the application of reductions and penalties (see footnote 3).




2


On the spot inspectors faced the problem of establishing the borders of the parcel to be measured.




3


Parcels not claimed or claimed partly only by one farmer can compensate for double or overdeclarations made by another farmer so that the real extent of over and/or double declarations inside a reference parcel cannot be correctly established. As a consequence, aid reductions and penalties are either not applied or applied at too low a level.




4


The evaluation of risk factors applied was not carried out and/or not documented.




5


The analysis of significant discrepancies found during the inspections has not or not sufficiently been carried out and/or in the case of significant irregularities the control rate was not increased in the same year (Article 18(2) of Regulation (EC) No 2419/2001).




6


The re-performance measurements carried out by the auditors could not confirm the initial measurement results in 18 % of the parcels measured.




7


Inspection results were not or not correctly taken into account for the calculation of the SAPS payment.




8


The administrative cross-checks allow for the claimed area to exceed the eligible area registered in the LPIS by up to 5 %.




9


The total area found for every crop by remote sensing inside a reference parcel was allocated to the respective farmers proportionally to the area they had declared.




10


Difficulties arose in establishing the boundaries of the parcel claimed and when measurement results exceeded the total cadastral area of the parcel measured, the area measured was considered to be the area established.




11


Reductions imposed due to non-compliance with conditions applicable to national top-up payments were extended to SAPS payments although the conditions applicable to SAPS were met.




12


The random selected inspections generated higher area discrepancies and a higher proportion of overdeclarations than risk-based inspections. This indicates that the underlying risk parameters were not effective.




13


Inspection results (e.g. permanent ineligible features) were not recorded in the Land Parcel Identification System to avoid overdeclarations in coming years.




14


Minor unexplained differences between the number of inspections and/or inspection results reported to the Commission and the underlying data trasmitted to the auditors and/or minor delays in trasmitting statistics.




15


Significant unexplained differences between the number of inspections and/or the inspection results reported to the Commission and the underlying data transmitted to the auditors and/or substantial delays in transmitting statistics to the Commission.








CHAPTER 6
Structural operations: regional policy, employment and social policy, rural development and fisheries
TABLE OF CONTENTS
Introduction
Specific assessment in the context of the Statement of Assurance
Specific characteristics of structural operations
The Court’s audit
Current Structural Funds programmes
Project expenditure affected by errors
Controls by Member States fail to meet key regulatory requirements
Previous Structural Funds programmes
Failure to make corrections and lengthy delays in closing programmes
Project expenditure affected by errors
Controls fail to meet key regulatory requirements
The Cohesion Fund
Financial corrections and reporting of recoveries in the Structural Funds
Limited extent of net financial corrections
Inadequate reporting of recovery action by Member States
Conclusions and recommendations
Conclusions
Recommendations
Follow-up of previous observations
Special Reports issued since the last Annual Report






THE COURT'S OBSERVATIONS


THE COMMISSION'S REPLIES




INTRODUCTION










6.1.


Structural operations cover four areas of European Union (EU) policy with interlinked objectives: regional policy, employment and social policy, rural development and fisheries.






 










6.2.


The measures are financed by the four Structural Funds: the European Regional Development Fund (ERDF), the European Social Fund (ESF), the European Agricultural Guidance and Guarantee Fund, Guidance section (EAGGF-Guidance) and the Financial Instrument for Fisheries Guidance (FIFG); and by the Cohesion Fund.






 










6.3.


The Structural Funds co-finance socio-economic development programmes. Structural Funds also co-finance Community Initiatives. They are Interreg, URBAN, Leader and EQUAL. The Cohesion Fund co-finances projects to improve the environment and develop transport infrastructure in Member States whose per capita gross national income is less than 90 % of the Union average.






 










6.4.


For the Structural Funds, which account for 92 % of structural operations expenditure, the funding is allocated across the EU mainly on the basis of three objectives:










—


Objective 1: promoting the development and structural adjustment of regions whose development is lagging behind;










—


Objective 2: supporting the economic and social conversion of areas facing structural difficulties;










—


Objective 3: supporting the adaptation and modernisation of policies and systems of education, training and employment.






 










6.5.


Total expenditure in 2005 amounted to 32 763 million euro (
Figures 6.1a and b
). Funding is provided in the framework of multiannual periods corresponding to the Financial Perspectives. The current funding period runs from 2000 to 2006; the previous funding period ran from 1994 to 1999. For the current funding period there are 545 Structural Funds programmes and 1 200 Cohesion Fund projects. For the previous funding period the Commission approved 1 104 Structural Funds programmes and 920 Cohesion Fund projects. Structural Funds programmes vary in size from under 500 000 euro to over 8 billion euro. Project expenditure within these programmes can vary significantly from a few hundred euro of aid to an individual beneficiary up to several hundred million euro for a major infrastructure project. Projects under the Cohesion Fund range from 50 000 euro to just over 1 billion euro.






 


















SPECIFIC ASSESSMENT IN THE CONTEXT OF THE STATEMENT OF ASSURANCE




Specific characteristics of structural operations










6.6.


Community financing of a structural operations programme or project takes the form of an advance payment followed by the reimbursement to the Member State of costs reported by the project promoter (1). The eligibility conditions for the reimbursement of project costs are defined by detailed regulations.






 










6.7.


Member States are required to check whether project costs are correctly reported and meet eligibility conditions. The Commission supervises whether Member States' arrangements for verifying expenditure comply with the requirements of Community law. This is called shared management. The accountability chain flows from the final recipients through national government bodies and other subsidiary entities in a Member State to the Commission via its Directorates-General. Thus, the Commission remains ultimately responsible for the regularity of structural operations expenditure.






 










6.8.


In summary, there is a large number of programmes and projects which are implemented over several years, a large number of eligibility conditions which are sometimes open to divergent interpretations, and a variety of entities which intervene in the management process. These factors increase the inherent risk that declared project costs are misstated or ineligible for reimbursement. Mitigation of that risk requires strong controls in the Member States as well as effective supervision by the Commission.












6.8.


The Commission rules set out common provisions on eligibility in certain important areas, and the Commission provides guidance on eligibility issues.




The inherent risks referred to are addressed in the Structural Funds regulations through the requirements on Member States to set up and apply effective systems for management and control, and through the exercice by the Commission of its powers to verify their functioning and where necessary to suspend payments and make financial corrections. The Commission's Action Plan towards an integrated internal control framework (COM(2006) 9) includes further measures to strengthen shared management.




The Court's audit










6.9.


The Court audited 16 Structural Funds programmes: six programmes from the previous funding period and 10 programmes from the current funding period. In the programmes from the previous funding period the Court audited 65 projects. In the programmes from the current funding period the Court audited 95 projects.






 










6.10.


The Court audited the closure by the Commission of a further sample of 30 Structural Funds programmes from the previous funding period.






 










6.11.


Furthermore, the Court audited nine completed Cohesion Fund projects (seven from the previous funding period and two from the current period): eight at the Commission and one both at the Commission and in the Member State.






 










6.12.


The Court also examined the application of the procedures for reporting recoveries and making financial corrections for Structural Funds programmes and Cohesion Fund projects for the current funding period.






 




Current Structural Funds programmes




Project expenditure affected by errors










6.13.


The Court found material errors in declared project expenditure across all audited programmes from the current funding period. Of the 95 projects audited, 60 were affected by material errors.












6.13.


The Commission will follow up the Court’s findings and ensure required corrections are applied.














6.14.


The most frequently occuring errors were:










—


lack of supporting evidence for items of expenditure declared (found in 35 projects);










—


non-respect of rules on public procurement or on State aid (16 projects);










—


declaration of advances or expenditure not actually paid out (21 projects);










—


unclear allocation of overheads between co-financed and non co-financed projects (13 projects);










—


declaration of costs unrelated to the EU co-financed action (13 projects);










—


declaration based on flat-rate amounts instead of real costs (10 projects).






 










6.15.


The Court found certain types of error appearing systematically in the projects for certain programmes. Examples are:












6.15.


 














—


ERDF Objective 1 United Kingdom (South Yorkshire): declaration of EU grant exceeding the co-financing rate without proper justification;












—


The Commission audited the South Yorkshire programme before the Court and also detected such errors. The audit is being followed up and appropriate financial consequences will be drawn.














—


ESF EQUAL Community Initiative Spain: inadequate supporting evidence for the expenditure declared because the training organisations in receipt of funding failed to clearly identify the ESF activity in their accounting systems;












—


The Commission is aware of this systemic Spanish problem and in 2004 took steps vis-à-vis the Spanish management and payment authority, as regards all programmes, to strengthen the audit trail and clearly establish the link between cofinanced operations and accounting systems. In that connection, a financial correction of EUR 173 million was decided on by the Member State on the basis of Article 39(1) of Regulation 1260/1999, after the launch of a procedure by the Commission and the setting up of a correction monitoring group composed of representatives of the Commission and the Member State.














—


FIFG France: the verification and checking activities carried out by the Direction Départementale des Affaires Maritimes prior to the payment of an invoice were not based on adequate supporting documentation.






 




Controls by Member States fail to meet key regulatory requirements










6.16.


The Court assessed whether Member States check expenditure as required by Community regulations. 
Table 6.1
 summarises the Court's assessment. It indicates that control failures were found in all of the audited programmes.






 










6.17.


According to the regulations the Member State should ensure that records are kept which enable the expenditure declarations made to the Commission to be reconciled to the accounting records and supporting documents of individual projects. This is known as the audit trail requirement. 
Table 6.1
 shows that there was a sufficient audit trail in only three out of 10 programmes examined. In the other programmes there was little or no supporting evidence for parts of the declared expenditure. The failure to collect or retain supporting documentation makes it difficult to check whether the declared expenditure is regular or not.












6.17.


In 3 out of the 7 remaining programmes, the Court found that the systems partly complied with the requirements.








Table 6.1 — Compliance of controls with key regulatory requirements














Audited Programmes


Regulatory requirements




Segregation of duties


Audit trail


Day-to-day management checks


Recovery procedures


Interim certification


Independent sample checks


Progress in independent sample checks


Set-up of winding-up body


Preparations for final validation




ERDF Interreg IIIA France-Belgium


 


 


 


 


 


 


 


 


 




ERDF Objective 1 UK (S. Yorkshire)


 


 


 


 


 


 


 


 


 




ERDF Objective 2 Italy (Lazio)


 


 


 


N/A


 


 


 


 


 




ERDF Objective 2 Germany (Nordrhein-Westfalen)


 


 


 


 


 


 


 


 


 




ERDF Objective 1 Greece (Competitiveness)


 


 


 


 


 


 


 


 


 




ESF EQUAL Community Initiative Italy


 


 


 


 


 


 


 


 


 




ESF Objective 1 Germany (SPALAR)


 


 


 


 


 


 


 


 


 




ESF Objective 3 UK (England)


 


 


 


 


 


 


 


 


 




ESF EQUAL Community Initiative Spain


 


 


 


 


 


 


 


 


 




FIFG Outside Objective 1 France


 


 


 


 


 


 


 


N/A


N/A








Legend






 


Control has complied with regulatory requirement




 


Control has partly complied with regulatory requirement




 


Control has not complied with regulatory requirement




N/A = Not assessed.














6.18.


In addition to the audit trail, a variety of checks are required. These include day-to-day management checks. The Member State should have in place a management system to check that projects are being implemented in line with EU regulations. Day-to-day management checks are the most effective mechanism for identifying or addressing any potential problems before a declaration of expenditure is made to the Commission. 
Table 6.1
 shows that day-to-day management checks were not carried out as required in any of the programmes audited. In some cases not enough checks were carried out. Where these checks had been done, they did not always cover aspects of the eligibility of the expenditure in sufficient depth. In certain cases they were restricted to desk checks, which do not make it possible to check whether the expenditure claimed took place and was eligible for support from the Community budget.












6.18.


In four out of the 10 programmes concerned, the Court found that the systems partly complied with the requirements. The Commission agrees with the Court on the key importance of these checks and has recently issued to Member States a note setting out good practice based on the results of its own audits.














6.19.


The relevant paying authority must certify that the expenditure declared to the Commission (a compilation of expenditure declarations from projects) complies with all the requisite conditions. However, 
Table 6.1
 shows that in seven cases this interim certification of expenditure was not carried out as required. These failures indicate that expenditure has been submitted for reimbursement without the managing or paying authorities carrying out their required checks effectively.












6.19.


In two out of the seven programmes concerned, the Court found that the systems partly complied with the requirements. The Commission recently issued a note to Member States setting out good practice in relation to the certification function based on the findings of Commission audits in Member States.














6.20.


Furthermore, an independent body within the Member State should carry out additional checks to verify the effectiveness of the systems set up and to validate the accuracy of a sample of the expenditure declarations that have passed through the day-to-day management and payment checks. In short, regulations require independent sample checks. 
Table 6.1
 shows that in four programmes examined progress in the independent sample checkswas not as required.












6.20.


In one out of the four programmes concerned, the Court found that the systems partly complied with the requirements. The Commission issued a guidance note in 2003 on the execution of the independent sample checks to promote satisfactory and consistent standards for this work. The Commisssion systematically reviews progress in the sample checks with Member States during the annual bilateral meetings in order to identify delays.














6.21.


Finally, at the closure of each programme the Member State is required to provide the Commission with a final validation statement as to the legality and regularity of the expenditure. It must be issued by a body independent of the designated managing authority, the person or department within the paying authority responsible for drawing up interim and final declarations and the intermediate bodies. 
Table 6.1
 shows that in six programmes audited the preparation for validation of the final payment is satisfactory.






 




Previous Structural Funds programmes




Failure to make corrections and lengthy delays in closing programmes










6.22.


In 2005, the Commission continued to make closing payments to Structural Funds programmes from the previous funding period. As in the case of current programmes, at the closure of a 1994 to 1999 programme, the Member States certify the legality and regularity of all the expenditure declared throughout the course of the programme. The Commission checks the reliability of these certificates in three ways. It performs pre-closure audits of selected programmes in the Member States. It makes desk checks of the closure documentation submitted by the Member States for all programmes. Finally, it performs ex-post audits of selected programmes which have been closed or are in the process of closure.






 










6.23.




Table 6.2
 shows that a significant number of programmes remained open at the end of March 2006.












6.23.


Programmes are counted as closed in the table only when both the final payment and the commitment, if any, have been made. The total of unpaid commitments on 1994-1999 programmes was down to EUR 1,4 billion (0,89 % of the decided Community contribution) at the end of 2005, which is an indicator of the amount of payments and decommitments effected.




The programmes that remain open are mainly ones where the Member State contests financial corrections and for which formal decisions must still be taken, and programmes in which some projects are the subject of legal proceedings in the Member State which prevent the payment or decommitment of the balance.










6.24.


In its audit of the closure process, the Court found three cases where the Commission closed programmes without making any financial correction despite there being significant reservations on the certified expenditure.












6.24.


The Commission will follow up the findings of the Court and where appropriate make the required corrections.














6.25.


The Court also identified several cases where programmes were closed late because the closure process on the part of the Commission was very lengthy. Although complex issues may arise, this does not fully explain the delays (sometimes exceeding a year) by the Commission in addressing correspondence to the Member States.












6.25.


There have been delays which were longer than desirable in some cases, which required in certain instances consultation on legal or financial issues.








Table 6.2 — Structural Funds programmes 1994 to 1999 closed at 31 December 2005 and 31 March 2006













Budgetary area (2)



Total


Closed before 2005


Closed at 31 December 2005


Closed at 31 March 2006




Number of programmes (3)



Decided Community contribution (euro)


Number of programmes


Total Community contribution paid (euro)


Number of programmes


Total Community contribution paid (euro)


Number of programmes


Total Community contribution paid (euro)




European Regional Development Fund




Objective 1


181


57 571 255 951


94


37 550 653 114


112


42 887 087 630


112


42 887 087 630




Objective 2 1994 to 1996


84


5 165 903 927


79


4 194 775 934


82


4 581 143 406


82


4 581 143 406




Objective 2 1997 to 1999


73


7 157 716 211


48


3 132 569 307


62


4 760 119 585


64


4 803 858 386




Objective 5b


84


3 302 548 791


62


2 458 401 459


80


3 099 127 079


80


3 099 127 079




Objective 6


2


355 453 472


2


333 854 319


2


333 854 319


2


333 854 319




Community Initiatives


520


9 223 064 769


326


3 916 629 881


425


5 660 960 735


431


6 189 811 196





Total




944




82 775 943 121




611




51 586 884 014




763




61 322 292 754




771




61 894 882 016





European Social Fund




Objective 1


102


22 806 888 948


59


9 800 246 487


76


16 659 397 467


89


18 121 641 456




Objective 2 1994 to 1996


82


1 597 251 132


79


1 341 684 839


79


1 358 409 253


81


1 362 443 873




Objective 2 1997 to 1999


72


2 112 708 834


43


732 343 850


55


1 180 807 704


62


1 481 524 409




Objective 3


56


13 221 222 835


30


6 568 750 561


37


7 498 226 022


44


8 564 234 926




Objective 4


16


2 614 128 525


11


1 324 982 251


12


1 691 290 757


12


1 691 290 757




Objective 5b


83


1 057 483 760


54


489 410 848


67


632 292 214


77


719 766 953




Objective 6


2


177 902 801


2


161 300 249


2


161 300 249


2


161 300 249




Community Initiatives


373


4 664 895 421


244


1 497 206 934


303


1 887 130 714


334


2 000 499 278





Total




786




48 252 482 256




522




21 915 926 019




631




31 068 854 380




701




34 102 701 900





European Agricultural Guidance and Guarantee Fund — Guidance Section




Objective 1


69


14 301 716 000


34


4 721 652 121


45


8 217 740 619


46


8 220 980 619




Objective 5a


66


5 544 906 000


43


1 728 707 188


52


3 641 981 610


53


3 661 092 924




Objective 5b


84


3 163 701 000


46


1 772 582 355


68


2 529 075 438


70


2 574 734 130




Objective 6


2


288 794 000


1


211 137 456


2


280 353 550


2


280 353 550




Community Initiatives


167


1 156 618 000


106


534 783 853


143


814 595 982


144


814 903 270





Total




388




24 455 735 000




230




8 968 862 973




310




15 483 747 199




315




15 552 064 493





Financial Instrument for Fisheries Guidance




Objective 1


18


1 797 039 031



2



127 659 610


8


288 574 118


8


288 574 118




Objective 5a


12


850 431 000


2


23 715 837


5


116 682 777


6


154 373 993




Objective 6


2


8 260 000


1


3 523 447


2


6 761 577


2


6 761 577




Community Initiatives


20


127 103 242



6



14 058 058


12


22 225 543


12


22 225 543





Total




52




2 782 833 273




11




168 956 952




27




434 244 015




28




471 935 231






TOTAL




2 170




158 266 993 650




1 374




82 640 629 958




1 731




108 309 138 348




1 815




112 021 583 640






Source: Table prepared by the Court of Auditors on the basis of data provided by the Commission.








Project expenditure affected by errors










6.26.


The Court found a material level of errors in the project expenditure declarations across all its sample of programmes for the 1994 to 1999 period (4). Of the 65 projects examined, 33 were affected by material error. The most frequently occuring errors were similar to those found in the sample of current programmes (paragraph 6.14).












6.26.


The Commission will follow up the Court’s findings and ensure required corrections are applied.














6.27.


For three programmes in the audit sample (ERDF Objective 1 Ireland (Industrial Development), ESF Objective 1 Germany (Sachsen) and ESF Objective 3 Sweden) some of the beneficiaries selected for audit had not retained the supporting evidence for their declared expenditure (5).












6.27.


In relation to footnote 3, for the future programme period, the document retention period is only to be reduced for operations included in a partial closure. Under this arrangement Member States will present a specific statement of expenditure and closure declaration for projects completed at the end of a given year and for the operations concerned the three-year document retention period will begin from the beginning of the year after partial closure. This option responds to the request of Member States to simplify the administrative work at closure and reduce the burden on beneficiaries.














6.28.


Similarly to the 2000 to 2006 programmes, certain errors also occurred systematically in the projects audited for certain individual 1994 to 1999 programmes. Examples are:










—


ERDF Objective 1 Ireland (Industrial Development): unclear allocation of overheads between co-financed and non co-financed projects;










—


ESF Objective 3 Sweden: declaration of costs for services provided by companies related to the project promoters, but with no underlying justification of the amounts charged;










—


EAGGF-Guidance Denmark: failure to inform the farmers that the aid was co-financed by the EU and therefore subject to specific eligibility rules.






 




Controls fail to meet key regulatory requirements










6.29.


The Court's examination of the control systems in the Member States for its sample of six closed programmes gave rise to observations similar to those it has made in recent years. These include failures to ensure an adequate audit trail, shortcomings in the checks of operations and weaknesses in the controls carried out by the independent audit body. These deficiencies in control impaired the reliability of the final expenditure declarations made by the Member States.












6.29.


The Commission was aware of systems weaknesses from its own pre-closure audits in the Member States. That is why in order to mitigate the risk the Commission has carried out a rigorous examination of the closure documents, applied financial corrections in the closure process and furthermore carried out closure audits of a sample of programmes. The Commission is following up these audits with financial corrections of the irregular expenditure. Corrections will be extrapolated when the level of errors is material or where there are systemic problems.








The Cohesion Fund










6.30.


The Court conducted a limited examination of nine Cohesion Fund projects which led to no material observations. However, the Court also noted that the annual declaration of the Director-General of Regional Policy for 2005 includes a reservation on the supervisory and control systems for the Cohesion Fund in Spain (the principal beneficiary of the Cohesion Fund).






 




Financial corrections and reporting of recoveries in the Structural Funds










6.31.


According to Structural Funds rules, the Member States bear primary responsibility for making financial corrections, i.e. withdrawing Community assistance from beneficiaries, in the case of detected individual or systemic irregularities. When Member States make such corrections, they may substitute the irregular amounts with other eligible expenditure in order to avoid a net loss.












6.31.


The right of Member States to recycle for other projects the Structural Fund contributions which they cancel because of irregularities is provided in Article 39(1) of Regulation 1260/1999. It is in accordance with the objective of enabling Member States to derive the maximum benefit from the Structural Funds.




Member States take the risk of recovery of expenditure already paid to beneficiaries in such cases and may therefore suffer financial loss. Where there is no further expenditure that can be substituted, notably after the deadline for execution of the programme, the correction will give rise to a net loss of Community funds.










6.32.


If the Member States fail to act, the Commission may impose financial corrections. In such cases, corrected expenditure may not be substituted by other eligible expenditure, leading to a net reduction in the Structural Funds contribution (net financial correction).






 




Limited extent of net financial corrections










6.33.


A total of 1,4 billion euro of financial corrections were applied to Structural Funds and Cohesion Fund 2000 to 2006 programmes and projects up to the end of 2005. These corrections arose almost exclusively as a result of the audits performed by the Structural Funds Directorates-General in the Member States. However, financial corrections have only been applied since 2004. Making such corrections can be a lengthy process and can take up to two years.












6.33.


Having regard to the rights of the Member State as auditee to reply to audit findings and the procedure for financial corrections laid down in the applicable regulations, a time lag between audit findings and financial corrections is unavoidable.














6.34.


Although most irregularities were identified by its own audits, the Commission, in line with the regulations, requested Member States to take the necessary corrective action. Therefore, the Member States were also able to replace these amounts with other eligible expenditure.












6.34.


As noted in the reply to point 6.31, Member States may not always be able to replace irregular amounts. At closure financial corrections generally do involve a net reduction in EU financing.














6.35.


The limited extent of net financial corrections (0,5 billion euro) does not encourage Member States to take action to prevent irregularities or to improve their management and control systems.












6.35.


The audit work of the Commission achieves its impact without necessarily leading tonet financial corrections, which, in view of the provisions of Article 39(1) of Council Regulation 1260/1999, can only be applied where the Member State does not take action.








Inadequate reporting of recovery action by Member States










6.36.


Member States are required to submit regular reports to the Commission on cancellation of Community contribution and adjustments to the management and control systems and on amounts recoverable. The Court found that the Member States have not systematically supplied this information to the Commission. This has deprived the Commission of an important indicator on the functioning of the management and control systems.












6.36.


The Commission is taking steps to remind Member States of their obligations and will monitor compliance.




However, the Commission obtains certain information on the treatment of irregularities by Member States and related financial corrections and recoveries from several sources: the irregularities reporting system, annual control reports, annual coordination meetings, and its own audit work. The Commission uses this information in its risk assessment and audit planning.










6.37.


In addition to the regular reportsmentioned above, each declaration of expenditure submitted by the Member States to the Commission for reimbursement should contain details on recoveries made since the previous declaration. Although Member States have also not systematically provided this information, the Commission has not refused to make payments. It is only in 2005 that the Commission issued guidance to the Member States on the nature of the information required.












6.37.


A guidance note had already been presented to the Member States in December 2003. However, experience showed that it had not answered all the questions — hence the need for the later note. Even before that a reminder to Member States of their obligation to provide information on recoveries with each expenditure declaration had been sent in June 2003.




The inclusion of recoveries information with payment claims is now checked systematically and payment procedures are interrupted if it is missing.




Conclusions and recommendations




Conclusions










6.38.


The Court obtained audit evidence which indicates that in budget year 2005 Structural Funds expenditure was not free of material errors (paragraphs 6.13 to 6.15 and 6.26 to 6.28).






 










6.39.


The Court's audit suggests that the Commission does not maintain effective supervision to mitigate the risk that the controls delegated to the Member States fail to prevent reimbursement of overstated or ineligible expenditure (paragraphs 6.16 to 6.21 and 6.29).












6.39.


The Commission has taken steps to mitigate the risks and to carry out effective supervision of the performance by Member States of their management and control functions under shared management in the following ways: execution of systems audits up to the end of 2005, audits have been carried out on 274 programmes in the original 15 Member States representing 62 % of the total Structural Funds contribution; application of action plans in Member States to rectify systems deficiencies detected; stopping the certification of expenditure pending the correction of serious deficiencies entailing a significant risk in payment claims; enforcing financial corrections for individual errors or system deficiencies found in audit work; providing guidance on key controls promoting improved reporting of audit results of national auditors — bilateral meetings with all 25 Member States held in 2005.




The Annual Activity Reports of the Structural Funds Directorates General report on these actions and provide indications of improvements made in the Member States’ systems. It is inherent in the system of shared management that certain errors and deficiencies will only be detected by the Commisssion after reimbursement of the expenditure concerned. The financial correction mechanism, as well as the programme closure procedure, provide a means for rectifying irregular payments.










6.40.


The Commission closed three programmes from the 1994 to 1999 period without a sound basis. Some programmes remained unclosed as a result of undue delays in their processing by the Commission (paragraphs 6.22 to 6.25).












6.40.


At this stage of the closure process, complex and contentious cases predominate, which increases the risk of delays. While in some cases there have been delays which have been longer than desirable, overall the Commission has succeeded in closing the large majority of programmes.




The Commission considers that the closure strategy which comprises ex-ante audits on the implementation of Regulation 2064/97, the thorough analysis of the closure documents and the results of the closure audits diminishes the risk of irregular final payments.










6.41.


The procedures in the Structural Funds for reporting recoveries and making financial corrections are not working effectively. This is detrimental to the fundamental purpose of the supervisory and control systems to ensure the legality and regularity of expenditure (paragraphs 6.31 to 6.37).












6.41.


The weaknesses in the reporting of recoveries are being rectified. The effect on the performance of the Commission's supervisory role is limited, given the other sources of information at its disposal.




Concerning the procedures for making financial corrections, the Commission remarks that the Member States make financial corrections as a result of their own and the Commission's audit work. Even corrections that do not involve a net reduction of the EU contribution may have an effect on national budgets.




Recommendations










6.42.


The Commission and the Member States should make better preparations for the closure of the 2000 to 2006 programmes than they did for 1994 to 1999 programmes. The lengthy closure process for the 1994 to 1999 period diverted resources from ensuring that the supervisory and control systems for the current period operate effectively.












6.42.


For the 2000-2006 period closure, the Commission has already discussed the preparations with Member States and is about to issue a detailed guidance document. The closure requirements are also more familiar. In the new period the new regulatory requirements (ex ante compliance assessment, annual audit opinion) will ensure that the supervisory and control systems can operate effectively from the beginning, despite simultaneous work on closing 2000-2006 programmes. The provisions on partial closure should also achieve an even more significant improvement in the closure arrangements.














6.43.


The Commission should obtain assurance on the proper application of the arrangements for reporting on cancellations of Community contribution and adjustments to the management and control systems and reporting on amounts recoverable. The Commission should seek a more even spread of its audit activity over each programming period and ensure that the procedures for financial corrections is used as an incentive to bring about improvements in the supervisory and control systems.












6.43.


The Commission has issued guidance to the Member States on the reporting of recoveries and is taking steps to ensure that the other required information is provided. The Commission applies a multiannual strategy for its audit work to take account of different priorities during the cycle of programme implementation and the fact that it has obligations for three different programme periods at the same time. The Commission considers that the main incentive to improve systems is effective audit work and timely follow up to ensure that recommendations are implemented. Financial correction decisions are an important measure to enable the Commission to fulfil its responsibilities but should normally need to be applied only as a last resort.














6.44.


Structural operations will account for almost half of the total EU budget under the Financial Perspectives for 2007 to 2013. The legislative provisions adopted by the Council for structural operations for the next funding period build on the financial control principles established by the existing regulations.






 










6.45.


In its Opinion No 2/2005, the Court pointed out a number of areas in the Commission's proposals which require further clarification. Nevertheless, the legislative framework as a whole should reinforce the mechanisms designed to provide assurance of the legality and regularity of expenditure. The main challenge facing the Commission and the Member States — as repeatedly demonstrated by the results of the Court's audits — is to ensure the effective application of those mechanisms.












6.45.


The Commission agrees that the challenge is to ensure the effective application of the control mechanisms. It considers that the improved framework, the increased cooperation with and reliance on Member States in accordance with the Single Audit approach, and the Action Plan towards an integrated internal control framework will help achieve a higher level of compliance and effective control.








FOLLOW-UP OF PREVIOUS OBSERVATIONS










6.46.


The results of the Court's follow-up of the principal observations in recent Annual Reports are in 
Annex 6.1
.






 










6.47.


Concerning the specific errors identified by the Court's tests of projects in recent Statements of Assurance, the Commission has not adequately followed up a number of cases. These relate mainly to programmes audited for the Statement of Assurance for 2003 and include some instances of serious system weaknesses on which the Commission has taken no action.












6.47.


The cases referred to by the Court concern ERDF and ESF. In all the cases, follow-up action has been taken when required, with some delays due to internal consultations.








SPECIAL REPORTS ISSUED SINCE THE LAST ANNUAL REPORT










6.48.


The Court has issued two Special Reports on structural operations since its last Annual Report:










—


Special Report No 1/2006 on the contribution of the European Social Fund in combating early school leaving; and










—


Special Report No 10/2006 on ex-post evaluations of Objectives 1 and 3 programmes 1994 to 1999 (Structural Funds).






 






(1)  Project promoters range from private individuals to associations, private or public companies to local, regional or national bodies.

(2)  Structural Funds objectives have since been regrouped for the 2000 to 2006 programme period.

(3)  For multifund programmes, each Fund part of a programme is counted separately.

Source: Table prepared by the Court of Auditors on the basis of data provided by the Commission.

(4)  The programmes audited were: ERDF Objective 1 programmes in Spain, Ireland (Industrial Development) and Portugal (Regional Development); ESF Objective 1 Germany (Sachsen), ESF Objective 3 Sweden and EAGGF-Guidance Objective 5a Denmark (Improving Efficiency of Agricultural Structures).

(5)  The Commission has proposed to relax the provisions concerning the time period for retention of supporting documents for the next programming period (2007 to 2013). In its Opinion No 2/2005, the Court has pointed out the serious limitations this would place on its audit prerogatives and on the scope for checks on programmes at the end of the period.

ANNEX 6.1
Follow-up of key observations in recent Statements of Assurance








Key observation by the Court


Court summary of action taken by the Commission


Comments by the Court


Commission's reply




Weaknesses in management and control, persistent errors




Substantive testing of underlying transactions (project expenditure) has revealed material errors affecting legality and regularity (paragraphs 6.13-6.15 and 6.26-6.28). The Court has continued to find material weaknesses in the supervisory and control systems (paragraphs 6.16-6.21 and 6.29-6.30).
(See also Annual Report concerning the financial year 2001, paragraphs 3.56 to 3.64; Annual Report concerning the financial year 2002, paragraphs 5.22 to 5.32; Annual Report concerning the financial year 2003, paragraphs 5.12 to 5.27 and 5.41 to 5.56; Annual Report concerning the financial year 2004, paragraphs 5.19 to 5.27 and 5.35 to 5.36).


For the expenditure of the 1994 to 1999 period, the Commission has implemented a closure strategy, involving pre-closure compliance audits, checking by the independent body of declarations accompanying final payment claims and ex post audits of closed programmes.
For 2000 to 2006 the Commission is reviewing the implementation of the management and control systems by the Member States, including audits of programmes. The Commission has provided some guidance and in 2005 has issued examples of good practice in the area of management checks.


The Commission should intensify its checks of projects for the 2000 to 2006 period and increase coordination between the structural measures Directorates-General in matters of management and control.
The Member States should seek to ensure that the management and control systems meet the required standards, especially concerning the approach to the checking of expenditure.



The Commission both carries out its own audit work on Member States' systems and monitors the audit work of Member States. In its audit work projects are checked to test the functioning of the systems. The Directorates-General responsible for structural measures closely coordinate their audit work under a joint audit strategy. The Member States carry out system audits and should follow up the resulting recommendations. The Commission has issued to Member States notes of good practices in day-to-day management checks and the certification of expenditure by paying authorities.





Delays and weaknesses in closing 1994 to 1999 programmes




Documentation submitted to the Commission by the Member States was of variable quality, necessitating further enquiries. The Commission has closed some programmes despite problems in the closure statements. Unjustified delays have occurred (paragraphs 6.22-6.25).
(See also Annual Report concerning the financial year 2002, paragraphs 5.36 to 5.38; Annual Report concerning the financial year 2003, paragraphs 5.28 to 5.39; Annual Report concerning the financial year 2004, paragraphs 5.28 to 5.34).


The Commission has implemented a closure strategy and, in some cases, has made financial corrections.
The Commission has formulated a guidance note for the closure of programmes from the 2000 to 2006.


The weaknesses identified in the closure process for 1994 to 1999 programmes need to be addressed before the closure of programmes of the current period begins.



The Commission has succeeded in closing the large majority of programmes. The closure strategy for 1994 to 1999 reduced the risk of irregular final payments.


For the 2000 to 2006 period closure, the Commission has already discussed the preparations with Member States and is about to issue a detailed guidance document.





Improvements necessary in the internal control environment of the Commission




Further measures need to be taken by the structural measures Directorates-General in order to comply with the internal control standards (paragraphs 2.21-2.23).
(See also Annual Report concerning the financial year 2002, paragraphs 5.7 to 5.8; Annual Report concerning the financial year 2003, paragraphs 5.9 to 5.10; Annual Report concerning the financial year 2004, paragraphs 5.14 to 5.18).


The structural measures Directorates-General have introduced action plans designed to address the weaknesses identified in the implementation of the internal control standards.


The Court will continue to monitor the implementation of the internal control standards.



The Commission is continuing to improve the application of the internal control standards.





Limitations in the Commission's assurance on the operation of the supervisory and control systems




The structural measures Directors-General affirm that the Commission's internal control systems provide reasonable assurance on the legality and regularity of underlying transactions, but include reservations on the operation of the supervisory and control systems in the Member States (paragraphs 2.14-2.19).
(See also Annual Report concerning the financial year 2002, paragraphs 5.10 to 5.14 and 5.21; Annual Report concerning the financial year 2003, paragraphs 5.40 and 5.57 to 5.62; Annual Report concerning the financial year 2004, paragraphs 5.39 to 5.45).


The structural measures Directorates-General have continued to examine the management and control systems in view of fulfilling the regulatory requirement to satisfy themselves that the systems meet the required standards.


The shortcomings noted by the Court in the application of supervisory controls by the Commission have to be addressed before the Commission can achieve greater assurance on the operation of the systems.



The Directorates-General continue to increase their level of assurance on systems in Member States through their own audit work, improved coordination with national control bodies, and dissemination of guidance and good practices.


The implementation of the Action Plan towards an Integrated Internal control Framework (COM(2006) 9) should further promote an integrated internal control system.





Delays in the follow-up by the Commission of the Court's audit findings




In general, the Commission has improved its follow-up to the Court's audit findings, although delays persist (paragraphs 6.46-6.47).
(See also Annual Report concerning the financial year 2002, paragraphs 5.44 to 5.52; Annual Report concerning the financial year 2003, paragraphs 5.63 to 5.65; Annual Report concerning the financial year 2004, paragraph 5.46).


The Commission has introduced a database to assist its follow-up activity.


The Commission should seek to ensure a comprehensive follow-up, avoiding any undue delays.



The Commission endeavours to follow up the Court's audit findings as expeditiously as possible.









CHAPTER 7
Internal policies, including research
TABLE OF CONTENTS
Introduction
Specific assessment in the context of the Statement of Assurance
Audit scope
Legality and regularity of transactions
Over-declaration of costs
Supervisory and control systems
Audit certification system for FP6
The Commission's ex-post financial audits
Supervision of National Agencies in the field of education and culture
Conclusions and recommendations
Special Reports issued since the last Annual Report






THE COURT'S OBSERVATIONS


THE COMMISSION'S REPLIES




INTRODUCTION










7.1.


The budgetary area of Internal Policies (IP), which covers a wide range of activities contributing to the development of the single market, entailed 9 549 million euro of commitments (see 
Graph 7.1
) and 7 972 million euro of payments (see 
Graph 7.2
) in 2005. More than half of the payments related to Research and Technological Development (RTD).






 










7.2.


The Commission directly manages the majority of IP actions (1). As a general rule, IP actions are implemented through multi-annual programmes allocating grants to private and public beneficiaries. The grants are usually paid through advances, followed by interim and final payments mainly based on the reimbursement of costs reported by the beneficiary. The principal inherent risk to the legality and regularity of the underlying transactions is that beneficiaries may overstate costs in their declarations, partly due to complex legal and contractual provisions, such as insufficiently clear definitions of eligible costs. A lack of sufficient sanction mechanisms amplifies the risk.












7.2.


The Commission has already taken actions to further reduce inherent risks concerning the legality and regulartiy of the underlying transactions, for example in the proposals for the Seventh Framework Programme for research, however a system based on reimbursement of actual costs remains complex. A considerable amount of guidance is available to provide as much advice and support as possible to the participants.




More dissuasive sanctions have been introduced. Simplifying modifications to the Financial Regulation and its Implementing Rules have also been proposed, which will contribute to reducing complexity.










7.3.


Such an environment requires effective controls at Commission level. The procedures applied by the Commission consist mainly of checks on cost declarations prior to payment and financial audits at the final beneficiary level after payment has been made. Several programmes require the cost declarations (2) submitted by beneficiaries to be certified by an independent auditor. Since 2003, the Commission has initiated action plans aimed at reducing the risk of overstatement of cost declarations.






 


















SPECIFIC ASSESSMENT IN THE CONTEXT OF THE STATEMENT OF ASSURANCE




Audit scope










7.4.


The audit focused on the following:










(a)


a sample of commitments and payments authorised in 2005;










(b)


the steps taken by the Commission to reduce over-declarations of costs;










(c)


the way selected supervisory and control systems work:






—


the system of audit certificates introduced for the Sixth Framework Programme for research and technological development (FP6),










—


an analysis of the evolution of the Commission's ex-post financial audits in the area of IP and a review of the ex-post audit function of Directorate-General for Education and Culture (DG EAC) and Directorate-General for Enterprise and Industry (DG ENTR),










—


DG EAC's supervisory and control systems for actions implemented by National Agencies (NAs).










 




Legality and regularity of transactions










7.5.


The Court examined a sample of 11 commitments and 69 payments made by the Commission during 2005. For 22 payments the review of the legality and regularity of the underlying transaction was extended to include an audit at final beneficiary level. The Court also tested 13 of these payments in order to assess the audit certificate system.






 




Material level of errors in costs declared by the beneficiaries










7.6.


The Court detected an overall material level of errors in three quarters of the transactions audited at final beneficiary level. The most frequent types of errors were:












7.6.


The Commission is verifying the Court's findings with the beneficiaries and if necessary it will take the appropriate measures both regarding the specifici beneficiaries and at system level.














(a)


lack of supporting evidence, in particular for working time charged, or double charging of costs;












(a)


The contractual provisions foresee that all costs claimed from the Commission for reimbursement need to be adequately substantiated by the contractors. The Commission will investigate the findings taking into account all relevant evidence on the working time charged.














(b)


use of average rates for personnel costs which deviate significantly from actual costs;












(b)


The Commission's own audits on comparable contracts show similar results: deviations occur both above and below average rates. Average rates can be accepted provided they are calculated according to a consistent methodology which does not generate average rates that are systematically higher than the actual costs.














(c)


unjustified allocation of indirect costs to the action;












(c)


According to the explanations given by concerned beneficiaries, the Commission will take the appropriate actions.














(d)


claims of costs which do not meet the eligibility criteria.












(d)


The Commission will examine the Court's findings and take appropriate action.








Frequent absence of a reliable time recording system










7.7.


In 5 out of 22 payments audited at beneficiary level, the Court had reservations about the quality of the time records. In these cases, part or all of the personnel costs declared could not be accepted. The regulatory framework stipulates that all the personnel costs incurred and charged have to be substantiated (3). However, the grant agreement does not provide clear provisions on how to fulfil this obligation. As suggested by the Court in its Opinion No 1/2006 on the Seventh Research and Development Framework Programme (4) it is essential that there is a clear requirement in the grant agreements to substantiate the working time of personnel involved in the action.












7.7.


The Commission considers that the legal and contractual requirements for the justification of personnel cost as such are clear and sufficient and that the issues of reliable time recording appear independent from the level of detail of the contractual provisions.




The Commission considers a need for flexibility to allow the use of equivalent alternative solutions regarding the set-up of cost accounting of participants and will clarify the guidelines as regards time recording.










7.8.


Over the years and various programmes in the IP area, the Commission has not succeeded in ensuring that beneficiaries implement a reliable system for recording personnel costs. In its Opinion No 1/2006 the Court explained on what conditions and in which circumstances cost reimbursement could be, in the area of research, replaced by lump sum finance. In view of the advantages of a results-based financing system for the scientific accountability of research programmes, the Court also encouraged the Commission to continue its reflections on more extensive use of lump sum financing.












7.8.


The Commission can specify the target to be achieved by the benficaries, but can never provide absolute assurance regarding the relibility of the many thousands of beneficaries' systems. The realistic aim is to reduce the risk of illegality and irregularity in this area to acceptable levels. Progress will continue in the frame of the Commission's action plan towards an integrated internal control framework (COM(2006) 9 of 17 January 2006).




The Commission welcomes the encouragement of the Court. Any move to systems based on extensive use of scales of unit costs or lump sums need to be carefully prepared and thoroughly examined beforehand. For example, a system based on lump sums creates other monitoring problems such as how to deal with payments if the expected milestones or results are not achieved or only partially achieved. As indicated in its Synthesis of the Commission's Management Achievements in 2005 (COM(2006) 277 final), the Commission will expand its use of simplified funding mechanisms such as lump sums, scales of unit costs and average rates, including through the rules of participation proposed for FP7.




Commission errors in applying scheme rules










7.9.


The Court detected errors by the Commission in applying scheme rules in the case of 13 out of 69 payments audited. For one TEN-T transaction, the EU contribution was 50 % instead of the 10 % ceiling stipulated in the rules, leading to an overpayment of 146 million euro. Two other transactions (78 million euro in total) concerned contributions to the Galileo Joint Undertaking (GJU). The Court observes that these payments took the form of contributions to capital in accordance with the statutes of the GJU (Council Regulation (EC) No 876/2002), while they were managed as TEN-T grants, although the TEN-T legal base does not allow contributions to capital.












7.9.


Two of the errors detected by the Court result from weaknesses in the management of contract amendments. For two additional cases, the Commission disagrees about the level of Community contribution applicable to the audited beneficiary.




The TEN-T transaction concerns the ERTMS project (5) for which, between 1995 and 2003, a total of EUR 182,7 million was granted through 10 subsequent Commission decisions, covering 50 % of related studies costs. These 10 Commission decisions clearly indicate that their subject are studies which can benefit from a rate of co-financing of up to 50 % of the cost, as long as the overall support throughout the lifetime of the project remains within 10 % of the total project cost.
The Commission interprets the rules in force in the sense of a project including the whole deployment phase following the study phase. The ERTMS system can not be deployed in an isolated way and the Commission has even nominated a European coordinator for this phase. The cost of the project has thus been estimated at EUR 5 000 million (COM(2005) 298). The amount spent on studies is within the limit of 10 %.
Applying IPSAS accounting rules, the Commission has a factual shared control on the GJU but not the ownership of any shares of the capital of the entity, which is thus a ‘joint controlled entity’. The Commission considers that this fact and other operational arguments allow it to confirm the grant nature of the EU fund.










7.10.


Tests by the Court on the sample of payments revealed that 11 payments had been made late. An analysis of the statistics on late payments reported by five Directorates General revealed that DG EAC did not have such statistics available, for Directorate-General for Research (DG RTD) and Directorate-General for Information Society and Media (DG INFSO) the situation had improved over the last three years and for Directorate-General for Energy and Transport (DG TREN) and DG ENTR the situation had worsened in comparison to 2003.












7.10.


Delays in the development of the management information system in DG EAC held up the provision of reliable statistics in 2005.




In DG ENTR and DG TREN the performance in 2005 was adversely affected by a combination of factors including a major reorganisation of the DGs and the inadequate registration of suspensions of approval and payment period In 2006 the situation is improving thanks to corrective measures.




Over-declaration of costs




No clear strategy for the coordination of existing controls










7.11.


The Commission does not have a clear approach or strategy on the coordination of key control procedures, such as the use of audit certificates, desk reviews of cost claims (basic checks or in-depth desk audits) and on-the-spot audits, to reduce the over-declaration of cost claims, and does not compare the costs of controls with the benefits they provide.












7.11.


The Commission's action plan towards an integrated internal control framework of 17 January 2006 sets out actions to be taken by the Commission and its services, specifically aimed at making the audit certification process more effective, establishing guidelines for sampling for on-the-spot audits and the use of external auditors The action plan also foresees improved presentation of control strategies and peer review to ensure harmonisation at policy level. A six-monthly progress reporting on the implementation of actions to Council and the European Parliament has been agreed.








No reliable indicators for over-declarations










7.12.


The Commission does not have a reliable set of indicators to monitor the incidence of over-declaration of costs and the way the related control systems work. The only existing indicators are based on the adjustment rates resulting from ex-post audits. There is no common approach to the reporting of the adjustment rates and the samples are not representative. As a consequence the Court cannot derive assurance from the Commission's indicators regarding the effectiveness of the control systems in respect of over-declaration of costs (6).












7.12.


The Commission considers the results of ex post controls as the most reliable indicators as only a full audit on the spot can determine with certainty the eligibility of the costs claimed and their compliance with the provisions of the contract. In 2005 a common methodology has been developed by Commission services in the research area in line with the Commission Synthesis Report 2004 in order to harmonise the assessment of errors arising during the execution of the programme by Commission services. Improvements in the representativity of sampling will be addressed in the action plan towards an integrated internal control framework.








Inadequate implementation of action plans










7.13.


As explained in paragraph 7.3, the Commission has introduced action plans designed to reduce over-declarations of costs. The following essential aspects of the plans have not been implemented in a satisfactory way:












7.13.


 














(a)


increasing the number of ‘desk audits’, involving checks on additional supporting documentation requested (such as time records or invoices);












(a)


Although additional assurance can be gained, the scope and dimension of desk controls remain limited. Their application for FP5 is made on a case by case basis by decision of the authorising officer, also taking into account the available resources.














(b)


increasing the number of on-the-spot audits (see paragraphs 7.19-7.20);












(b)


The year 2005 must be considered as atypical for the reasons developed in the reply to paragraphs 7.19. and 7.20. For FP5, the Commission has increased the overall number of audits of participants compared to previous framework programmes.














(c)


developing a harmonised methodology for the reporting and selection of ex-post audits (see paragraph 7.12);












(c)


Common principles for control strategies will be developed as part of the Commission's action plan towards an integrated control framework. At present, a common audit policy of the Research DGs is developed within the research family, and DG ENV is elaborating an ex post audit plan as well as a reserve audit list for each year. This audit plan is based on internal risk assessment criteria and takes into consideration the audit requests of the operational units and is sent to those units, once approved, for information.














(d)


implementing a common IT system for FP6 (7);












(d)


The Commission's corporate IT systems for the management of FP6 support the management of research projects in research DGs while respecting the organisation of the Commission's services. Work is continuing in this area.














(e)


simplifying the financial management of research FPs (see paragraph 7.16).












(e)


Simplification remains a major point of interest and action for the Commission. In FP7, measures including the extended use of lump sum financing, one common electronic registration desk for participants to submit their basic legal, administrative and financial data, simplification of the presentation of eligible costs based on contractors' usual accounting and management practices and principles are introduced.
(See also paragraph 7.16).








Supervisory and control systems










7.14.


The frequency and the material level of errors, stemming mainly from complex contractual provisions and guidelines and the inherently high risk of over-declaration, underline the importance of effective controls at Commission level. However, the Court's audit of supervisory and control systems revealed weaknesses in the following areas:










(a)


the audit certification system for FP6;










(b)


the Commission's ex-post financial audits in the IP area as a whole;










(c)


the supervisory and control systems of NAs in the field of education and culture.












7.14.


See answer to 7.2.




On the detailed observations of the Court, see the Commissions replies in paragraphs 7.16. to 7.27.




Audit certification system for FP6










7.15.


A key control introduced in FP6 with the aim of reducing the over-declaration of costs, is the requirement to have cost claims in relation to interim and/or final payments (8) certified by an independent auditor or a competent public officer in the case of certain public bodies. The Court analysed this certification system in order to assess the contribution that it can provide to the assurance regarding the legality and the regularity of the underlying transactions.






 




Complexity of FP6 financial provisions affects audit certification system










7.16.


The FP6 funding schemes remain complicated. The contractual provisions are too general and insufficiently clear, especially regarding eligibility criteria and the independence of certifying auditors (in particular competent public officers) and they are rendered even more complex by complicated non-binding guidelines. The Commission only published the guidelines on audit certificates after a significant part of the audit certificates had already been submitted. Altogether, this has created uncertainty among beneficiaries and auditors about which rules apply.












7.16.


The Commission considers that the contractual provisions, including details on eligibility criteria, are sufficiently clear, and participants can find further assistance in interpreting those provisions in the guide to financial issues. This guide includes a number of aspects relating to the issuance of audit certificates. Many FP6 contracts require certificates only at the end of the project.




The Commission has committed itself (9) to simplify the regulatory framework and fine tune the use of audit certificates. This will be done in the light of the experience gained.




High frequency of material errors despite unqualified audit certificates










7.17.


The Court audited 16 cost claims for which an unqualified audit certificate has been issued. In two thirds of the cases, the Court found that those claims were materially affected by errors, most of them associated with personnel costs and related overheads. Therefore, this control tool cannot yet provide adequate assurance of the costs claimed (10) (see 
Annex 7.2
 for the overall assessment of the audit certificate system).












7.17.


The error rates noted by the Court in the 16 audited cost claims are considerably lower than was the case in previous audits of uncertified cost claims.




On the basis of the findings of the Court, of the assessment of the certification system based on the ex post activity and of the survey of the Commission, the Commission will improve the audit certification system where possible. The Commission will further continue to evaluate and monitor the reliability of the audit certification system as an important part of the common audit strategy for FP6.




The Commission's ex-post financial audits










7.18.


Certain types of errors can only be detected at final beneficiary level. A sufficient number of on-the-spot audits must therefore be carried out to detect and correct over-declarations and to obtain assurance as to the legality and regularity of the underlying transactions. The Court therefore analysed the information on ex-post audits carried out by or on behalf of the Commission and reviewed the manner in which DG EAC and DG ENTR carry out ex-post audits.






 




Significant reduction in the number of ex-post audits completed










7.19.


Although the average level of over-declaration detected by the Commission's ex-post audits remained material, the Court found that the overall number of finalised ex-post audits had dropped from 491 audits in 2004 to 267 in 2005 (see 
Table 7.1
 and 
Annex 7.1
). Only 1 % of all open contracts was subject to audit during 2005.












7.19.-7.20.


The Commission had to reconsider its overall target of auditing 10 % of the FP5 contractors, because the final number of auditable FP5 contractors is considerably higher than anticipated (see Annual Report 2004, paragraph 6.20). Secondly, ex-post controls in 2005 mainly covered payments under FP5, and there is no intention to reduce the number of financial audits. The statistics in table 7.1 refer to closed audits and, due to the unavailability during a major part of 2004 of external audit capacity from external audit firms and to delays encountered with the newly appointed external audit firm, the year 2005 must be considered as an atypical year. Notwithstanding this, a substantial number of audits have been launched in 2004 and 2005.




A new framework contract for FP6 audits has been signed to provide adequate external support to implement the audit activity for FP6 (see paragraph 7.13.(b)). An audit strategy for FP6, including a concrete audit target, is being finalised. It will be reviewed in the light of audits results, cost/benefit considerations, and as an element of the overall control strategy.










7.20.


The reduction in the number of ex-post audits is most significant in the Research area, where it fell from 313 in 2004 to 68 in 2005 (see 
Table 7.1
 and 
Annex 7.1
). The Commission has again fallen short of its own target of auditing 10 % of FP5 contractors and has not yet set a concrete audit target for FP6, although advised to do so by the Court (11). During 2005, only three audits of FP6 grant agreements were carried out. This reduces the potential for timely corrective action in respect of problematic areas and diminishes the resulting dissuasive effect of the Commission's audit activities.






 




Table 7.1 — Ex-post financial audits completed in 2005























Directorate-General


Number of completed audits


Number of audited contracts


Number of open contracts


Value of audited contracts (million euro)


Value of open contracts (million euro)


Adjustments of eligible costs in favour of the Commission as a result of the audits


% audited contracts/open contracts




All programmes


Research programmes




2004


2005


2004


2005


2004


2005


2004


2005


2004


2005


2004


2005


2004


2005


2004


2005




 


 


 


 


 


 


 


 


 


 


 


 


 


Value (million euro)


% value audited contracts


Value (million euro)


% value audited contracts


 


 




AGRI — Agriculture


5


7


 


 


6


20


245


153


16,18


22,67


42,54


35,48


0,00


0,0


1,68


7,4


2,4


13,1




EAC — Education and Culture


75


66


 


 


80


66


15 884


11 748


24,10


23,14


740,30


570,46


7,80


32,4


3,20


13,8


0,5


0,6




EMPL — Employment and Social Affairs


25


33


 


 


27


37


1 639


1 553


11,53


14,47


139,56


131,11


0,19


1,7


0,37


2,6


1,6


2,4




ENV — Environment


42


44


 


 


73


49


1 748


1 774


35,07


68,60


385,87


431,30


1,18


3,4


0,47


0,7


4,2


2,8




JLS — Justice, Freedom and Security


8


11


 


 


47


46


901


1 055


28,60


17,90


117,00


177,00


2,53


8,8


1,10


6,1


5,2


4,4




SANCO — Health and Consumer Protection


8


7


 


 


12


7


522


476


6,29


5,34


153,90


165,58


0,36


5,8


0,27


5,1


2,3


1,5




TREN — Energy and Transport (12)



54


16


53


7


81


20


1 077


1 099


87,09


21,49


689,41


899,46


9,95


1,8


0,85


0,0


7,5


1,8




ENTR — Enterprise and Industry


43


8


34


1


64


8


1 684


1 672


38,12


22,28


221,96


305,75


1,00


2,6


1,38


6,2


3,8


0,5




FISH — Fisheries and Maritime Affairs


18


11


15


7


41


29


238


239


12,23


50,25


270,01


174,51


1,16


9,5


1,39


2,8


17,2


12,1




INFSO — Information Society and Media (13)



95


41


93


30


230


83


2 320


5 727


115,37


57,75


1 745,00


2 030,00


8,20


7,1


5,17


8,9


9,9


1,4




RTD — Research


118


23


118


23


167


35


7 696


8 906


263,40


38,25


3 451,39


5 032,43


2,79


1,1


0,72


1,9


2,2


0,4





Total




491




267




313




68




828




400




33 954




34 402




637,99




342,15




7 956,94




9 953,07




35,16




5,5




16,59




4,8




2,4




1,2









Weaknesses in the follow-up of ex-post audits by DG EAC and DG ENTR










7.21.


As in previous years, the ex-post audits finalised by DG EAC during 2005 revealed a material level of over-declarations In 41 out of 62 audits material ineligible costs were detected.












7.21.


DG EAC continues its audit strategy using an external audit company. A change in the external contractor took place over the reporting period as significant flaws in the work delivered were identified. The quality of the audits improved considerably through the cooperation with the new external contractor. Better and more accurate results are thus expected for the future.














7.22.


The average time lapse between the date of the audit and the final audit report exceeded one year. Furthermore, the procedures regarding the follow-up to audits were inadequate. Of the 43 audits finalised during 2004 that revealed recoverable amounts, for 19 audits, no recovery had yet been made at the end of 2005. The Court and the Commission had already reported these weaknesses in DG EAC's ex-post audits (14). However, the situation has not significantly improved since these observations were made.












7.22.


DG EAC terminated the cooperation with the external audit firm among other reasons because of the very late delivery of reports. The cooperation with the new contractor has shown far better results in terms of delivery. DG EAC stressess however, that audits often were carried out with difficult beneficiaries for which doubt occurred during the contractual period. Their legal situation complicated in certain cases the recovery procedure. DG EAC is establishing an action plan to improve the situation.














7.23.


The Court found that the number of audits finalised in DG ENTR fell from 43 in 2004 to 8 in 2005, mainly as a result of operational delays in the implementation of the audits planned. The follow-up to the audit findings was also inadequate. With regard to 32 audits finalised during 2004, for which amounts recoverable had been detected, in 15 cases no corrective actions had been taken by the end of 2005.












7.23.


The reduction in the number of finalised audits was due to delays by the external audit firm in executing its tasks. There was no reduction in the level of the DG's audit activity: further to the eight finalised audits, 52 audits were at different stages of completion in 2005. Moreover since the start of FP5, the DG has launched audits for 21 % of contractors under this program.




As to the follow-up of the audit findings, corrective actions were taken in 2005 and strengthened in 2006 so as to ensure a systematic and timely application of the audit results.




Supervision of National Agencies in the field of education and culture










7.24.


DG EAC entrusts the implementation of more than 60 % (15) of its budget to NAs. In order to provide reasonable assurance as to the legality and regularity of the underlying transactions, DG EAC should monitor the management and control systems of the NAs.












7.24.


DG EAC is taking full responsibility for meeting the obligation of monitoring the management and control system of the NAs by establishing and following an action plan on the NAs implying system audits of all 99 NAs by the end of the period 2004 to 2006.








Insufficient prior checks on NAs control systems










7.25.


The Financial Regulation (FR) (16) requires the Commission to carry out checks on the management and control systems of the NAs before entrusting to them the implementation of Community Actions. In its 2003 annual activity report, DG EAC made a reservation concerning the non-compliance with this requirement. To remedy this, DG EAC established an action plan, which made provision for 99 system audits in NAs over the 2004 to 2006 period. As this action plan is still on-going (44 audit reports have been finalised), the Court considers that DG EAC still does not comply with the requirement of the FR.












7.25.


DG EAC explained the absence of a reservation for 2004 in the answer to the Court's analysis of the Annual Activity Report. DG EAC made a reservation in the 2005 AAR concerning the management of the NAs. Provisions are included in the legal base for the new programmes covering the period 2007 to 2013 enabling the Commission to reasonably assure the legality and regularity of transactions carried out by NAs.








Checks on control systems do not provide sufficient assurance










7.26.


The Court could not obtain any evidence that the system audits included on-the-spot checks on projects implemented by the beneficiaries of the NAs. This limits the assurance as to the legality and regularity of the underlying transactions that can be provided by these audits.












7.26.


While on the spot checks are not included in the task list of the external auditor, agencies are contractually obliged to carry them out. Where system audits revealed weaknesses in this respect, corrective action is taken. Moreover, the task list of the external contractor has, as from early 2006, been extended to include testing NA's activities in this area.














7.27.


The Court's review of a sample of system audit reports (17) revealed several weaknesses in them, such as inappropriate or inconsistent classification of the importance of findings as well as insufficient action to correct the weaknesses identified (see 
Annex 7.2
 for the overall assessment of the Commission's supervisory and control systems relating to the National Agencies).












7.27.


The issue has been clarified with the new external contractor following detailed discussions. A common understanding will be applied throughout the remaining reports. Regarding the identified weaknesses DG EAC is taking appropriate action.








Conclusions and recommendations










7.28.


The Court's audit revealed a high frequency and material incidence of errors in payments to beneficiaries, which affected the legality and regularity of transactions. Furthermore, the assessment of the Commission's supervisory and control systems revealed that these systems do not provide assurance as to the legality and the regularity of the underlying transactions in the IP area.












7.28.


Given the prohibitive cost of auditing every project on the spot, the Commission must tolerate a certain risk of error, the level of which is commensurate with the nature of the aid granted under internal policies. Directors-General draw on a number of information sources and indicators in establishing their annual declaration of assurance. These sources and indicators have been considered sufficient to provide reasonable assurance (in some cases with reservations). Work now continues with the improvement of the overall control system including all the parties (beneficiaries, independent auditors) in the frame of the action plan towards an integrated control framework.














7.29.


The Court recommends that the Commission should:












7.29.


 














—


continue its efforts to simplify and to clarity further the rules governing the shared-cost programmes with respect to minimum requirements for time recording and, where appropriate, make more extensive use of lump sum financing to move to a results-based financing system (paragraphs 7.7-7.8 and 7.16-7.17) (18);












—


The Commission is pursuing those objectives across its internal policies and programmes. Its proposals for FP7 indicate that greater use can be made, where appropriate, of flat rates (including scale of unit costs) and lump sums within the terms of the Financial Regulation and its implementing rules. In addition, the grant agreements to be put in place for the Competitiveness and Innovation Framework Programme will include a method and the supporting tools for the beneficiary to report on personnel costs.
DG EAC seeks to allow for simple and clear rules to govern the implementation of its new programmes through the design of the legal base which also includes the use of lump sum financing arrangements where possible.














—


ensure rigorous and cost-conscious implementation of key controls to reduce over-declarations (paragraphs 7.11-7.13);












—


This is the objective addressed by the roadmap to an integrated control framework described in paragraph 7.28.














—


improve the scope, quality and follow-up of the systems audits of NAs (paragraphs 7.24-7.27);












—


DG EAC has taken the necessary steps to improve the overall quality of ongoing system audits of NAs working in the framework of the current programmes. The new programmes covering the period 2007 to 2013 already take into account the recommendations of the Court when determining the implementation.














—


consider carefully the legal form of Joint Undertakings so as (1) to enable them to benefit from consistent funding schemes and (2) to enable a fair recognition of their nature and associated risks (paragraph 7.9).












—


The Commission has made proposals on this.








SPECIAL REPORTS ISSUED SINCE THE LAST ANNUAL REPORT










7.30.


Special report No 6/2005 on the Trans-European Network for Transport (TEN-T).






 






(1)  Management of some programmes such as the European Refugee Fund and the Schengen Facility is however shared with Member States; the Commission manages parts of the Socrates, Leonardo and Youth programmes through national agencies.

(2)  E.g. the Sixth Framework Programme for research and technological development (FP6), the Financial Instrument for the Environment (LIFE), Trans European Energy Networks (TEN-Energy).

(3)  See e.g. the following model contracts: FP5, Article 23, Annex II; FP6, Article 19, Annex II; Ten-T, Article II, 14.1.

(4)  Opinion No 1/2006 of the European Court of Auditors on the proposal for a regulation of the European Parliament and of the Council laying down the rules for the participation of undertakings, research centers and universities in actions under the Seventh Framework Programme and for the dissemination of research results (2007 to 2013).

(5)  Feasibility Study for harmonisation at European level of safety and rail traffic management.

(6)  Opinion No 2/2004 of the European Court of Auditors on the 'single audit model', paragraph 48.

(7)  Annual Report concerning the financial year 2004, paragraph 6.10 and Opinion No 1/2006, paragraphs 41 and 42.

(8)  Only interim and/or final payments that meet certain criteria have to be certified.

(9)  In its Synthesis of the Commission's Management Achievements in 2005 (COM(2006) 277 final).

(10)  Opinion No 1/2006 of the European Court of Auditors, paragraphs 74 to 77.

(11)  Annual Report concerning the financial year 2004, Chapter 6, Annex 1.

(12)  Excluding TEN-T.

(13)  Audits finalised in 2005 relating to Media have been included in the statistics of DG INFSO.

(14)  Annual Report concerning the financial year 2003, paragraphs 6.32 and 6.33.

(15)  609 million euro in payments for 2005.

(16)  Article 35 of the Implementing Rules of the Financial Regulation applicable to the general budget of the European Communities.

(17)  The sample comprised 11 out of 44 audit reports finalised.

(18)  Opinion No 1/2006 of the European Court of Auditors, paragraphs 58 to 70 and 94.

ANNEX 7.1
Internal policies — Assessment of key aspects previously observed








Observations


Action taken in 2005


Recommendation Court of Auditors


Comments Commission




1. Supervisory and control systems — RTD framework programmes




In 1998 the five Directorates-General operating the RTD framework programmes jointly formulated an audit approach, setting themselves for FP5 a target of auditing 10 % of the contractors (see the Annual Reports concerning the financial years 2001, 2002 and 2003, paragraph 6.30). These audits are to a large extent carried out by external audit firms on behalf of the Commission.
In 2004 the Commission adopted a common audit approach for FP6. A definition of measurable audit objectives for FP6, which can realistically be achieved, was still outstanding.


The total number of FP5 audits closed still falling short of target.
Although the new framework contract for the audit of FP5 indirect RTD actions was signed in November 2004, the Commission has experienced operational problems leading to a drop in the number of audits carried out.
The award of a contract for the audit of FP6 indirect RTD actions was not finalised during 2005.


In the absence of a reconsideration of the overall target of auditing 10 % of FP5 contractors, the Commission should reinforce its audit activities in order to achieve its audit target for FP5 without affecting the number of audits on FP6.
An audit target for FP6 has yet to be defined.
A new framework contract for FP6 should be signed to provide adequate external support to enable the Commission to implement its audit approach for FP6.



The emphasis of the FP6 audit policy is rather qualitative than quantitative


The target for FP5 has been reconsidered (see Annual Report 2004).


2005 is an atypical year. The Commission is not reducing the number of audits. Audit activities continue at an intensive level.


The framework contract has been signed in 2006.





2. Supervisory and control systems — TEN-T




The Court found that TEN-T actions were not covered by the Directorate-General for Energy and Transport's audit programme. Following the recommendations of the Court, DG TREN has established a specific framework contract for auditing TEN-T actions. A target has been set by DG TREN to audit each year at least 20 % of the projects and 35 % of total costs of projects finalised in the previous year.


In 2005, DG TREN audited 20 TEN-T financing decisions, representing 12 % of the projects and 49 % of the total costs of projects finalised in the previous year.


Although the target set by DG TREN has been only partially achieved, i.e. of auditing each year at least 35 % of total costs of projects finalised in the previous year, the target of auditing 20 % of projects has not been met. The necessary measures should be taken to ensure that the target set by DG TREN is reached.



In 2004, when DG TREN started auditing Trans-European network projects (TEN) the sample initially selected covered more than 35% of the total costs of the projects finalised in 2003. The aim of maintaining this target was fixed at this time together with the intention of covering 20% of the projects finalised. After issuing the drafts of the first batch of 20 audits, DG TREN realised that for cost efficiency reasons the target of auditing 20% of the projects was not pertinent since audits on TEN projects are rarely followed by financial adjustments, audit adjustments are compensated by eligible costs in excess of the amount foreseen in the decision.


DG TREN decided to stick to its audit policy of auditing a large part of the budget and to cover as many beneficiaries as possible but with a risk based approach and with reasonable audit costs.





For TEN-T actions, eligible and ineligible costs are defined in the legal basis and the Commission Decisions (Annual Reports 2001 and 2002).
The Court found that these definitions are insufficiently specific to establish the actual costs incurred by the beneficiary. A new model Commission Decision was adopted in 2004, including a definition of eligible and ineligible costs and a modified definition of studies and works.


A further step was taken for new projects in 2005 with the inclusion in the decision text of binding models for the financial and technical reporting.


As proposed by the Court, in order to avoid financing construction works at the increased rate for studies, clear definitions of the scope of the two main forms of aid, ‘studies’ and ‘works’, still remain to be transposed into the legal basis and the financing decisions.



DG TREN already introduced clear definitions in the decision text of binding models for the financial and technical reporting. This inclusion has been welcome by the budgetary authority in its report 2004. The new draft TEN regulation (applicable in 2007) contains clear definitions of works and studies.







ANNEX 7.2
Supervisory and control systems






A


Works well, few or minor improvements required.




B


Works just well enough but improvements desirable/necessary.




C


Works, but not at a satisfactory level.













System of audit certification FP6


Commission


Intermediate level


Beneficiary


Overall assessment




Conception


C


—


—


C




Practical transposition in procedural stages






—


compliance with standards










—


taking into account of experience






B


—


—


B




Actual operation






—


compliance with standards










—


taking into account of experience






C


—


C


C




Results






—


remedial effect










—


preventive effect






B


—


C


C




Overall assessment


B


—


C


B
















Commission's supervisory and control systems relating to the National Agencies (NA)


Commission


Intermediate level


Beneficiary


Overall assessment




Conception


B


—


—


B




Practical transposition in procedural stages






—


compliance with standards










—


taking into account of experience






C


—


—


C




Actual operation






—


compliance with standards










—


taking into account of experience






C


—


—


C




Results






—


remedial effect










—


preventive effect






C


—


—


C




Overall assessment


C


—


—


C




COMMENTS OF THE COMMISSION TO COMMISSION’S SUPERVISORY AND CONTROL SYSTEMS RELATIVE TO THE NATIONAL AGENCIES (NA)

The Commission’s supervision and control systems relating to NAs include external auditors. The contracted audit firm and the contractual conditions were subject to change in the middle of the reporting period in  order to improve the quality of the audits and the reports. Positive results were apparent already at the end of 2005.





CHAPTER 8
External actions
TABLE OF CONTENTS
Introduction
Specific assessment in the context of the Statement of Assurance
Audit scope
Legality and regularity of underlying transactions
Transactions carried out at Delegation level
Transactions carried out at implementing organisation level
Supervisory and control systems
Risk analysis
Information and communication
Commission control and audit activities
Internal audit
Decentralisation under CARDS
Conclusions and recommendations
Follow-up of previous observations
Verifications of United Nations organisations
Introduction
The Financial and Administrative Framework Agreement (FAFA)
Progress in 2005 in seeking agreement with the UN on aspects of financial control
Conclusion
Special Report No 25/98 concerning activities undertaken by the European Union in the field of nuclear safety in Central and Eastern Europe (CEEC) and in the New Independent States (NIS) from 1990 to 1997
Introduction
Intervention strategy clarified but not free of shortcomings
Human resources and programme management have improved
Project implementation has improved, but some problems persist
Involvement of beneficiaries has improved slightly
Conclusion and recommendations
Special Reports issued since the last Annual Report






THE COURT'S OBSERVATIONS


THE COMMISSION'S REPLIES




INTRODUCTION










8.1.


This chapter deals with the external aid financed from the general budget (1). The main areas are food aid/food security, humanitarian aid, NGO co-financing and relations with Asia, Latin America, the Commonwealth of Independent States, the western Balkans, the Middle East and the Southern Mediterranean. The Directorates-General for External Relations and for Development are responsible for formulating development cooperation policies, country/regional strategies and multiannual programming, and the EuropeAid Cooperation Office (EuropeAid) is responsible for their implementation. The Directorate-General for ‘Humanitarian Aid’ (DG ECHO) and ‘Enlargement’ (DG ELARG) are responsible for both the formulation of the policy and the strategy as well as for its implementation; DG ECHO for humanitarian aid and DG ELARG for CARDS (2). 
Diagrams III and IV of Annex I
 show the funds spent in 2005 for financial perspective Heading 4 ‘External actions’ (commitments: 5 516 million euro; payments: 5 013 million euro). The CARDS programme is implemented either through the EC Delegations (Albania, Bosnia and Herzegovina, and Croatia) or the European Agency for Reconstruction (Serbia and Montenegro, Kosovo and FYROM).






 




SPECIFIC ASSESSMENT IN THE CONTEXT OF THE STATEMENT OF ASSURANCE




Audit scope










8.2.


The overall objective of the specific assessment was to provide a conclusion as to the legality and regularity of underlying transactions in external actions. The audit comprised an evaluation of the supervisory and control systems which are designed to ensure the legality and regularity of transactions, supported by tests of transactions at the Delegations and implementing organisations. Transactions processed by Commission headquarters, mainly relating to direct budgets support and multi-regional projects, were not included in the Court's audit sample. The part of CARDS which is implemented through the European Agency for Reconstruction (3) is the subject of a separate annual financial audit.






 










8.3.


Most payments in the external actions field consists of advance payments made to project implementing organisations (international organisations, government institutions, NGOs or management units established for that purpose). Final payments are usually made upon completion of the projects and approval by the Commission of their final reports. As in previous years, the Court identified the compliance with the prescribed contracting procedures and the eligibility of expenditure at project level as being the highest risk areas.






 




Legality and regularity of underlying transactions




Transactions carried out at Delegation level










8.4.


The Court audited a judgemental sample of 33 payments (for a total of 23 million euro) and 17 tenders (for a total of 29 million euro) focusing on high-value amounts at six Delegations (4). No errors were found in the payments, but two were detected for the tenders: in one case the winning offer did not comply with the tender requirements and in the other the payment conditions were altered after the contract was awarded.












8.4.


Concerning the case for which the Court believes the payment conditions were altered after the contract was awarded, the Commission considers that the principle of equal treatment of potential applicants was fully respected. This change in the payment schedule made after formal approval of a derogation fully conformed to the applicable Commission financial rules and regulations, guidelines and procedures.








Transactions carried out at implementing organisation level










8.5.


The Court visited 17 projects managed by implementing organisations, where a judgemental sample of 170 payments (for a total of 6,2 million euro) and 40 tenders (for a total of 5,8 million euro) was audited focusing on high-value amounts. A material incidence of error was found in the transactions examined, such as the non-compliance with the prescribed contracting procedures (encountered in seven projects out of the 17 audited on-the-spot), ineligible expenditure (three out of 17) and insufficient supporting documentation (two out of 17).












8.5.


The Commission has continued to improve its supervisory and control system, in order to ensure the correct application of contractual procedures by beneficiaries. The terms of reference for financial audits to be launched by beneficiaries have been revised so as to reinforce the verification of compliance with the contract terms including those relating to procurement and eligibility.








Supervisory and control systems




Risk analysis




EuropeAid cooperation Office at central level










8.6.


EuropeAid made two risk analyses in 2005. The one completed in January for the 2005 Annual Management Plan was reviewed by the Court in its Annual Report concerning the financial year 2004 (5), where it was noted that EuropeAid did not consider the financial risks at the level of the project implementing organisations to be the highest. The risk analysis finalised in December 2005 for the 2006 Annual Management Plan now identifies the risk to the legality and regularity of transactions at project level based on the Court's past observations. However, the analysis did not make reference to the findings of the Commission's own services or of those of project external auditors and to the analysis of risks for the different types of implementing organisations (NGO, international organisation, government institution, etc.) and funding method (grant, budgetary support, trust fund, etc.).












8.6.


The criteria mentioned by the Court are already taken into account by EuropeAid in its approach to risk management. The Commission will endeavour to further reinforce the current mechanism and better communicate the basis of its analyses.








Directorate-General for Humanitarian Aid (DG ECHO)










8.7.


DG ECHO's risk analysis concluded that, with the exception of the quality of the implementing partners, many risks were inherent to the provision of humanitarian aid and therefore beyond DG ECHO's control. As in previous years, the approach to managing this risk was through the procedures for selecting the implementing partners.












8.7.


DG ECHO's risk assessment concluded that these risks, inherent to the provision of Humanitarian Aid, are mitigated to the extent possible by control measures put in place by the Commission in Brussels (such as selection and assessment of implementing partners) and in the field (e.g. monitoring and audit of projects).








Information and communication




EuropeAid cooperation Office at central level










8.8.


The Common Relex Information System (CRIS) provides data on the implementation of activities. Its use is at present limited by the fact that not all data fields have been systematically filled in, with the result that there is insufficient or inconsistent financial information available by type of implementing organisation or funding method on which to base the more detailed risk analysis mentioned in paragraph 8.6.












8.8.


The Commission is working to improve the quality of data input. Nevertheless, financial information can be extracted by implementing organisations, type of contract and management mode for the purpose of risk analysis.














8.9.


The Court has in previous years (6) drawn attention to the lack of a database containing comprehensive information on audits, including their findings and the corrective action needed and taken. This would provide a useful source of information for the risk analysis and for setting and monitoring EuropeAid's audit strategy. CRIS-audit is a module intended to provide such information but at present only a small proportion of external audits have been input, and the link between these audits and the related project management information is cumbersome. The results of audits carried out by Commission staff have not been included.












8.9.


The current system for the planning and centralised monitoring of external audits allows EuropeAid to provide all the information necessary for EuropeAid's risk analysis and audit strategy.




CRIS-Audit has to be seen as a complementary tool to the current system. In this optic, EuropeAid intends to further improve the operation of CRIS-Audit building on the experience gathered. The aim is to simplify and standardise the data to be introduced with a view to allow a better exploitation of the system at both Headquarters and Delegations.










8.10.


External assistance management reports enable Delegations to provide headquarters with important financial and technical information on a six-monthly basis. The Court's review of a sample of 16 such reports indicated that the information they provided on external audits for 2005 was incomplete (only one report gave any information on results) and inconsistent in terms of the audits shown (planned and/or in progress, managed by the Delegation or also by project implementing organisations). Similar findings were reported in last year's Annual Report (7).












8.10.


Delegations have to report on the implementation of their audit plans in the EAMRs. In addition to the key items that contribute to the legality and regularity of transactions, in 2006 Delegations are also highlighting the general aspects, where appropriate. As regards the use of audit results, relations between EuropeAid and the Delegations ensure proper, more regular and more detailed exchanges of information.




The Annual Audit Plan covers all departmental activities, including, where appropriate, the mandatory audits identified during risk analysis which are carried out by the Commission or by external auditors on behalf of the Commission. Information relating to mandatory audits conducted by contractors is therefore additional information that goes beyond what is required by reporting obligations.
In fact, in the above reports, some Delegations also included the schedule prepared in the third quarter of 2005 of audits to be conducted in 2006.




Directorate-General for Humanitarian Aid (DG ECHO)










8.11.


DG ECHO's reporting and management information systems are adequate in relation to its activities. However, as observed by the Court in its Special Report on the Tsunami (8), sometimes DG ECHO does not have detailed information on the activities of projects that have complex organisational structures, such as where DG ECHO's implementing partners have sub-contracted activities to third parties.












8.11.


As indicated in its replies to the Court's special report, the Commission will reinforce the monitoring system to accommodate the Court’s recommendations in the most appropriate manner.








Commission control and audit activities




EuropeAid cooperation Office










8.12.


EuropeAid has a programme of ex-post controls which, on a sample basis, assess whether the authorising officers carried out the required checks. The results to date are consistent with the Court's own findings (see paragraph 8.4) that payments at Commission level are a low-risk area. As the checks do not cover transactions at the level of project implementing organisations, they can only make a limited contribution to the overall assurance on systems and procedures and the legality and regularity of the underlying transactions.












8.12.


The definition of the characteristics (scope, typology…) of the ex-post transactional controls arise from an assessment of the residual risk and the dovetailing of the ex-post transactional control with the other components of the control system.




Controls focus on the main points regarding legality and regularity of transactions, namely eligibility (substantial and formal), beneficiary and bank account, and bank guarantees. Experience acquired during the first two years will form the basis for further reorienting the ex-post transactional controls.










8.13.


The finance units of two out of the three geographic directorates managing devolved operations (9) have carried out an adequate annual programme of audits of their Delegations, consisting of a review of their financial systems for processing transactions, their contracting system and their supervisory and control systems, completed by tests of transactions processed by the Delegations and some project implementing organisations. The third finance unit carried out audits only in two Delegations.












8.13.


All geographic Directorates carry out assessments of their delegations' management of devolved operations, using a varying combination of checks, inspections and audits.




EuropeAid intends to promote the use of best practice for these assessments building on the experience acquired, and is developing a standardised methodology.










8.14.


EuropeAid's audit strategy aims at verifying the legality and regularity of expenditure at project level. A first layer is provided by the certification audits required in most project financing agreements and a second layer consists of the annual audit plan of about 140 projects selected on the basis of a risk analysis. Projects managed by international organisations, representing a significant proportion of expenditure and requiring specific verification methodologies, were not included in the annual audit programme.












8.14.


In accordance with the financial regulations and international agreements currently in force, projects cofinanced with international organisations are subject to specific verification missions by Commission departments.














8.15.


In the countries visited by the Court, 13 external audit certification reports of projects were reviewed. The main weakness found was that in 10 out of the 13 reports reviewed the external auditors were not provided with complete terms of reference, meaning that some risk areas were not covered by the audits, such as the need to test compliance with the prescribed contracting procedures. In 2006 EuropeAid has included standard terms of reference for external audits in its Practical Guide.












8.15.


The standard terms of reference for external audits introduced through the 2006 revision of the Practical Guide, specifically address compliance with the contract terms including those relating to tendering procedures launched by beneficiaries.








Directorate-General for Humanitarian Aid (DG ECHO)










8.16.


DG ECHO has a comprehensive approach for auditing its implementing partners. The audits included an assessment of the internal controls of the implementing partners and the testing of a sample of expenditure of projects implemented by them.






 




Internal audit










8.17.


In 2005 the Internal Audit Service (IAS) finalised reports on the financing of activities through NGOs by DG ECHO and EuropeAid. Their findings are consistent with those of the Court and the IAS made pertinent recommendations on reporting, carrying out a specific risk analysis for NGOs and external audits.












8.17.


EuropeAid and DG ECHO have established and are implementing an action plan on the basis of the recommendations of the IAS.




A number of IAS recommendations were already part of the on-going reflections and initiatives within the two services, such as for EuropeAid the strengthening of internal controls, the definition of an audit strategy and the review of the certification audit and the standard agreement for grants, in the context of a maturing de-concentration process.










8.18.


The Internal Audit Capability (IAC) completed a number of assignments in 2005, including the follow-up of the implementation of internal control standards at EuropeAid Directorates. As in previous years, the IAC's annual work programme could not be completed, mainly because of a lack of human resources.












8.18.


The annual work programme is a dynamic document which is adjusted to reflect the emerging priorities as well as the experience gathered. Where relevant, some tasks can be rolled forward to the following year.








Decentralisation under CARDS










8.19.


The management of one CARDS project in Albania and seven projects in Croatia had been decentralised to national implementing agencies with ex-ante control of procurement and award decisions. Before the decentralisation, however, the management capacity of these implementing agencies had not been assessed according to the rules set out in Article 53 and 164 of the Financial Regulation. The projects in Croatia have been managed without problems but for the project in Albania the management responsibilities had to be taken back by the Delegation.












8.19.


As for Croatia, Commission Decision PE/1378/2002 of 23 July 2002 approving the CARDS 2002 National Programme provides the appropriate legal framework for the granting of the decentralised management. Following this Commission Decision, a Financing Agreement was concluded on 9 October 2002 with the Croatian Authorities. This Financing Agreement foresees the possibility of a decentralised implementation method. On this basis, and in accordance with the Financial Regulation applicable at the time (Council Regulation of 21 December 1977), the Commission and the Croatian Authorities concluded on 13 February 2003 a Memorandum of Understanding on the establishment of the Central Finance and Contract Unit.




As for Albania, the Commission carried out an on-the-spot visit to the Programme Management Unit (PMU) between 1 and 4 July 2003. Following this mission, a Memorandum of Understanding on the granting of decentralised management to the PMU for the implementation of the Local Community Development Programmes with the Albanian Authorities was signed on 14 July 2003.




Conclusions and recommendations










8.20.


As in previous years, the Court's audit revealed few errors affecting transactions at the level of the Delegations (see paragraph 8.4). However, a material incidence of error with financial impact was detected in the sample tested at the level of the project implementing organisations (see paragraph 8.5). The most frequent type of error was the failure to ensure that contracting procedures, including tenders, complied with the Commission's requirements.












8.20.


The Commission appreciates that as in previous years the Court considers that the financial management carried out by the Commission services, in particular the Delegations, is functioning well. The Commission is aware of the risks at project implementing organisation level and has adopted over the last years a number of measures to mitigate such risks and address the issues raised by the Court (see also paragraph 8.5).














8.21.


The Court's overall assessment of the Commission's supervisory and control systems in 2005 is shown in 
Table 8.1
. As explained in paragraphs 8.14 to 8.15, there continued to be weaknesses in the systems designed to ensure the legality and regularity of transactions at the level of project implementing organisations.












8.21.


A number of instruments are already in place to mitigate the risk that ineligible project expenditure be charged to the budget. Additional specific measures recently introduced, have further reinforced the control mechnisms. The new standard contracts and terms of reference for expenditure verifications annexed to the revised Practical Guide for instance, specifically address the contractual aspects mentioned by the Court.








Table 8.1
(a) The Court's assessment of supervisory and control systems in 2005








 


DG Humanitarian Aid (ECHO)


EuropeAid Cooperation Office


Delegations




Overall concept


A


A


—




Procedures and manuals


A


A


A




Functioning in practice


A


B (10)



B (10)





Internal audits


B (11)



B (11)



B (11)





Management reporting


A


B (10)



B







(b) The Court's assessment of external audits at the level of organisations implementing projects funded by EuropeAid






Quality of audits


A




Quantity of audits


B




Definition of terms of reference


B (12)





Commission's involvement in appointing auditors


B (12)





Inclusion of tender procedures in the audit scope


B (12)





Reporting of results of review of accounting systems


C




Evidence of the use and follow-up of audit reports


B







Key to indicators






Rating of supervisory and control systems




Works well. Few or minor improvements necessary


A




Works, but improvements necessary


B




Does not work as intended


C







(c) Key areas followed up by the Court of Auditors in 2005








 


DG Humanitarian Aid (ECHO)


EuropeAid Co-operation Office


Delegations




Risk analysis


Carried out analysis as in previous years.


Risk analysis in December 2005 now mentions the project-level financial risks.


—




Reporting systems


Maintained good standards.


Reporting systems need further development:






—


CRIS-Audit module still not used and not well linked to management information;










—


EAMRs incomplete.






Delegations reported via bi-annual external assistance management reports (EAMRs).




Concept of external audits and controls


Fully implemented.


Improvements made in 2005.


—




Implementation of external audits and follow-up


Audits carried out and followed up.


Terms of reference issued in February 2006. Follow-up need to be further improved.


—














8.22.


The management of certain CARDS projects in Albania and Croatia had been decentralised without the required prior assessments.












8.22.


As for Croatia, the decision to decentralise management taken in 2002 was in compliance with the provisions of the former Financial Regulation.




Concerning Albania, the decision to decentralise management was based on the mission carried-out to the PMU in July 2003, further to which a Memorandum of Understanding with the Albanian Authorities was signed on 14 July 2003.










8.23.


Based on its findings as detailed above, the Court recommends that:












8.23.


 














(a)


EuropeAid's risk assessment should be further developed by making reference to the findings of internal and external auditors at project level, and by differentiating between the different types of implementing organisations and funding method (see paragraph 8.6);












(a)


The criteria mentioned by the Court are already taken into account by EuropeAid in its approach to risk management. The Commission will endeavour to further reinforce the current mechanism and better communicate the basis of its analyses.














(b)


all external auditors of projects should carry out their work on the basis of terms of reference that cover all known risk areas, including compliance with the Commission's requirements regarding contracting procedures and the eligibility of expenditure (see paragraph 8.15);












(b)


The Commission shares the Court's views and has already adopted a number of measures in this respect. The new standard contracts and terms of reference for expenditure verifications annexed to the revised Practical Guide, which entered into force on 1 February 2006, specifically address the contractual aspects mentioned by the Court.














(c)


CRIS should include information on all audits of projects, whether carried out by external auditors or Commission staff, and this information should be better linked to the corresponding project management information (see paragraph 8.9);












(c)


EuropeAid intends to further improve the operation of CRIS-Audit building on the experience gathered. The aim is to simplify and standardise the data to be introduced with a view to allow a better exploitation of the system at both Headquarters and Delegations.














(d)


the financial information provided by Delegations about audits should be better reviewed by EuropeAid headquarters to ensure it is complete and consistent. This should be supported through headquarters' audits carried out by all directorates (see paragraphs 8.10 and 8.13);












(d)


As explained in paragraph 8.10, information on audits is ensured through the current system. Moreover, in order to further improve and focus the information provided by Delegations, the format of Delegations' regular reports has been recently revised, including the section and the annex relating to audits.
All Directorates carry out monitoring/verification missions of their Delegations' management of devolved operations. EuropeAid intends to promote the use of best practice for these assessments, building on the experience acquired, and is developing a harmonised methodology.














(e)


the Commission should ensure that management capacity of the national implementing agencies is assessed before decentralisation (see paragraph 8.19).












(e)


The Commission has always been aware of the need to assess the ability and the quality of the national implementing agencies and will continue to ensure that all the aspects linked to that assessment are complied with.








FOLLOW-UP OF PREVIOUS OBSERVATIONS




Verifications of United Nations organisations




Introduction










8.24.


Previous annual reports have highlighted problems of access to UN organisations' documentation by the European Court of Auditors (13). In its resolution on the discharge of the EU general budget for 2004, the European Parliament requested the Commission to clarify the Court's right of access to projects managed by UN agencies (14).












8.24.


The Court's right of access to documentation of projects was raised and reiterated in the 3rd Working Group of the Financial and Administrative Framework Agreement (FAFA) between the Commission and the UN.








The Financial and Administrative Framework Agreement (FAFA)










8.25.


The Financial and Administrative Framework Agreement (FAFA) sets out the framework for managing the financial contributions made by the European Commission to the United Nations. It contains a verification clause, first agreed in 1994, which allows the European Communities to undertake on-the-spot checks relating to operations they have financed. The same clause requires the United Nations to make available to the European Communities all relevant financial information.






 




Progress in 2005 in seeking agreement with the UN on aspects of financial control










8.26.


The Commission and the United Nations created a verification sub-working group within the FAFA Working Group, i. a. to address the problems of access to documentation experienced by both the Court of Auditors and the Commission (15). This sub-working group met in December 2005, proposing confidence building measures for the medium and longer term with the aim of demonstrating the assurance provided by UN bodies to the Commission's Authorising Officers and improving coordination with the Commission. The sub-working group also highlighted the need in the shorter term for concrete measures to resolve disputes over problems arising during verifications.












8.26.


The Court correctly focuses on the importance of the successful implementation of the verification clause that underpins the FAFA and acknowledges the Commission's and UN's efforts in deepening the renewed partnership.














8.27.


A sub-working group was also created to produce guidelines regarding an agreed level of detail needed when UN agencies report on the implementation of projects. Only where UN reports provide insufficient detail, Article 2 of the FAFA enables the Commission to request a specific format for reports. The reporting sub-working group met in March and December 2005, and confirmed that practical guidelines were necessary to address the shortfalls in reporting.






 




Conclusion










8.28.


The Commission is discussing with the UN within the framework of the FAFA a number of verification aspects. Additional work is ongoing to develop clear guidelines and procedures to strengthen assurance provided by the effective use of controls regarding UN projects funded by the Commission (16).












8.28.


As acknowledged by the Court, the Commission, in the spirit of partnership, focuses with the UN on the search of mutually acceptable solutions in the areas referred to by the Court.




The FAFA working group is the institutional forum to address these and other future issues.




Special Report No 25/98 concerning activities undertaken by the European Union in the field of nuclear safety in Central and Eastern Europe (CEEC) and in the New Independent States (NIS) from 1990 to 1997




Introduction










8.29.


In 1998 the Court published Special Report No 25/98 on nuclear safety activities financed under the PHARE and TACIS programmes (17). In its Annual Report concerning the financial year 2000 the Court published the results of the first follow-up review of the above report concluding that:










(a)


the Commission had clarified its strategy, but did not have specific performance indicators for the measurement of progress in nuclear safety,










(b)


it was necessary to allocate adequate human resources to the programme management and increase the involvement of the Delegations,










(c)


strict time limits in tender preparation should be imposed,










(d)


more generally, stricter conditions for the interventions were needed, and










(e)


the limited ownership and commitment of beneficiaries and insufficient coordination between projects was to be tackled.




Subsequently the Council (18) welcomed the action taken by the Commission in response to the Court's original Special Report and noted the remaining shortcomings.


 










8.30.


The objective of this second follow-up review was to assess to what extent the Court's observations had been addressed. The scope of the second review was limited to the nuclear safety interventions financed under the TACIS programme in the Russian Federation and Ukraine (excluding the Chernobyl Nuclear Power Plant (NPP)).






 










8.31.


TACIS funds allocated to nuclear safety amounted to 774 million euro during the period from 1991 to 2000. From 2001 to 2005 the allocation was 342 million euro (excluding funds for the Chernobyl NPP).






 




Intervention strategy clarified but not free of shortcomings










8.32.


The Commission had laid out its new strategy for future assistance to nuclear safety in the NIS and in the CEEC in its Communication to the Council and the European Parliament in September 2000 (19). This strategy document is consistent and comprehensive. However, its implementation is not free of shortcomings.












8.32.


As regards the implementation of the intervention strategy please refer to the replies provided below.














8.33.


The transfer of western safety culture to NPPs in the NIS has been the main objective of all the TACIS interventions. At the level of NPPs this has been addressed through offering both ‘soft’ on-site technical assistance and modern equipment. Since 2001 the Commission has applied a new two-phased approach whereby the actual Plant Improvement Projects are implemented only after the completion of a Preliminary Project Planning phase. In 2005 the Court found that the planning system was well designed and the approved projects were relevant and ready for implementation.






 










8.34.


Whilst the EU has contributed to the transfer of safety culture to the NPPs, more attention has been paid only recently to the treatment of radioactive waste, although it is part of the intervention strategy. At the end of 2005 national waste management strategies were only at early stages of development in both countries and the implementation of preparatory phases of a limited number of radioactive waste treatment projects for NPPs had commenced despite the importance attached to the issue by all parties.












8.34.


Attention has increased in the recent years to the treatment of radioactive waste, since it is part of the intervention strategy. Several projects regarding radioactive waste treatment at the level of the NPPs have been initiated in line with the importance attached to the issue by all parties.














8.35.


The International Atomic Energy Agency (IAEA), and others, have established performance indicators for the NPPs. The national regulatory authorities report annually on safety standards to the IAEA in a global manner. According to their information, the indicators have progressively demonstrated improvements. The Commission has access to this information and considers that there is no need to develop its own general safety indicators.






 










8.36.


The Commission should, however, be able to verify the effectiveness of TACIS expenditure. Still at the end of 2005, it was not possible for the Commission to establish the contribution of the TACIS programme to the improvement of safety at the level of individual NPPs. The Commission does not receive information from the NPPs or from its own technical assistance teams. Under these circumstances it is difficult (if not impossible) to set rationally the objectives for future spending in this area, to plan the activities and to design a possible exit strategy.












8.36.


An evaluation of all the on-site assistance projects has been launched in 2006 to analyse the impact.




In order to establish the objectives for future spending in this area and to plan future activities, an initiative will be developped in cooperation with IAEA (Vienna) which should result in an overall joint assessment of the present safety level of VVER type reactors in Ukraine and Russia.




Human resources and programme management have improved










8.37.


At the level of its central services the Commission has reinforced the unit responsible for the operational management of the TACIS nuclear safety programme by deploying 50 % more permanent staff. It has also secured the services of the Joint Research Centre — Institute for Energy in the programme management.






 










8.38.


In Moscow and Kiev the Commission has involved its Delegations in programming and implementation. At the end of 2004 a Joint Support Office was set up in Kiev to support the beneficiary organisations and the Commission. It is similar to the Joint Management Unit in Moscow, established in 1997 and has contributed to making nuclear safety interventions more efficient and effective, as explained below. However, the Commission has not sufficiently defined the roles, functions and mandates of the Delegations and the support offices.












8.38.


Due to centralised management of the programme, the Delegation involvement has been limited. Should the devolution in the nuclear safety be implemented, provided it fits with the objective to improve nuclear safety and to deliver better programme management, the role, functions and mandates of the Delegations and the Support Offices will be defined accordingly.








Project implementation has improved, but some problems persist










8.39.


The cumulative contracting backlog (20) remained stable until the end of 2002, when it was 168 million euro, and was reduced to about 108 million euro by the end of 2004. The average lead time needed for a contract to be signed was reduced from around 700 days in 2000 to 200 days in 2005.






 










8.40.


During project implementation delays continue to accumulate throughout the process. The Commission has not imposed strict time limits on the parties involved. The Commission statistics show that the delays were mostly due to long response times of the beneficiary organisations. The n + 3 rule, introduced by the Financial Regulation (21), is, however, motivating all stakeholders to act more quickly.












8.40.


Because of the complex nature of the nuclear safety projects, delays can occur during project implementation. The Commission has avoided imposing strict limits on the parties involved due to the high priority objective of improving nuclear safety in completing the projects, which prevails over the issue of project delays. However steps are taken to avoid such delays; the Commission supervises the project partners (Contractors, beneficiairies and Contracting Authorities) so as to ensure the best efficiency and delivery.














8.41.


The many problems linked to the procurement of equipment continued to cause very long delays (in some cases up to four years) in the NPP projects. They were related to 8.29(a) the design and approvals of the technical specifications, 8.29(b) the procurement procedures, which the many and often inexperienced participants found complex and inflexible; and 8.29(c) limited competition caused by highly specialised technology and the small number of potential suppliers.












8.41.


Due to the technical complexity each of the industrial projects (PIP — Plant Improvement Project) is decided only after the execution of a preliminary project (PPP — Plant Preparation Project). The PPP allows the identification of the tasks and conditions that will form the basis of the PIP as second phase. Such initial phases are essential to get the matured definition and the licensing activities required to achieve the highest safety impact.














8.42.


The Court found no violations of regulations in the procurement processes for the service and supply contracts reviewed in 2005. However, problems persisted with regard to exemption from VAT for equipment purchased domestically or imported.












8.42.


The Commission is aware of the persisting problems regarding the compliance by the beneficiary countries' authorities with the rules for VAT exemption as stipulated by the TACIS regulation. This problem is regularly highlighted at the political level, unsuccessfully as of today.








Involvement of beneficiaries has improved slightly










8.43.


The structures and administrative capacities of the Russian and Ukrainian nuclear safety authorities at the central level have been reinforced. In 2005 the authorities in both countries expressed their satisfaction with the development of their involvement in the planning and implementation of TACIS activities.






 










8.44.


The western on-site experts and the NPPs emphasised their overall improved cooperation. Project ownership and general commitment to safety improvement by the NPPs themselves had been satisfactory. However, the central level of the utility companies, i.e. the owners of the NPPs, did not effectively participate in the dissemination or replication of project results.












8.44.


The Commission has developed with the contributions of the JRC-IE Petten two projects (one for Russia, one recently for Ukraine) dedicated to the dissemination of the main projects results among the end-users (NPPs and institutes).




In the next programme major efforts will be devoted to the improvement of safety culture in the beneficiary countries Russia and Ukraine. This will encompass the dissemination of the best practices together with the activities required for transferring the projects results at the level of the end — user (NPPs).










8.45.


Despite the positive developments, obtaining required information and data from Russian and Ukrainian institutes on the design parameters of the NPP installations continued to be difficult.






 




Conclusion and recommendations










8.46.


Since 2000 the Commission has made major improvements in the management of the NSP. To improve the effectiveness of the programme further the Court recommends that the Commission should further strengthen:












8.46.


The Commission will further strengthen:














(a)


the implementation of its intervention strategy by:












(a)


the implementation of its intervention strategy:














 








(i)


developing a system of measurement of the impact of the TACIS NSP at the level of individual NPPs and setting verifiable objectives for the new programming period,
















 








(i)


The Commission is working on a possible method for measuring the impact of the Tacis projects at the level of individual NPP and the dissemination in the entire nuclear sector. These efforts will have to be integrated during the early stage of the next programme.


















 








(ii)


increasing the efforts of identifying and implementing projects also in the area of radioactive waste, and
















 








(ii)


The Commission shall study with the beneficiaries additional projects in the area of radioactive waste considering the most important priorities.


















 








(iii)


introducing an approach involving the whole utility company in the dissemination and replication of the project's results; and
















 








(iii)


The Commission aims at implementing projects with the greatest implication of the beneficiary and end-users at the technical, managerial and financial levels, without making it conditional.


















(b)


the management of the programme by:












(b)


the management of the programme:














 








(i)


increasing the involvement of the Delegations, allocating adequate human resources and clarifying their responsibilities,
















 








(i)


The Commission shall study the increased involvement of the Delegations, provided it fits with the objectives of improving nuclear safety and better programme management, including allocating adequate human resources and defining their responsibilities.


















 








(ii)


considering making any further funding conditional on the beneficiary meeting contractual obligations,
















 








(ii)


The Commission will continue to urge the beneficiary countries to respect their contractual obligations.


















 








(iii)


analysing in detail the whole process of procurement of equipment and applying tested best practices, e.g. co-financing, to make these processes more efficient.
















 








(iii)


The Commission shall review the whole process of procurement of equipment bearing in mind that it should not contradict the objective of improving nuclear safety and offer better project management conditions.












SPECIAL REPORTS ISSUED SINCE THE LAST ANNUAL REPORT










8.47.


The Court has published four Special Reports relevant to external actions in the last twelve months concerning:










(a)


the performance of projects financed under TACIS in the Russian Federation (Special Report No 2/2006),










(b)


the European Commission Humanitarian Aid Response to the Tsunami (Special Report No 3/2006),










(c)


the MEDA programme (Special Report No 5/2006),










(d)


the environmental aspects of the Commission's development cooperation (Special Report No 6/2006).




They can be found on the Court's website (www.eca.europa.eu).


 






(1)  Aid provided through the European Development Funds is reported separately as it is not financed from the general budget.

(2)  The CARDS programme promotes stability and peace in the Western Balkan Countries.

(3)  More than 60 % of the CARDS commitments in 2005.

(4)  The Delegations visited were those of Albania, Colombia, Croatia, India, Georgia and Lebanon.

(5)  Paragraph 7.17.

(6)  See the Annual Report concerning the financial year 2004, paragraph 7.21.

(7)  See the Annual Report concerning the financial year 2004, paragraph 7.19.

(8)  See the Special Report No 3/2006 concerning the European Commission Humanitarian Aid Response to the Tsunami, paragraph 37.

(9)  The geographic directorates are: Asia and Central Asia; Europe, the Southern Mediterranean, Middle East and Neighbourhood Policy; Latin America.

(10)  Most elements function, but some need to be improved.

(11)  The Internal Audit Capability focused on system analysis and has not yet tested the systems; in the case of DG ECHO, testing started in 2005, according to the Commission, and this procedure will be completed during 2006.

(12)  Improvements are necessary for external audits commissioned by implementing organisations; new measures, introduced by the Commission should have an impact for 2006.

(13)  The Annual Reports concerning the financial years 2001 and 2004 described the difficulties of the Court in accessing data from UN agencies. The Annual Report concerning the financial year 2004 recommended that the Commission should clarify with UN agencies the Court's right of access to projects managed by them. In 2005 no UN agencies were selected for the Court's audit work for the Statement of Assurance.

(14)  Paragraph 171 of the resolution included in the report on the discharge for implementation of the European Union general budget for the financial year 2004 A6-0108/2006.

(15)  Article 13 of the Financial and Administrative Framework Agreement (FAFA) establishes a working group to meet at least once a year to promote a regular exchange of information on all matters arising out of the Agreement.

(16)  In a case of a UN project in Indonesia, after initial reticence DG ECHO was given access in 2005 through the proper application of FAFA.

(17)  OJ C 35, 9.2.1999.

(18)  Council Recommendation on the discharge for 2000.

(19)  COM(2000) 493 final, 6.9.2000.

(20)  RAC (reste à contracter).

(21)  See Article 166 (2) of Council Regulation (EC, Euratom) No 1605/2002 of 15 June 2002 (OJ L 248, 16.9.2002, p. 1): ‘Financing agreements with the beneficiary third countries….. shall be concluded by 31 December of year n+1 at the latest, year n being the one on which the budgetary commitment was made. The individual contracts and agreements which implement such financing agreements shall be concluded no later than three years following the date of the budgetary commitment. Individual contracts and agreements relating to audit end evaluation may be concluded later.’



CHAPTER 9
Pre-accession strategy
TABLE OF CONTENTS
Introduction
Specific assessment in the context of the statement of assurance
Scope of the audit
Audit findings
Legality and regularity of the underlying transactions
Supervisory and control systems
Conclusions and recommendations
Special Reports issued since the last Annual Report






THE COURT'S OBSERVATIONS


THE COMMISSION'S REPLIES




INTRODUCTION










9.1.


This chapter of the annual report deals with Heading 7 of the Financial Perspectives covering expenditure under the pre-accession instruments (Phare, ISPA and Sapard) for Central and Eastern European countries (1), and the pre-accession assistance programme for Turkey.






 










9.2.


The Phare programme (2) and the pre-accession assistance programme for Turkey (3) are managed by the Directorate-General for Enlargement. These pre-accession programmes support institution-building and investments. ISPA (4) was set up to facilitate accession in the fields of environment and transport and is managed by the Directorate-General for Regional Development. Sapard (5) is implemented under the responsibility of the Directorate-General for Agriculture and aims to help the beneficiary countries deal with problems arising from structural adjustment in their agricultural sectors and rural areas and to contribute to the implementation of the Common Agricultural Policy.






 










9.3.


The Phare, Turkey and ISPA programmes and projects are mainly implemented through a Decentralised Implementation System (DIS), with ex-ante control of procurement and contract award decisions carried out by the Commission Delegations, or through the Extended Decentralised Implementation System where the Commission’s ex ante control of tendering and contracting is waived (EDIS) (6). Under decentralised management, the payments to contractors and beneficiaries are made by the national authorities with ex-post control by the Commission.






 










9.4.


Sapard on the other hand, is also implemented in a decentralised manner, but without ex-ante approval by the Commission for project selection, tendering and contracting. Based on its own assessments, the Commission has conferred management of the programme on each beneficiary country. Implementation and payment functions are the responsibility of accredited paying agencies, which reimburse expenditure incurred by beneficiaries. Each paying agency is required to provide the Commission annually with a certificate on its accounts and an audit report by an independent certifying body. The Commission checks to ensure that systems are adequate and are operating as intended and carries out clearance of accounts procedures at the end of a financial year.






 










9.5.


In 2005, payments under the pre-accession programmes totalled 2 985 million euro. 
Graph 9.1
 shows a breakdown of the funds committed and spent in 2005. For the eight Central and Eastern European countries that became Member States in 2004, no new expenditure was committed after accession (except for Sapard, where some commitments were made up to the end of 2004) although payments will continue until at least 2006. Former ISPA projects in those countries are treated as Cohesion Fund projects.






 




SPECIFIC ASSESSMENT IN THE CONTEXT OF THE STATEMENT OF ASSURANCE




Scope of the audit










9.6.


For the Phare and Turkey programmes, the Court:










(a)


carried out substantive tests on transactions under central management at the level of the Commission (8 payments) and transactions under decentralised management in Bulgaria, Romania and Turkey (26 individual tenders and 39 payments under 13 projects); and






 
























(b)


evaluated the supervisory and control systems, with a specific focus on the operation of systems for the control of national co-financing agreements (11 projects tested in Bulgaria, Latvia, Poland, Romania and Slovakia) the system for procurement under EDIS (13 tenders tested in Latvia, Poland and Slovakia) and decentralized management in Croatia (7).






 










9.7.


For ISPA, the Court performed a limited review at the Commission involving mainly an examination of Commission activities concerning management and control systems in one of the candidate countries (Croatia) and in the accession countries (Bulgaria and Romania), including an examination of the advancement of EDIS for the latter countries. The audit did not involve an examination of specific underlying transactions.






 










9.8.


For Sapard, the Court's audit comprised tests of control and tests of transactions in Bulgaria and Romania on five projects in each country, covering the main measures implemented at the time of the audit. These audits involved verifying the project documentation in the respective paying agencies and the legality and regularity of the projects on-the-spot. The audit also involved an appraisal of the supervisory and control systems including the Commission's review of the certifying body's reports.






 




Audit Findings




Legality and regularity of the underlying transactions










9.9.


For the Phare and Turkey programmes, the transactions tested by the Court were not affected by material errors. However, for the Phare Programme the Court found, under expenditure declared as parallel national co-financing, some ineligible expenditure, mainly VAT, as well as expenditure incurred outside the eligible time period. In reaction to the Commission's reply, the Court would like to repeat that the Directorate-General for Enlargement's acceptance of VAT as eligible expenditure under parallel co-finanicing does not have a legal basis. The Phare regulation excludes VAT from community funding, and the purpose of that exclusion would be circumvented if VAT were eligible for co-financing (8).












9.9.


No material errors have been found for these transactions. The treatment of VAT as eligible expenditure under national parallel co-financing, is consistent with the Phare regulation, since the Commission considers that this regulation sets out the rules applicable to Community financing only.




In the Financing Memorandum, the deadlines for contracting and disbursing refer to the ‘EC Grant’. The National Authorities can therefore argue that these dates are applicable only to the EU contribution and not to their co-funding.










9.10.


The Sapard transactions audited by the Court were affected by significant errors. The Court found that changes in procedures for approving Sapard projects in Bulgaria had not been given the necessary prior approval by the Commission. Sapard expenditure of 3,4 million euro in respect of 53 projects was therefore ineligible. In both Romania and Bulgaria, the Court found projects where beneficiaries did not comply with their contractual obligations. In particular, one project audited in Romania was found to have been ineligible for EU financing because the essential conditions governing the use of the grant aid facilities were not met. Furthermore, certain requirements had not been adequately checked by the paying agencies leading to cases of acceptance and payment of projects without adequate evidence to ensure compliance with eligibility criteria.












9.10.


The Commission considers that these errors, including the cases for non-respect of contractual obligations by beneficiaries, are not significant in the case of Bulgaria.




The Commission regrets that the Bulgarian authorities did not request prior approval for the procedural changes that were introduced. It has expressed its concerns to them, and reminded them of the obligation to submit any proposed changes to the procedures to the Commission before their implementation. However, it considers that this does not affect the eligibility of the projects. In 2005 an Estonian consultant rejected the new procedure, but a subsequent audit carried out by an external auditor, concluded ‘that there are no significant risks resulting from the application of the Limited Time Procedure’. All the controls were undertaken before payment.
For the point concerning projects where contractual conditions were not respected, and for the checking of requirements, the Commission has examined additional information and considers that these are not significant errors.




Supervisory and control systems










9.11.


The reviewed closure audit reports, relating to projects financed under the 1999 and 2000 Phare national programmes and submitted during the year by the contracted external auditors were corroborated by the results of the Court's tests of transactions, where a financially insignificant level of error was found.






 










9.12.


For Phare and ISPA, the EC Delegations' ex-ante control of the tendering and awarding of contracts under decentralised management continued to be an effective key control to ensure the legality and regularity of the underlying transactions.






 










9.13.


For the Phare and Turkey programmes, the Court's audit revealed a relatively high frequency of corrective actions resulting from the Delegations' ex-ante controls. This is indicative of the weak functioning of the national supervisory systems in the accession and candidate countries. However, the ex-ante approval procedure has not been standardised and the scope of the checks has not been clearly defined.












9.13.


The ex-ante control is the key element of a learning process where the national implementing bodies are looked upon with the aim to improve steadily their management capacity on their way to the accreditation to EDIS. As a consequence, the tightness of the controls may vary in time when the management capacity is found to have improved, so that a driven-through codification of the procedure did not appear to be necessary.














9.14.


The control of national co-financing agreements under Phare has improved, especially in Romania, where the Implementing Agencies included monitoring of parallel national co-financing in their normal control procedure. However, at Commission level, the Court found that in the Directorate-General for Enlargement there was no systematic procedure for reminding the national authorities about their obligation to submit final declarations on time and no checklists had been developed for the review process.












9.14.


The Commission is doing its utmost to obtain the final declarations within the period stipulated in the financing agreements, occasionally suspending payment requests. But some countries do have difficulties in sending in the documents on time. In order to give the National Funds more time to collect the necessary information, the period allowed for submitting the declarations has been lengthened.














9.15.


With the granting of EDIS in the new Member States, specific implementing agencies were accredited to implement the Phare programme without the Commission's ex-ante control of tendering and contracting. However, the Court found cases (9), where the accredited implementing agencies were not the actual contracting authorities and did not always exercise the type of control foreseen in the EDIS accreditation. Nevertheless, the process of implementing EDIS was a major step towards improving management capacity and control systems in the new Member States.












9.15.


Given the depth and breadth of the control systems established in the accreditations it is not surprising that some failures to exercise at least some controls foreseen in the accreditation can be identified. During the follow-up audits carried out in all EDIS-accredited countries situations like the ones described by the Court have been identified. In all these cases the Commission has demanded information and actions from the National Authority and where appropriate has considered action (suspending payments etc.).














9.16.


The EDIS accreditation process for Phare and ISPA in Bulgaria and Romania was further delayed. Romania submitted its EDIS application at the end of 2005, while Bulgaria had not submitted an application by that date. Both countries had planned to have EDIS in place by January 2006 (10). Furthermore, in the case of ISPA, the Court noted a combination of incompatible management and control functions within the Ministry of Finance in Bulgaria, while the Managing Authority for Infrastructure as National ISPA Coordinator in Romania was inadequately resourced.












9.16.


The delays mentioned by the Court took place despite pressure from the Commission for stronger action on the part of the National Authorities concerned.




In Romania, on-the spot audit missions have been undertaken based on applications received. The Commission granted EDIS accreditation to all ISPA implementing agencies on 28 June 2006. It hopes to grant accreditation for Phare by the end of 2006.
Bulgaria has been slower in presenting its applications and, for both ISPA and Phare, the accreditation process will only be possible after some further on-the-spot audit work which in both cases is expected to take place before end of autumn 2006.
In March 2006, the problem of segregation of functions for ISPA in Bulgaria was resolved through a reallocation of responsibilities. Following recommendations by the Commission, the staffing level of the National ISPA Coordinator (NIC) in Romania considerably improved in 2006.










9.17.


The Court's audit in Bulgaria and Romania found that the Sapard systems included the key concepts but their functioning showed weaknesses:












9.17.


 














(a)


the documentation underlying public tenders in Romania did not ensure that bids were received within the deadlines and were duly examined;












(a)


The Romanian authorities have already taken action following problems in public tendering procedures at municipalities. Since June 2005, experts from the Regional Offices have had to participate in the opening of all tenders and take copies of all the tenders received, to provide additional assurance that tendering procedures are respected. The Commission is examining the operation of public tendering procedures in Romania and will follow up the observations of the Court in this context via the clearance of accounts process.














(b)


no appropriate supporting documents were provided for the reimbursement of certain amounts (11) to the beneficiaries, which meant that the paying agency was not able to ensure whether they had been really incurred and/or were eligible (Romania). In Bulgaria, some expenditure is reimbursed (by Sapard) on a flat rate basis. The precise composition and justification of these amounts could not be established;












(b)


The Romanian authorities have notified the Commission of the method used to calculate these additional costs and consider that comprehensive supporting documents are included in all the payment files. As the calculations of price increases normally exceed the maximum thresholds of 5 % or 10 %, this gives the impression that the thresholds are automatically applied, which is not the case. This will be verified in the clearance of accounts process.
Regarding the reimbursement of flat rate amounts by the Bulgarian Sapard Agency, beneficiaries are paid the lower of the flat rate (usually an amount per square meter) and the invoiced amount. This ensures that, at most, only invoiced amounts will be co-financed.














(c)


systems to check the reasonableness of prices (such as a price data base) affecting eligible amounts were not yet in place in Romania and they were not fully operational and documented in Bulgaria;












(c)


The Commission shares the Court’s concern. The existence of databases, while not a regulatory requirement, could provide even greater assurance of sound financial management in private purchasing.














(d)


some invoices for high value items were settled by the beneficiary in cash (Bulgaria), which is more difficult to verify and therefore presents a higher risk.












(d)


The Commission accepts that payments in cash are a higher risk.














9.18.


In the Court's Annual Report concerning the financial year 2004 (12) it was highlighted that the quality of the assessment of the Sapard applications, and the related payment claims, carried out at the end of the contracting period presented a higher risk due to time pressure and possible staff shortages. The importance of this risk was confirmed by the situation found in Hungary in 2005, where the procedure for project approval was modified by reducing the checks on project applications. The changes were applied from April 2004 without the Commission having granted its prior approval. The relevance of this risk is therefore reiterated.












9.18.


It is regrettable that the Commission was not informed about the changes in the Hungarian procedures. However, it has now examined the impact of the changes and considers that sufficient controls were in place.








CONCLUSIONS AND RECOMMENDATIONS










9.19.


Overall, taking into account the audit scope (paragraphs 9.6-9.8), the transactions audited by the Court were not materially affected by error except for the transactions financed under the Sapard Programme, where significant errors were found. While the Court noted improvements in the supervisory and control systems at the level of the Commission, important weaknesses were noted at national level. In the case of the Phare and Turkey Programmes and ISPA projects, the relatively high frequency of these weaknesses were compensated by corrective action resulting from the Delegation's ex-ante controls.












9.19.


The Commission welcomes the Court’s conclusion that there have been improvements in the supervisory and control systems at the level of the Commission. The Court’s special report 4/2006 concerning Phare investment projects in Bulgaria and Romania concluded that the Commission’s checking of projects prior to financing proved effective in preventing irregularities in the procurement process.




The Commission recognises that errors have been found for Sapard, however, with the possible exception of public tendering in Romania, it does not consider that these are significant.
The Commission is of the opinion that the overall situation relating to Sapard implementation in 2005 is broadly similar to that for 2004.










9.20.


The Court recommends that the Commission:












9.20.


 














—


monitor closely the effective functioning of national supervisory and control systems, notably as far as award and payment procedures are concerned,












—


The Commission will continue to monitor closely the effective functioning of national supervisory and control systems.














—


clearly define the procedures to be applied by the Delegations in the ex-ante control process,












—


The Commission considers that these procedures are already clear. However, the Commission is ready to review the procedures in the light of the experience gained in the last years.














—


give a higher priority to the follow-up of final declarations of expenditure for Phare programmes, especially as regards parallel co-financing,












—


The Commission is doing its utmost to obtain the final declarations within the period stipulated in the financing agreements.














—


for Sapard, pay particular attention to the risks associated with projects approved during the end of the contracting period,












—


The Commission is aware of the potential risk, but has so far found no evidence of a resultant financial risk.














—


ensure, through close monitoring, that no changes to the accredited procedures are introduced by the Sapard paying agencies without its prior approval.












—


The countries concerned are regularly reminded of the obligation to submit any proposed procedural changes to the Commission before their implementation. The Commission will examine unapproved changes in procedures and assess their control impact as appropriate.








SPECIAL REPORTS ISSUED SINCE THE LAST ANNUAL REPORT










9.21.


The Court has published a Special Report relevant to the pre-accession strategy in the last twelve months concerning the Phare Investment projects in Bulgaria and Romania (Special Report No 4/2006). It can be found in the Court's website (www.eca.europa.eu).






 






(1)  The eight new Member States (Czech Republic, Estonia, Latvia, Lithuania, Hungary, Poland, Slovenia, the Slovak Republic) and the two accession countries (Bulgaria, Romania) and the candidate country Croatia.

(2)  Poland, Hungary and Restructuring in the East, Council Regulation (EEC) No 3906/89 (OJ L 375, 23.12.1989, p. 11).

(3)  Council Regulation (EC) No 2500/2001 of 17 December 2001 concerning pre-accession financial assistance for Turkey (OJ L 342, 27.12.2001, p. 1), corrected by OJ L 285, 23.10.2002, p. 26.

(4)  Instrument for Structural Policies for Pre-Accession, Council Regulation (EC) No 1267/1999 (OJ L 161, 26.6.1999, p. 73).

(5)  Special Accession Programme for Agriculture and Rural Development, Council Regulation (EC) No 1268/1999 (OJ L 161, 26.6.1999, p. 87).

(6)  EDIS was granted to the eight new Central and Eastern European Member States where specific implementing agencies were accredited to implement the Phare and ISPA programme without the Commission's ex-ante control of tendering and contracting.

(7)  The first Phare programme in Croatia was committed in 2005. In order to test Croatia's management capacity the Court audited transactions financed under the CARDS programme and implemented by the national authorities.

(8)  See Annual Report concerning the financial year 2004, paragraphs 8.24-8.26.

(9)  Latvia, Poland.

(10)  See Annual Report concerning the financial year 2004, paragraph 8.18.

(11)  Labelled as ‘actualisation costs’ and ‘costs for unforeseen circumstances’.

(12)  Paragraph 4.70.



CHAPTER 10
Administrative expenditure
TABLE OF CONTENTS
Administrative expenditure of the institutions and Community bodies
Introduction
Specific assessment in the context of the Statement of Assurance
Audit scope
Legality and regularity of underlying transactions
Supervisory and control systems
Specific observations
Parliament
Council
Commission
Court of Justice
Court of Auditors
European Economic and Social Committee
Committee of the Regions
European Ombudsman and European Data-Protection Supervisor
Overall conclusion
Special Reports issued since the last Annual Report
European Union Agencies
The European Schools






THE COURT'S OBSERVATIONS


 




ADMINISTRATIVE EXPENDITURE OF THE INSTITUTIONS AND COMMUNITY BODIES




Introduction










10.1.


This chapter covers the administrative expenditure of the Institutions and other bodies. The appropriations relating to this expenditure are managed directly by each Institution or body and are used to pay the salaries, allowances and pensions of persons working for the Institutions, as well as rent, purchases and miscellaneous expenses. In 2005 administrative expenditure by the European Union's institutions was 6 191 million euro, as further specified in 
Table 10.1
.






 




Table 10.1 — Payments by Institution







(million euro)




 


2004


2005




European Parliament


1 166


1 235




Council


507


533




Commission


3 721


3 952




Court of Justice


216


211




Court of Auditors


84


92




European Economic and Social Committee


92


96




Committee of the Regions


63


64




European Ombudsman


5


6




European Data Protection Supervisor


1


2





Total




5 856




6 191









Specific assessment in the context of the Statement of Assurance




Audit scope










10.2.


The audit appraised the legality and regularity of the transactions underlying the accounts of the Institutions’ administrative expenditure, in order to provide a specific assessment in the context of the statement of assurance. The Court carried out substantive tests on a representative sample of transactions and evaluated the supervisory and control systems put in place by the autorising officers of the institutions.












10.2.


THE REPLY OF THE EUROPEAN PARLIAMENT
In Parliament, the self appraisals carried out by the authorising officers by delegation on the basis of the minimum management and internal control standards laid down for 2005 show that their supervisory and control systems are continuing to improve in terms of quality and reliability, as the action plans and the Internal Auditor's recommendations are implemented.














10.3.


Past audits by the Court had shown that the errors found were not material nor due to serious weaknesses in the control systems. A follow-up to observations from past Annual Reports is presented in 
Table 10.2
.












10.3.


THE REPLY OF THE EUROPEAN PARLIAMENT
See reply in the last column of table 10.2.










10.3.


REPLY BY THE COUNCIL
The Court presents in table 10.2 the follow-up to observations made in the past, in particular the payment of additional annual leave. It concludes on one hand that the GSC has taken appropriate action in order to gradually eliminate the stock of compensatory leave but on the other hand it states that the payment of additional annual leave, which is an integral part of the action taken, should be discontinued.








 


The GSC is fully aware that certain of its internal rules regarding compensation for work outside standard hours went beyond the provisions of the Staff Regulations and are therefore ‘praeter legem’. These rules were designed to take account of the impact on officials' health of the particularly demanding working hours (notably long night sessions and sessions during holidays) imposed by the political imperatives linked to the Council's particular role in the legislative process.
However, on the basis of a number of fundamental changes to the Council working methods, the SGC took a broad array of measures with the intention to correct the anomalies which have arisen over the years. These specific measures aim at aligning GSC rules and practices with the Staff Regulations as quickly as possible. At the same time, they have to avoid the disruptive consequences that a solution based exclusively on leave would have on the operation of the GSC. Furthermore, they take account of the legitimate expectations which the officials concerned have developed based on the longstanding former GSC rules, and which make it hard to justify an abrupt end to the practice.
The action taken to eliminate the stock of additional leave granted before 31 December 1997 and which the Court qualifies as appropriate, can be summarised in the following way:






—


An appeal to officials to use up stocks of compensatory leave on a voluntary basis (Staff Note 80/05 of 17 May 2005) already led to a reduction of the stocks by approximately one third.










—


Specific measures to eliminate the remaining stocks were announced in Staff Note 25/06 of 10 February 2006 and confirmed in Staff Note 115/06 of 30 June 2006.










 








—


compulsory liquidation of all stocks over 25 days;














 








—


liquidation over maximum period of four years (2006-2009) at a minimum rate of 25 % per year;














 








—


liquidation is to take the form of leave or payment, with automatic payment at year end of that part of the compulsory 25 % which has not been used up through ‘temps libre’;














 








—


stock remaining on departure from GSC will be paid.








In conclusion, as spelled out above, the GSC shares the opinion of the Court that the existing stocks should be eliminated as soon as possible.




Table 10.2 — Follow-up to observations from past Annual Reports








Observations


Action taken


Further action needed?


Parliament's reply




Payment of additional annual leave not taken




Annual Report concerning the financial year 2004, paragraph 9.18:




At the Council additional annual leave granted before 31 December 1997 as a compensation for overtime is paid on retirement if the official has not taken the additional leave. As staff of the A and B categories are not entitled to compensation for overtime, such payments are not in accordance with Article 56 of the Staff Regulations.


The General Secretariat has taken appropriate action in order to gradually eliminate the stock of compensatory leave for A and B staff granted before 31 December 1997.


The payment of additional annual leave not taken should be discontinued.


 





Additional pension scheme for Members of the European Parliament



 


 


Legal basis for Parliament's contribution to the non-profit-making association ‘Pension Fund — Members of the European Parliament’:




Annual Report concerning the financial year 2002, paragraphs 9.17 to 9.20:
If the additional pension scheme for Members of the European Parliament is to continue, a sufficient legal basis has to be created as soon as possible. There should be clear rules established in the scheme to define the liabilities and responsibilities of the European Parliament and of the members of the scheme in the case of a deficit.


The additional pension scheme is mentioned in Article 27 of the Statute for Members of the European Parliament adopted by the Parliament on 28 September 2005. The Statute will enter into force on the first day of the European Parliament parliamentary term beginning in 2009. No rules have been established defining the liabilities and responsibilities of the European Parliament and of the members of the scheme in the case of a deficit.


Until the first day of the European Parliament parliamentary term beginning in 2009 the Statute has no legal effect and cannot provide a legal basis for the parliamentary contribution to the ASBL pension fund. Appropriate rules should be established defining the liabilities and responsibilities of the European Parliament and of the members of the scheme in the event of a deficit.



Article 27 of the Statute for Members stipulates that the Pension Fund‘shall be maintained after the entry into force of this Statute for Members or former Members who have already acquired rights or future entitlements in that Fund’. By employing the word ‘maintained’, the Statute implicitly acknowledges that there is a legal basis for the Pension Fund which also covers the period prior to the entry into force of the Statute. The transitional period, from the adoption of the Statute by means of a Parliament decision of 28 September 2005 to the entry into force of the Statute in 2009, can therefore be regarded as being covered by Article 27 of the Statute. The legal basis valid for the period prior to the adoption of the Statute is specified in Parliament's reply to paragraph 9.18 of the Court's annual report concerning the financial year 2002.

Rules governing the commitments and liabilities of Parliament and the members of the scheme in the event of a deficit:

At its meeting of 30 November 2005 the Bureau considered the situation of the Voluntary Pension Fund ahead of the adoption of the Statute for Members. At that meeting, it undertook to draw up rules governing the respective relations between and responsibilities of the Fund and Parliament, on the basis of an independent actuarial study, and, in connection with the decisions relating to the implementation of the Statute for Members that it would be called upon to take pursuant to Article 24 of that Statute, once the measures required to guarantee payment of the additional pensions after the entry into force of the new Statute in 2009 had been adopted. An open invitation to tender for an independent actuarial study will shortly be issued. The working party responsible for finalising the measures implementing the Statute for Members has also started work.









Legality and regularity of underlying transactions










10.4.


The Court’s audit did not reveal any material errors.






 




Supervisory and control systems










10.5.


In 2005 all the Institutions had supervisory and control systems complying with the requirements of the new Financial Regulation. However, some Institutions had not fully implemented all their Internal Control Standards (ICS) (1).












10.5.


REPLY OF THE COURT OF JUSTICE
In the course of the first six months of 2006, the administration carried out an assessment of the situation of the minimum Internal Control Standards. That assessment was accompanied by proposals to improve the systems put in place and an action plan was established for achieving these improvements within a reasonable time-limit.














10.6.


In 2005, the NAP (Nouvelle Application Paie), a computer application for calculating staff remunerations created in 2003 and managed by the Commission Paymaster Office (PMO), was being used by all the Institutions. In 2005 the technical weaknesses noted in 2004 were overcome, minimising the risk of erroneous calculation of the various elements of staff remuneration. However, the institutions did not systematically use the reporting facilities of NAP in order to verify, before the final pay run, all the data concerning situations specific to individual members of staff (e.g. compensatory allowances, officials transferred between institutions, promotions, and, in general, NAP data which have been modified manually). Except at the Commission, for remunerations paid in Luxembourg, and at the European Economic and Social Committee, regular ex-post controls were not carried out. Although not mandatory pursuant to the Financial Regulation, ex-post controls would increase the reliability of the administrative procedures for managing staff remunerations and help to uncover possible weaknesses and errors in the system.












10.6.


THE REPLY OF THE EUROPEAN PARLIAMENT
Compared to its predecessor, the NAP payroll application does indeed offer greater facilities in terms of reporting and the extraction of data for statistical and control purposes. However, it was not possible, in 2005, to develop the necessary expertise to fully exploit them. For that reason, DG Personnel carried out in 2005, as in previous years, systematic checks on balances in the Payments and Allowances Unit and, until December 2005, all appointing authority decisions (which are essential determinants of the payroll) were subject to individual checks before being fed into the payroll. The checks on balances, which are carried out for each payrolls category (‘centre de paie’) are particularly effective in identifying anomalies arising, for example, from interinstitutional transfers. Finally, data entered manually into the system is subject to double checking within the Payments and Allowances Unit.




Moreover, it is questionable whether the possibilities that the NAP offers can reasonably be exploited to carry out a substantive programme of verification and control before the final pay run. That is one reason why DG Personnel has taken the view that payroll controls could more effectively be carried out on an ex-post basis. While limited resources and the problems associated with the introduction of the new Staff Regulations precluded generalised recourse to ex-post controls in 2005, a systematic programme of such controls has been in operation since March 2006.






10.6.


REPLY BY THE COUNCIL
The SGC would like to note that the limited use of the NAP management tools was due to NAP-related conditions — NAP had only a few tools and they were not documented and frequently malfunctioning. The SGC considers the existing tools (that the PMO has communicated to the users in a comprehensive manner only in May 2006) very useful since they are a way to check results, and the responsible service has, despite the lack of supporting documentation, used them as much as possible.










10.6.


REPLY OF THE COMMISSION
In each institution, each authorising officer by delegation puts in place the control procedures adapted to its specific situation. It was never envisaged that each institution systematically uses all the reporting facilities offered. The PMO has made available, upon request, the reports to every authorising officer.








 


For the ex ante controls, the PMO has defined the tables to be controlled in 2002 when the NAP was put into production for a first group of Commission staff, has documented this in 2003 when the NAP started to be used for other populations, and has applied these ex ante controls since. These documents were also made available to other institutions and recently all NAP users received an updated document describing the minimal controls suggested by the PMO.
In the light of the experience gathered, notably for remunerations paid in Luxembourg, the PMO considers its current controls as sufficient and does not envisage, at this stage, strengthening its ex-post controls. The latter consume the most experienced resources and the PMO envisages using them in 2006 and 2007 to help building in a large number of automatic ex ante controls in a new IT system (IRIS) for the management of individual rights. Once this system is put into production, the PMO will revise its control strategy.










10.7.


The amended Staff Regulations, which entered into force on 1 May 2004, state that accommodation costs incurred on mission are reimbursed up to a maximum fixed for each country, on production of supporting documents (Article 13 of Annex VII to the Staff Regulations). Contrary to this rule, all the Institutions, except the Court of Justice, the Court of Auditors and the Ombudsman, provided in their internal rules for the payment of a flat-rate sum, ranging from 30 to 60 % of the maximum allowable amount, to staff who do not produce any evidence of having incurred accommodation costs. After the publication of the European Court of Auditors’ Annual Report concerning the financial year 2004, the European Economic and Social Committee amended its internal rules in December 2005 in order to ensure compliance with the Staff Regulations.












10.7.


THE REPLY OF THE EUROPEAN PARLIAMENT
Parliament faces particular problems in regard to missions owing to the nature of its activities and their dispersal over three places of work.




The application of a flat-rate system takes account of the legal advice tendered to Parliament's Bureau on this subject and is intended to strike a reasonable balance between the requirements of the regulatory framework and the exigencies of the institution's particular working environment. Moreover, the simplified provisions which have now been introduced will help to reduce the administrative costs generated by the management of a particularly high number of missions.






10.7.


REPLY BY THE COUNCIL
The GSC raised this issue during the meeting of the Chefs d'administration on 26 January2006. In the course of the discussion it became clear that the some other institutions were not convinced of the need to change their practices. The GSC envisages to pursue discussions on this issue in order to reach a solution that would be coordinated between the institutions.










10.7.


REPLY OF THE COMMISSION
The Guide to Missions, the internal rules adopted by the Commission governing missions of its staff, is currently under review to take due account of the remark of the Court. Adoption of the new rules is scheduled for the beginning of 2007.










10.7.


THE REPLY OF THE COMMITTEE OF THE REGIONS
Regarding the costs incurred on missions, the Committee of the Regions has taken into account the Court of Auditors' remarks and, consequently, it has not paid in 2005 any flat-rate sum to staff who had not produced any evidence of having incurred accomodation costs. The Committee of the Regions internal rules on missions will be subject to some modifications in 2006, and this rule will be formally introduced in the Guide to Missions.








Specific observations










10.8.


The following section concerns specific observations relating to each of the Institutions.






 




Parliament










10.9.


Weaknesses were observed, as in the past (see paragraph 9.16 of the Annual Report concerning the financial year 2004), in the supervisory and control systems relating to the payment of allowances to Members of the European Parliament (MEPs).












10.9.


THE REPLY OF THE EUROPEAN PARLIAMENT
In response to the Court's observations concerning 2004, the IT application currently being developed to deal with the end-of-service allowance will in future issue recipients with a reminder of the conditions governing continued eligibility for the allowance. The matter will also be considered in connection with the implementation of the Statute for Members.








 


For parliamentary assistance expenses, see the reply to paragraph 10.10.










10.10.


The rules governing the payment of assistance allowances were modified by the Bureau (a body consisting of the Parliament’s President and 14 Vice-Presidents) in 2004. New provisions were introduced regarding the submission of supporting documents by MEPs. The obligations resulting from the new provisions were clarified and explained to the MEPs by a Quaestors’ communication of July 2005 requiring the Members to present documentary evidence of the use of their allowance by 1 November 2005. At the end of November, less than 20 % of the documents required had been submitted. In January 2006, the Quaestors extended the deadline to 17 March 2006. The amended rules were thus not adequately implemented in 2005, and payments to providers of services or payments to assistants through paying agents (2) were still not based on appropriate supporting documents, such as invoices paid by the MEP and detailed justifications of the expenses of the paying agent.












10.10.


THE REPLY OF THE EUROPEAN PARLIAMENT
The Quaestors' communication could only be sent to Members late in July 2005. The clarification provided by the new provisions was an important first step. Following the EU-10 enlargement and parliamentary elections in 2004, with all their implications, it is not surprising that the 1 November 2005 deadline proved to be too short. The task of the administration to give information proved also to be difficult because of the complexity of the rules, the national obligations which differ in each of the 25 Member States and the large number of languages to cope with.




The Quaestors thus extended the deadline for submitting supporting documents for a first time in January 2006 and a second time in April 2006. The implementation of amended rules began nevertheless in 2005. Parts of the rules were fully implemented from the beginning of 2005, like the obligation of the Members to submit evidence as to social security registration and insurance against accidents within three months of the start of the employment contract. By mid-2006, roughly 54 % of invoices issued by service providers for the period from July 2004 to June 2005 have been forwarded. Roughly 29 % of paying agents have submitted the requisite documents for the same period.




Council










10.11.


The Council reformed its system for reimbursing the travel expenses of delegates of Council Members with Decision 190/2003, applicable from 1 January 2004. The reimbursement is paid within the limit of a fixed allocation per Member State. Each Member State is paid two instalments per year: one in January and the other in July. Before the end of February, each Member State provides the General Secretariat with a statement showing how the total appropriation allocated to it during the previous year has been used. Unused sums and amounts for which no supporting documents have been provided are deducted from the amounts to be paid in the next instalment. The Court found that the new system greatly reduced the administrative burden on the Council of paying delegates’ expenses, but that there had been insufficient checks on the validity of Member States’ statements before payment of the July 2005 instalment.












10.11.


REPLY BY THE COUNCIL
On the basis of a report of the Internal Audit Service of the GSC on the functioning of the new system of travel expenses of delegates of Council Members one year after its introduction in 2004, the GSC is currently reviewing the system.








Commission (3)











10.12.


The payment of different types of family allowance is based on information submitted by the staff. Staff receiving the household allowance and having no dependent children are not regularly required to update the information. In fact, there was no evidence that 676 out of 1 605 Commission staff concerned based in Brussels had been requested to confirm or update their original declarations. Insufficient checks were also carried out concerning cases where national dependent child allowances might have been received and, if so, should have been deducted from the allowances paid according to the Staff Regulations.












10.12.


REPLY OF THE COMMISSION
For each type of family allowance, a specific control strategy is applied.




Regarding the household allowance, the result of a control is only systematically registered since 2002.
Up to now, for the Brussels population the Commission proceeded with sample controls based on a risk assessment. However, all the cases mentioned here will be verified over the next two years to allow for a regular verification of the complete population. In general, files need to be verified every four years at the latest to be able to recuperate in view of the deadline of five years imposed by Article 83 of the Staff Regulations.
As regards national child allowances, it is envisaged to use the same control mechanism as outlined above for the household allowances.




Court of Justice










10.13.


In paragraph 9.21 of the Annual Report concerning the financial year 2004 the Court of Auditors observed that the head of the Internal Audit Service was responsible for ex-ante verification of the authorising officers’ operations. The same situation was noted concerning the financial year 2005. Such an involvement in the carrying out of financial operations is not compatible with the total independence with which the internal auditor ought to perform his audit duties, in accordance with the principle stated in Article 86 of the Financial Regulation.












10.13.


REPLY OF THE COURT OF JUSTICE
As already stated in the reply to paragraph 9.21 of the 2004 Annual Report, ex-ante verification activities on the one hand, and internal audit activities on the other, are performed by different people within one administrative unit under the administrative authority of a single official, also appointed as internal auditor. This administrative structure was originally used having regard to the size of the Court of Justice and owing to the lack of staff qualified to perform the duties of control and financial management. In addition, the view was taken that the administrative authority conferred on the internal auditor, consisting of managing a small team of verification agents, in no way affected his independence in the conduct of his audit duties.




However, in the light of the comments made in this regard by the control and discharge authorities, the administration of the Court, in the course of preparing the estimate of the revenue and expenditure for the financial year 2007, proposed modifying this organisation by creating an administrative unit with exclusive competence for verification, which to this end would be provided with two new jobs (one administrator responsible for management and an assistant to reinforce the team responsible for verifications). This new administrative structure may thus be implemented in the coming months.










10.14.


In the second half of 2005 the internal auditor carried out some specific audits and addressed recommendations to the services concerned. However, at the time of the audit by the Court of Auditors no reports by the internal auditor were available.












10.14.


REPLY OF THE COURT OF JUSTICE
When the auditor of the Court of Auditors came to the internal auditing unit of the Court of Justice in April 2006, it was agreed that a copy of the reports of the audits carried out in 2005 could be delivered to him officially after being sent to the President of the Court of Justice. A copy of the reports was sent to the President in May 2006 and then to the relevant department of the Court of Auditors.








Court of Auditors










10.15.


The Court of Auditors is audited by an independent external audit firm which issued a ‘certificate concerning the regularity and fairness of the financial statements at 31 December 2005’, accompanied by a ‘report on the administrative and accounting procedures, the soundness of the financial management and the internal control system’. The report states that, in the auditor’s opinion, his work did not ‘disclose any facts which might cast doubt on the adequacy of the administrative and acounting procedures or internal control or the compliance of financial management with the applicable regulations’. The certificate and the report will be published in the Official Journal.






 




European Economic and Social Committee










10.16.


The setting-up in the course of 2005 of a unit responsible for coordinating financial and contractual activities throughout the joint services of the European Economic and Social Committee and the Committee of the Regions improved annual procurement planning and provided the operational units with guidance on tendering procedures. However, some weaknesses still appeared concerning the operational management of certain procurement procedures (for example: too little time allowed for the verification of complex draft contracts), and coordination procedures between the new unit and the operating units had not been clearly defined.












10.16.


REPLY OF THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND OF THE COMMITTEE OF THE REGIONS




The Committees welcome the recognition by the Court that annual procurement planning has improved and that the operational services have benefited from clear guidance on tendering procedures. In 2005, the coordinating procedures between the new ‘finance and contracts’ unit in the EESC/CoR Joint Services and the operational services were adopted and published on the Intranet. On the basis of experience acquired, more detailed guidelines may be issued in the second half of 2006. Furthermore, in 2006, verifying agents have been more systematically involved in the early stages of public procurement procedures and 28 model documents for public procurement procedures have been approved by the legal services and published on the Intranet.




Committee of the Regions










10.17.


The remarks in paragraph 10.16 also apply to the Committee of the Regions.






 










10.18.


Following the Court’s 2004 DAS audit and two internal audits, the administration of the Committee of the Regions asked certain beneficiaries of weighted salary transfers to present additional evidence. Several transfers which had not been regularly carried out before May 2004 and/or for which the beneficiaries did not present sufficient evidence were discontinued. In 2005 the administration did not recover any overpayments, although, according to Article 85 of the Staff Regulations, ‘any sum overpaid shall be recovered if the recipient was aware that there was no due reason for the payment or if the fact of the overpayment was patently such that he could not have been unaware of it.’












10.18.


THE REPLY OF THE COMMITTEE OF THE REGIONS
The internal audit on salaries transfer requested by the Secretary General was only completed in February 2006, and a copy has now been sent to the Court of Auditors. In consequence, the Administration is now proceeding with the recovery of overpayments which concern a limited number of officials. Most of the audit recommendations have already been implemented.








European Ombudsman and European Data-Protection Supervisor










10.19.


The audit did not give rise to any material observations.






 




Overall conclusion










10.20.


Improvements have been made by all the Institutions in order to adapt their supervisory and control systems to the requirements of the new Financial Regulation. The Court’s audit found that, notwithstanding the weaknesses mentioned in the previous paragraphs, the supervisory and control systems were adequate to manage the risk as regards legality and regularity of the transactions underlying the accounts of the Institutions’ administrative expenditure. The Court’s audit did not reveal material errors affecting the legality and regularity of the administrative expenditure.






 




Special Reports issued since the last Annual Report










10.21.


Special Report No 9/2006 concerning translation expenditure incurred by the Commission, the Parliament and the Council.






 




EUROPEAN UNION AGENCIES










10.22.


Audits of the European Union's agencies (hereinafter referred to as the ‘agencies’) are the subject of Special Annual Reports. The Court audited 18 agencies for the financial year 2005. The agencies’ budgets totalled 926,8 million euro in 2005, as against 885,3 million euro in 2004. The number of authorised posts for all the agencies rose from 2 233 in 2004 to 2 644 in 2005. The principal data concerning the agencies are set out in 
Table 10.3
.












10.22.


REPLY OF THE COMMISSION
The agencies are independent and have a separate discharge procedure for their administrative expenses. Thus, the Court’s observations are a matter for the agencies themselves. Where they request it, the Commission provides assistance and support, e.g. to help them to understand and interpret the rules as well as to introduce internal control arrangements.








Table 10.3 — European Union Agencies — Principal data











European Union Agencies


Headquarters


Year of establishment


Budget (4)

(million euro)


Authorised posts




2004


2005


2004


2005




European Centre for the Development of Vocational Training


Thessalonica


1975


16,6


16,6


88


91




European Foundation for the Improvement of Living and Working Conditions


Dublin


1975


18,1


18,8


91


94




European Environment Agency


Copenhagen


1990


33,6


32,1


115


115




European Training Foundation


Turin


1990


18,4


26,7


104


104




European Monitoring Centre for Drugs and Drug Addiction


Lisbon


1993


12,2


13


77


77




European Medicines Agency


London


1993


99,1


110,1


314


379




Translation Centre for the Bodies of the European Union


Luxembourg


1994


29,8


28,4


181


181




Community Plant Variety Office


Angers


1994


11,3


10,5


38


38




Office for Harmonization in the Internal Market


Alicante


1994


190


218,4


675


675




European Agency for Safety and Health at Work


Bilbao


1995


10,7


13,4


38


40




European Monitoring Centre on Racism and Xenophobia


Vienna


1997


7,9


8,2


34


37




European Agency for Reconstruction


Thessalonica


2000


374,6


276,5


114


114




Eurojust


The Hague


2002


9,3


13


76


87




European Aviation Safety Agency


Cologne


2002


11,3


57,5


95


200




European Maritime Safety Agency


Lisbon (5)



2002


13,3


35,3


55


95




European Food Safety Authority


Parma


2002


29,1


36,7


138


194




European Network and Information Security Agency


Heraklion (6)



2003


—


6,8


—


38




European Railway Agency (7)



Valenciennes


2003


—


—


—


—




European Centre for Disease Prevention and Control


Stockholm


2005


—


4,8


—


85





Total




885,3




926,8




2 233




2 644















10.23.


In several agencies the distinguishing feature of the implementation of the budget is the limited extent to which appropriations are utilised. This phenomenon is due in particular to programming that takes no account of the agencies’ organisational capabilities. This limited utilisation of appropriations contrasts with the sizeable cash margins available to some of them. The Court found that, when disbursing funds to agencies, the Commission did not always comply with the rule that fund transfers are to be based on regular and justified estimates of the agencies’ cash requirements.












10.23.


REPLY OF THE COMMISSION
Weaknesses in the implementation of the budget in agencies have systematically been brought up in the audits made by the Internal Audit Service (IAS) in its role as internal auditor of the agencies.




Pursuant to Article 50 of the framework Financial Regulation (EC, Euratom) No 2343/2002, each agency ‘shall present to the Commission requests for payment of all or part of the Community subsidy, supported by a cash-flow forecast, under terms and at intervals agreed with the Commission.’ As a general rule, the Commission makes payments by tranches. Once the Commission receives the agencies’ annual accounts approved by their management board, the Commission must retrieve sums that were not spent. The Commission carefully examines cases identified by the Court and, where necessary, reminds the authorising officers by delegation — who alone are responsible for approving agency requests — of the procedures to be followed.










10.24.


Several agencies have not assessed their operational risks. The Court once again detected shortcomings in staff recruitment and contract award procedures with regard to compliance with the principle of transparency in decision-making. The Court believes that the Commission's internal auditor, who is also the internal auditor for each of the agencies financed by Community funds, should continue his efforts to ensure that the agencies’ internal control systems are improved.












10.24.


REPLY OF THE COMMISSION
The introduction of internal control, assessment of their operational risks and compliance with recruitment and procurement procedures are within the sole remit of the agency's board of management. However, IAS audit reports on agencies filed since 2004 contain specific recommendations regarding internal control. As regards procurement, the Commission publishes guidelines, provides the agencies with access to its libraries of financial information and to its helpdesk and offers training to the ‘Inter Agency Legal Network’ (IALN). On 16 December 2005 the Commission adopted guidelines for personnel policy in regulatory agencies, which recommend a standardisation of agencies’ selection procedures through a greater involvement of EPSO.














10.25.


The Court found as a general rule that activity-based management had not been introduced within the agencies, even though the framework financial regulation applicable to them recommends this form of management, following the example of the general budget. The Financial Regulation also provides for accruals-based accounting as of the financial year 2005. Since the agencies’ financial statements are consolidated with the Community institutions’ accounts, the Commission should provide more direct support to help agencies to comply with the rules laid down by its Accounting Officer.












10.25.


REPLY OF THE COMMISSION
The agencies must, under their own financial regulation based on the framework Financial Regulation (EC), Euratom) No 2343/2002, which requires it for expenditure (Article 30), to set up ‘a nomenclature with a classification by purpose’.




The Commission considers that activity-based budget management should gradually be introduced in the agencies, notably following the IAS audits, which systematically underline the need for it.
The Commission expects the agencies to apply the new accrual accounting rules and that these are fully reflected both in the information given for consolidation purposes and in the individual accounts of the agencies. Extensive guidance through meetings and manuals has been provided by the Commission to the agencies regarding the correct application of the rules.










10.26.


When auditing the agencies, the Court found the Commission gave limited support on the spot to the agencies, despite the growing complexity of Community administrative rules and notwithstanding the Commission's increased responsibilities towards the agencies (8). The fact that the agencies are independent does not mean that the Commission should refrain from taking global initiatives to provide the technical support they need in view of their smaller size.












10.26.


REPLY OF THE COMMISSION
The Commission provides support to the agencies, e.g. on accounting, procurement, staff policy and audit (see replies to 10.23, 10.24 and 10.25) but the number of agencies concerned precludes doing this on the spot.














10.27.


Several agencies set up a joint service to help users in the agencies adapt financial management information systems to make them compatible with those used by the Commission. This service, called the Common Support Service (CSS), which has an annual budget approaching 400 000 euro, does not have a legal personality of its own (9). Since the financial year 2000, these funds (some 1,8 million euro) were managed by the CSS outside the agencies’ budgetary systems. While the idea of cooperation between the agencies is to be encouraged, the manner of such cooperation should not disregard the budgetary principles of unity and transparency. This situation ought to be rectified, notably by managing the agencies’ contributions to the CSS as assigned revenue, with the Commission's support.












10.27.


REPLY OF THE COMMISSION
The CSS is an example of good cooperation between the agencies in order to share costs and knowledge. Advances paid to the CSS appear among the budget expenses of the agencies that use the system. The CSS bank account balance appears in the provisional accounts of the European Medicines Agency (EMEA) for the financial year 2005 (EMEA was the chair of the CSS in 2005). However, as stated by the Court, the presentation of this cooperation in the agencies’ accounts should respect the budgetary principles of unity and transparency. The agencies are fully independent of the Commission, and the Commission has no power of control over the financial activities of the agencies. The Commission will nevertheless take the Court’s findings up with the agencies.




Moreover, most present users of the financial management system supported by CSS have requested to be linked directly to ABAC, and to be supported by the Commission. It is planned to accede to this request from 2007.




EUROPEAN SCHOOLS










10.28.


The Court’s Special Annual Report on the European Schools (not published in the Official Journal) is submitted to the Board of Governors and Directors of the European Schools. The Schools’ 2005 budget of 227 million euro was financed mainly by a Commission grant 127 million euro) and by contributions from the Member States (50 million euro). The principal data concerning the European Schools are set out in 
Table 10.4
.






 










10.29.


The Court’s report for the financial year 2005 regarding the Schools has not yet been adopted.






 




Table 10.4 — European Schools — Principal Data













European School


Country


Year of establishment


Budget (10)
 (11)

(million euro)


Grant received from the Commission (11)

(million euro)


School Population (12)





2005


2004


2005


2004


2005


2004




Office


Belgium


1957


8,5


7,9


6,6


5,7


—


—




Luxemburg I


Luxemburg


1953


33,3


34,6


19,4


20,3


3 190


3 101




Luxemburg II


Luxemburg


2004


6,6


2,7


3,7


1,2


891


827




Brussels I Uccle


Belgium


1958


27,1


26,0


16,0


17,0


2 617


2 394




Brussels II (Woluwé)


Belgium


1974


27,3


27,1


17,1


17,7


3 014


2 917




Brussels III (Ixelles)


Belgium


1999


25,6


24,2


16,9


15,7


2 781


2 773




Mol


Belgium


1960


10,7


10,9


6,0


6,4


622


643




Varese


Italy


1960


16,4


15,8


8,4


7,8


1 318


1 317




Karlsruhe


Germany


1962


11,8


11,8


4,3


3,9


1 044


1 074




Munich


Germany


1977


18,7


18,6


0,9


1,0


1 557


1 504




Frankfurt


Germany


2002


9,4


8,8


3,5


4,2


876


809




Alicante


Spain


2002


10,4


9,9


3,2


5,7


987


950




Bergen


Netherlands


1963


10,8


11,5


5,0


6,3


626


664




Culham


United Kingdom


1978


11,2


12,3


5,4


5,5


856


889





Total




227,8




222,1




116,4




118,4




20 379




19 862






N.B.: Variations in totals are due to the effects of rounding.










(1)  The Council adopted its ICS in July 2005, but, at the end of 2005, was still preparing an action plan to implement them; the Court of Justice had not implemented several ICS; at the Parliament an optimal level of implementation had not yet been attained; some ICS had not been fully implemented at the Committee of the Regions.

(2)  Secretarial assistance allowance payments may be made to a paying agent contracted by the MEP to handle, in whole or in part, the administrative management of his or her secretarial assistance allowance.

(3)  The Commission departments responsible for most of the administrative expenditure are the following: Directorate-General for Personnel and Administration, Directorate-General for Translation, Directorate-General for Interpretation, Directorate-General for Communication, Directorate-General for External Relations, Office for Infrastructures and Logistics — Luxembourg, Office for Infrastructures and Logistics — Brussels, Office for the Administration and Settlement of Individual Entitlements, European Personnel Selection Office, Publications Office.

(4)  Commitment appropriations.

(5)  In 2005 this body's provisional headquarters were in Brussels.

(6)  This body's provisional headquarters were in Brussels for part of 2005.

(7)  In 2005 the Commission was responsible for managing this body's budget. There was no special report on the implementation of this budget.

(8)  In the case of all agencies other than OHMI and OCVV, which are essentially self-financing, the Commission plays a decisive role in appointing the director and certain members of the Management Board, states its position regarding the work programmes, proposes and pays the amount of the administrative subsidy, consolidates the accounts and appoints one of its officials as the internal auditor for all the agencies.

(9)  The agreement to set up the group that was concluded in 1998 provided for one of the agencies to manage the group and incorporate its transactions into the agency's own accounts. This has not been done since the financial year 2000.

(10)  Total revenue and expenditure as foreseen in the budget of each European School and the Office including all modifications made to the budgets initially adopted.

(11)  Source: European Schools.

(12)  Source: 2005 Annual report of the Secretary General to the Board of Governors of the European Schools.

N.B.: Variations in totals are due to the effects of rounding.



CHAPTER 11
Financial instruments and banking activities
TABLE OF CONTENTS
Introduction
The Tripartite Agreement with the EIF
The phasing-out of risk capital operations
Background
European Community Investment Partners (ECIP)
MEDIA Programme
Phasing-out of risk capital operations managed by DG ECFIN
Conclusions and recommendations
The Guarantee Fund for External Actions
The European Coal and Steel Community in Liquidation






THE COURT'S OBSERVATIONS


THE COMMISSION'S REPLIES




INTRODUCTION










11.1.


The Community financial instruments relating to banking activities are as follows:










—


loans granted from budget resources or from borrowed funds, including risk capital operations (1);










—


interest subsidies from budgetary funds;










—


guarantees on borrowings subscribed and on loans granted by third parties, including the Guarantee Fund for External Actions;










—


shareholdings in common interest bodies (2); and










—


participation in special operations, such as the provision of venture capital.






 










11.2.


These financial instruments operate both in the Member States and, to a greater extent, outside the Union, in the context of external policies. Their main aims are to boost economic development, improve infrastructure and create jobs, notably in small and medium-sized enterprises (SMEs), through measures to enhance their access to finance. The European Coal and Steel Community in Liquidation is involved in similar transactions.






 










11.3.


The Court's audit covered the phasing-out of risk capital operations, the operation of the Guarantee Fund for External Actions and the activities of the European Coal and Steel Community in Liquidation (ECSC i.L.).






 




THE TRIPARTITE AGREEMENT WITH THE EIF










11.4.


The Tripartite agreement with the European Investment Fund (EIF) and the European Commission was concluded for the first time in 2001. The agreement was subsequently re-confirmed by the Court for a further two years to September 2005. Article 2 of the agreement stipulated that, for the purpose of the Court's audit of the Community's subscription of the capital of the EIF, the EIF Audit Board shall provide access to its reports and to those of external auditors and to any working documents which are relevant for the Court's audit. However, access to working documents of auditors was refused at a meeting on 10 June 2005 with the EIF Audit Board. The Court therefore decided against a further extension after September 2005.












11.4.


Access to additional information is being considered in the renegotiation of the Tripartite Agreement as mentioned in point 11.5.














11.5.


The intention to re-negotiate the agreement was communicated in a letter from the President of the European Court of Auditors (ECA) in June 2005. The discussions with the EIF and with the Commission were still ongoing in July 2006.






 




THE PHASING-OUT OF RISK CAPITAL OPERATIONS




Background










11.6.


The EU has participated in various risk capital operations and, as the programmes have come to an end, a number of these operations have been in the process of being phased out in recent years. Repayments of grants and loans were foreseen under certain conditions after a certain period. The Court's audit covered five risk capital operations, managed by EuropeAid Co-operation Office (DG AIDCO), Directorate-General for Information Society and Media (DG INFSO) and Directorate-General for Economic and Financial Affairs (DG ECFIN). The total amounts outstanding for the audited operations are set out in 
Table 11.1
. Over a number of years, the Court has identified persistent reconciliation and valuation problems and a failure by the Commission to address the issues raised (3). The purpose of the current audit was to determine whether the Commission has taken appropriate measures to monitor the phasing-out of the operations and to protect the Community's financial interests, and whether the related items of the financial statements are complete and reliable.






 




Table 11.1 — Overview on risk capital operations audited










(million euro)




Measure


Total payments


Assets in balance sheet


Value adjustments in balance sheet




up to 31.12.2005


31.12.2004


31.12.2005


31.12.2004


31.12.2005




ECIP (European Community Investment Partners)


224,2


63,66


51,19


–38,88


–8,9




MEDIA II


302,3 (4)



41,66


36,53


–28,07


–24,53




Venture consort


10,2


1,49


0,77


–1,49


–0,77




Eurotech Capital Programme


9,5


1,63


0,46


–1,63


–0,46




Joint Venture Programme


10,3


5,76


4,41


–5,76


–4,41








European Community Investment Partners (ECIP)










11.7.


ECIP was a programme for promoting the creation of joint ventures in the emerging markets of Asia, Latin America, the Mediterranean and South Africa. Total payment for ECIP amounted to 224,2 million euro. As the ECIP programme stopped in 1999, the two Technical Assistance Units to which the Commission outsourced the administration and financial management of the operations finished their activities at the end of 2000 (5). However, for the contract management, the Commission did not make significant progress in the closure of the programme until September 2005 when a specific unit established within DG AIDCO became operational. This unit had to reconstitute the database and identified 1 843 pending cases from various sources but, because of the failure to monitor activities over the preceding five-year period, the reliability and completeness of the data cannot be assured. At the end of 2005, 1 276 of the most problematic files were still open. Key financial information was missing for numerous files. The Court's audit showed that erroneous payments amounting to 207 000 euro, dating back many years, were not followed up (6), and that recovery orders were either not followed up (4 million euro) or not issued (62,3 million euro). In March 2006, the specific unit of DG AIDCO estimated that the amount still to be recovered is 21 million euro.












11.7.


The Commission recognises that notably in the period 2001-2004 insufficient attention was paid to the liquidation of ECIP and that this situation still affects the reliability and completeness of the financial statements. Nevertheless also before the establishment of the specific unit in EuropeAid limited measures have been taken towards the closure of the ECIP files.




The ECIP programme is now regularly and adequately monitored. On 31.5.2006 there were still 800 ECIP actions to be analysed and the forecast is that all files will have been analysed before the end of 2006. The Commission will at that stage be able to provide complete and reliable financial statements.




MEDIA Programme










11.8.


The MEDIA (7) programmes aim to encourage the European audiovisual industry. Council Decision 95/563/EC of 10 July 1995 (8) established MEDIA II, which is currently being phased out. This programme concerned a total of 302,3 million euro, of which 130,3 million euro were made available for loans or conditionally repayable advances, 149,6 million euro for subsidies, the rest was used up for the horizontal actions of the programme (MEDIA Desks, costs of the Technical Assistance Offices…). At the end of 2005 open pre-financing payments were 48,6 million euro, of which 6,9 million euro were converted into grants, 10,4 million euro of recovery orders were issued and 31,3 million euro were classified as receivables.






 










11.9.


The loans and subsidies granted to the audiovisual industry under this programme were subject to particularly complex conditions which require constant monitoring over a long time. For example, if a project did not go into production or was abandoned within a certain time-limit, 25 % of the loan received was repayable. If the project went into production within three years, however, the full amount of the loan was due, but compliance with these conditions was never monitored by the Commission. Up to the end of 2005 (9), the MEDIA II programme was administered by a Technical Assistance Office (TAO) on behalf of the Commission. The Court found that, for financial operations before 2001, the Commission services had no detailed accounting information for the programme nor a specific auditor's certificate for the financial operations involved. For more recent transactions, documentation was often incomplete and there was inadequate follow-up, leading, in certain instances, to recovery orders not being issued in a timely manner (10).












11.9.


Despite delays in some cases, the Technical Assistance Office (TAO), under the Commission’s supervision, has monitored the projects during the three years covered by the contracts for the development support agreements.




The cases dealt with by the TAO, as well as those dealt with by the Commission, were transferred when the MEDIA Programme files were taken over by the new Education Audiovisual and Culture Executive Agency (EACEA) on 1 January 2006.
The structural weaknesses of the past were resolved after the Executive Agency took over the MEDIA Programme files.




Phasing-out of risk capital operations managed by DG ECFIN










11.10.


The objective of the three venture capital investment programmes, representing a total EU contribution of approximately 30 million euro, is to stimulate investment in desirable but risky market segments. The audit showed weaknesses in the management, follow up and closure of the programmes in the past: problems with the management of revenues, absence of valuation of the investments, disruption in the monitoring and reporting processes, delay in the closure of the files. It was therefore not possible to obtain assurance on the soundness of the financial management, nor on the protection of the Communities' financial interests, nor on the related accuracy of the sums recorded in the EU financial statements. DG ECFIN's Internal Audit Capability (IAC) came to the same conclusions as a result of its earlier audit conducted during 2005.












11.10.


Following the audit of DG ECFIN’s Internal Audit Capacity (IAC) in July 2005, a proactive and overall strategy of closure for all three investment facilities is in place to close the remaining files (out of a total of 91 files, only 14 remained open at end 2005). This policy has already led to additional closures in 2006. Some files (7) cannot be closed until 2012 due to contractual exit dates.




In the light of the action plan established after the DG ECFIN’s IAC audit, the Commission considers that it has now reasonable assurance on the accuracy and completeness of the figures related to the three programmes on the basis of various checks which were carried out over the last year.




Conclusions and recommendations










11.11.


Despite the fact that the various programmes were complex, the Commission never allocated the capacity to manage such measures successfully on a long-term basis. Although the Commission has started corrective action, the audit confirmed, in line with previous Court observations (except for MEDIA II), persistent monitoring weaknesses and failure to protect the financial interest of the Community in the past.












11.11.


The Commission believes that the ECIP programme is now regularly and adequately monitored and the current forecast is that all files will have been analysed before the end of 2006. The Commission will at that stage be able to provide complete and reliable financial statements.














11.12.


Concerning the ECIP and MEDIA II Programmes, the related items of the financial statements provide neither a complete nor a reliable valuation of the assets in the Commission's balance sheet. For ECIP, substantive clearance work still has to be carried out.












11.12.


The management procedures for the Media II programme ruled out any detailed bookkeeping for the implementing transactions.




Since March 2005 substantive clearance work has been undertaken for ECIP and it is expected that this will be essentially completed before the end of 2006.










11.13.


The Court recommends that:












11.13.


 














—


recovery orders should be issued, as soon as the amount to be recovered has been established. Payments should be netted-out against recoveries, the liquidation of action files should be speeded up by improved internal monitoring through setting weekly and monthly targets and the phasing-out procedure should be improved;












—

The Commission agrees that payments should be netted-out against recoveries. EuropeAid already ensures a weekly monitoring of the performance against the target and finds that correct phasing-out procedures are now in place.














—


in respect of the phasing-out of MEDIA II, action should be taken towards creating an overall plan to speed up the liquidation process. Part of the monitoring process (11) could be further rationalised. In order to resolve persistent problem cases on the spot, control visits should be considered;












—


After the merger, the EACEA Executive Agency took over the cases transferred by the TAO to the Commission as well as those directly transferred by the Commission. On the basis of the inventory drawn up, the Agency will lay down the procedures and timetable for clearing the MEDIA II dossiers. For the MEDIA programmes, this will be done in consultation with DG INFSO, the Agency’s parent DG.














—


since the current audit has once again confirmed the administrative failures found in the past (except for MEDIA II), resulting in material financial losses for the Community, the Commission should consider to take appropriate actions.












—


The Commission has since March 2005 taken appropriate action to liquidate ECIP and significant progress been made since then. It is expected that all individual ECIP actions will be closed before the end of 2006 and that during 2007 it will be possible to finally liquidate ECIP and close the accounts.








THE GUARANTEE FUND FOR EXTERNAL ACTIONS










11.14.


The purpose of the Guarantee Fund for External Actions (12) (the Fund), which guarantees loans to third countries, is to reimburse the Community's creditors (13) in the event of a beneficiary’s defaulting and to avoid direct calls on the Community budget. The administrative management of the Fund is carried out by DG ECFIN while the EIB is responsible for its treasury management (14). At 31 December 2005, the Fund's (provisional) total resources were 1 323,9 million euro.






 










11.15.


The Court found that the Guarantee Fund was managed in a satisfactory manner during 2005. In 2005, no guarantee calls were made to the Fund.






 




THE EUROPEAN COAL AND STEEL COMMUNITY IN LIQUIDATION










11.16.


After the expiry of the Treaty establishing the European Coal and Steel Community on 23 July 2002, the assets and liabilities of the ECSC were transferred to the European Community (15). The objective of the Court's audit was to obtain reasonable assurance as to the reliability of the accounts and compliance with the rules governing the ECSC i.L.






 










11.17.


During 2005, the investment strategy had not yet achieved the proposed maturity distribution (16) target for the portfolio, and a constant excess of liquidity was noted.












11.17.


The maturity target structure was revised in 2004 to adjust it to the Financial Guidelines set out in the Council Decision. The derived adjustment consisted in the lengthening of duration through substantial switches from shorter term to long term investments.




In the context of what was generally perceived as a low interest rate environment, the risk had to be avoided that potentially a major part of the portfolio was invested long term at historically lowest interest rates or that excess liquidity would build up. In order to address that, a strategy has been devised based on objective indicators and aiming at phased long term investments. This strategy is being implemented.










11.18.


In 2005, DG ECFIN approved a decision to dispose of the Eurotunnel shares and the remaining portion of the junior debt (17) acquired in a past restructuring. However, the disposal of these assets happened during the lowest price-range of the year. The loss is 34,4 million euro for the shares and 4,6 million euro for the junior debt.












11.18.


The Commission decided to sell the assets referred to by the Court in line with its continuing strategy of disinvestment. These did not comply with ECSC’s general investment criteria but were acquired as a result of a past restructuring and not the result of voluntary investment decisions. The 2005 sale was thus the final one in a series.




In spring 2005, the banks most involved in trading these assets considered that the prices of both shares and lower tiers of junior debt would decrease substantially in the face of another restructuring. To make the company concerned viable, a large debt-for-equity swap was expected, which would have substantially further reduced the share price. It therefore seemed prudent to sell at the levels of April-June 2005 in order to avoid even greater losses. However, in a highly illiquid market with a small number of active players prices are event-driven and expectations are highly uncertain.
The impact on the profit and loss account in 2005 was limited to 1 million euro, since the remainder was covered by earlier provisioning and value adjustment.










11.19.


The Court notes a backlog of 7,7 million euro relating to Coal Research projects which were awaiting processing by the Commission. This has had a negative impact on liquidity management. The Court also detected a lack of follow-up of outstanding commitments, notably regarding the expiry of the final date for implementation.












11.19.


Concerning ECSC coal projects, the Commission has started taking the necessary measures to tackle the backlog. The commitments of which ‘final due date’ was exceeded have been closed by 6 April 2006.














11.20.


IT weaknesses persisted and, furthermore, the implementation of the new accounting system, which was foreseen for 2005, was substantially delayed and had to be postponed to 2006. This time constraint had a significant impact on the ECSC i.L. in terms of automation and reconciliation, and has caused delays in the preparation of the accounts and operational inefficiencies.












11.20.


All IT weaknesses identified in the past except one have been resolved. The remaining item (SWIFT disaster recovery site) needed the identification of an appropriate site and the necessary infrastructure works. This is under way and planned to be finished in 2006. The automatic fire extinguishing system will be installed at the new site the relevant service is moving to in 2006.




As far as the new accounting software is concerned, the contractor concerned severely underestimated the workload needed for the implementation of the specific requirements in the context of banking operations. This has led to a significant additional operational workload but did not, however, impact on the correctness of the accounts.










11.21.


The winding-up of the financial operations of the ECSC i.L. is proceeding in compliance with the relevant legislation, including the multiannual financial guidelines, although some operational weaknesses have been identified (see paragraphs 11.17 to 11.20).












11.21.


The Commission will continue to manage the winding-up of ECSC i.L. in compliance with the rules and, in view of the replies in 11.17. and 11.18., does not consider that it is appropriate to refer to operational weaknesses.










(1)  Risk capital is investment in high-risk enterprises but with growth aspects, such as investments in start-up firms, small businesses and new technologies.

(2)  For example, the European Investment Fund (EIF) and the European Bank for Reconstruction and Development (EBRD).

(3)  Annual Report concerning the financial year 2004, paragraph 1.19 and Table 1.1; Annual Report concerning the financial year 2003, paragraph 1.10 and Table 1.1; Annual Report concerning the financial year 2002, paragraphs 1.18 to 1.22; Annual Report concerning the financial year 2001, paragraph 9.20.

(4)  Out of the total amount, 130,3 million euro concern loans and conditionally repayable advances.

(5)  Regulation (EC) No 772/2001 of the European Parliament and of the Council of 4 April 2001 (OJ L 112, 21.4.2001, p. 1) stipulated inter alia that the Commission shall take the necessary steps to close and liquidate the ECIP projects.

(6)  For instance, three cases, totalling 207 000 euro. These are amounts exceeding initial commitments and paid by error to incorrect bank accounts. Initial commitments could be exceeded because only global commitments were entered into.

(7)  MEDIA I 1991 to 1996 (almost closed, with the exception of two cases, all financial assets, 26,7 million euro were written off at the end of 2003 and there is no intention to make further recoveries), MEDIA II 1996 to 2000, MEDIA plus 2001 to 2006 (still ongoing).

(8)  OJ L 321, 30.12.1995, p. 25.

(9)  With effect from 1 January 2006, the management and programme administrative tasks have been transferred to the new ‘Education, Audiovisual and Culture Executive Agency’ of the Commission.

(10)  In 9 of 32 transactions tested, the estimated overall amount is some 1,1 million euro. This includes one contested case which has not been followed up since 2003, accounting for estimated 1 million euro.

(11)  Such as the sending of reminder letters.

(12)  Council Regulation (EC, Euratom) No 2728/94 of 31 October 1994 (OJ L 293, 12.11.1994, p. 1), as last amended by Regulation (EC, Euratom) No 2273/2004 of 22 December 2004 (OJ L 396, 31.12.2004, p. 28).

(13)  Principally the EIB, but also Euratom external lending and EC macro-financial assistance (MFA) loans to third countries.

(14)  Management agreement between the EIB and the European Community, as last amended on 28 April 2002 and 8 May 2002.

(15)  Protocol on the financial consequences of the expiry of the ECSC Treaty and on the Research Fund for Coal and Steel (OJ C 80, 10.3.2001, p. 67).

(16)  Maturity is the time when the principal amount of a bond must be repaid.

(17)  Junior debt is a debt that is either unsecured or has a low priority. It is similar to a subordinated debt.