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 1.6 to 1.45).

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 1.46 to 1.86) (3).

1.4.

Once again, the Court paid particular attention to the efforts made by the Commission to strengthen its internal control system and to the follow-up given to the action plans annexed to the annual activity reports and their Synthesis for the financial year 2003 (see paragraphs 1.54 to 1.86).

1.5.

In addition, the Court provides 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 3 to 9).

1.6.

The Court’s observations concern the final consolidated annual accounts for the financial year 2004 (4), as drawn up by the Commission in compliance with the provisions of the Financial Regulation of 25 June 2002 (5).

1.7.

Pending the complete implementation of the action plan on the modernisation of the accounting system as of the financial year 2005 (see paragraphs 1.21 to 1.45) and 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. The information used for this was not always linked to the budgetary transactions from which they stem and the central accounting department was not always able to guarantee its accuracy or completeness (see paragraph 1.9).

1.7.

The new 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 project in December 2002 (see COM(2002) 755 final of 17 December 2002).

1.8.

Furthermore, in 2004 the accounting system still followed, to a large extent, 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 (see paragraphs 1.17 to 1.18 and also paragraphs 1.28 to 1.45).

1.8.

The differentiation between capital and non-capital expenditure is one of the improvements arising from the introduction of the new accounting system. The 2005 opening balance sheet is currently being prepared using this distinction.

1.9.

The reservations contained in the declaration of the Director-General for Budgets (inadequate presentation of the assets and liabilities and of the financial position of the Communities and the EDF, and security issues (6) on the accounting system) are confirmed by the Court’s findings. However, the efforts made by the Commission as part of the modernisation of the accounting system have already resulted in improvements in the quality of information provided.

1.10.

Table 1.1 contains a follow-up of the reservation concerning the reliability of the accounts which was expressed in the Statement of Assurance for the 2003 financial year, as well as other points raised by the Court in that Annual Report which, according to the Commission, ought to be settled in the context of the modernisation of the Community accounting framework.

1.10.

As in last year’s replies, and as stated by the Court in its remark, the reservation of the Court in 2003 concerning revenues and advances is addressed by the introduction of the new accounting system in 2005. The new system will also address the other points raised in table 1.1.

1.11.

Despite the progress noted, in particular as regards the presentation of the annual accounts and the reduction in the number and scale of the reservations, the Court’s audit identified problems, most of them already pointed out in previous reports (see paragraphs 1.12 to 1.20).

1.11.

As the Court has noted, progress has been made in the presentation of the annual accounts. However, many of the remarks the Court refers to can only be addressed with the introduction of accrual accounting and the new accounting system in 2005.

1.12.

Despite the Court’s observation in its 2002 (7) and 2003 (8) Annual Reports, there continues to be no sufficient and precise indication in the explanatory notes to the year-end accounts that some transactions are likely to be corrected at a later date by the Commission’s departments or by the Member States (clearance of the EAGGF-Guarantee paying agencies’ accounts, adjustment of the provisional amounts in the case of the closure procedure for projects and programmes relating to Internal policies, External actions and Structural Funds). Additionally, the explanatory notes contain no indication of the possible scale of such corrections (e.g. the magnitude of the corrections made in previous financial years or the extent to which payments charged to the budget might be subject to future corrections).

1.12.

An additional comment is included in the 2004 final accounts indicating that most of the payments made by the Commission during the year are provisional and subject to varying conditions. Following the modernisation of the accounting system, the Commission has new accounting rules in place for accounting methods of recoveries of amounts paid out, and this also covers the explanatory notes to the annual accounts. The effects of the new rules should be seen in the 2005 annual accounts.

For Structural Fund payments, it is difficult to predict the level of future corrections as it depends on the outcome of lengthy procedures in large numbers of individual cases.

Concerning agricultural spending, the annual accounts necessarily present financial information as known at the time of their closure. The reliability of this information will always be subject to the findings of audits underway at that time or undertaken subsequently. The accounts can only recognise the definitive amounts to be recovered when the Commission adopts its final decisions under clearance of accounts or similar procedures.

The Commission will analyse the possibility of improving information on the financial impact of corrections made concerning prior years.

1.13.

Furthermore, there are other uncertainties which may temporarily affect the accounts, for example, 20 paying agencies, managing 11 000 million euro of agriculture funds, received a qualified or negative opinion on their accounts from the certifying bodies (see paragraph 4.19), and the Commission’s postponement of its financial clearance decision for the financial year 2004 of paying agency accounts representing 9 % of the expenditure declared for the financial year 2004, pending further information or the completion of certain audit work (see paragraph 4.20).

1.13.

As stated in point 4.19, qualifications and negative opinions are restricted in the great majority of cases to particular issues and measures, concerning specific aspects of the activities of the 20 paying agencies concerned. The expenditure concerned is in general limited.

It should be emphasised that the postponement of the clearance of accounts decision does not cause any financial consequences for the Member States concerned, nor does it prejudice any exclusion of expenditure of Community financing. The Commission has already initiated a procedure to recover any material undue payments.

1.14.

According to the Accession Treaty (9), ISPA projects not fully implemented by the date of accession, shall be considered approved by the Regulation on the Cohesion Fund, while payments made since that date (345,5 million euro) to the new Member States concerned, continue to be made against appropriations for pre-accession intervention. On the basis of the budgetary principle of transparency it would be appropriate to clarify the situation in the financial statements (10).

1.14.

According to the Financial Regulation, a payment can only be made against the budget heading on which the commitment was made. The heading title has now been changed to ‘closure of pre-accession aid for the eight candidate countries’. Therefore, the Commission is no longer paying on pre-accession appropriations. As underlined by the Court, the management of these projects according to Cohesion Fund rules was provided for by the Accession Treaty.

1.15.

In the context of the common agricultural policy (11), the Member States have the possibility of reducing the payments due to farmers under certain aid schemes and using the funds withheld to finance additional rural development measures. According to this system (known as modulation), accounting entries have been made against a budget heading which will ultimately not be the one to which the concerned expenditure will be charged (165,2 million euro in 2004), and expenditure which has not yet been implemented (263 million euro at 31 December 2004) has been presented in the accounts as already having been effected (see paragraphs 1.13 and 1.14 of the 2002 and 1.10(a) of the 2003 Annual Report).

1.15.

With regard to the entry into the accounts of 165,2 million euro in 2004, the accounting methods applied to the amounts withheld under Articles 3 and 4 of Regulation (EC) No 1259/1999 and Article 1 of Regulation (EC) No 1655/2004 are established in accordance with Article 1 of Commission Regulation (EC) No 1017/2001 (amending Article 2 of Regulation (EC) No 296/96).

With regard to the expenditure not yet implemented by the Member States (263 million euro in 2004), Member States can withhold part of the direct aid for farmers, on the basis of modulation and eco-conditionality, to be used during a specific period for measures accompanying rural development (under Articles 3 to 5 of Regulation (EC) No 1259/1999 and Articles 153(4) and 155 of Regulation (EC) No 1782/2003). The amounts withheld and not used must be reimbursed at the end of that period.

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. How it is treated in general accounts is under examination as part of the changeover to accrual accounting in 2005.

1.16.

Reservations concerning the completeness and accuracy of the amounts due to the Commission in respect of the EAGGF-Guarantee debtors ledger (665,5 million euro net at 31 December 2004) have been expressed by several certifying bodies (see paragraph 1.25 of the 2002 and 1.10(d) of the 2003 Annual Report).

1.16.

The provision for doubtful debts continues to be based on the best estimates of each paying agency involved, as in previous years. It is assumed that the paying agencies are in the best position to evaluate the chances of recoveries. The Commission has made several improvements to accounting arrangements for CAP debtors in recent years. These include requiring paying agencies to maintain debtors’ ledgers, and certifying bodies to check that these ledgers are complete. Certifying bodies for 86 of the 91 paying agencies were able to provide assurance that debtors’ ledgers were stated fairly.

Approximately one third of the amount mentioned by the Court is attributable to one paying agency, for which a reservation was made by the Certifying Body and for which the accounts were disjoined by the Commission.

1.17.

The recording of sundry debtors (4 139,8 million euro at 31 December 2004) continues to pose problems (12). Provisional payments are still entered as final expenditure and amounts to be recovered are not entered immediately. In the absence of adequate internal control procedures for miscellaneous revenue in the authorising officers’ departments, the Court cannot obtain assurance that the record of amounts receivable is complete and accurate.

1.17.

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

1.18.

Furthermore, in the absence of a suitable accounting system, the Court is unable to give assurance as to the accuracy and completeness of the amounts entered as held by financial intermediaries (13) totalling 1 313,6 million euro (14) at 31 December 2004 (see paragraph 1.27 of the 2002 and 1.10(f) of the 2003 Annual Report).

1.18.

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).

1.19.

In addition, the basis on which the Commission recorded a value reduction of 29,6 million euro on advances for ECIP (13) (European Community Investment Partners) (51,5 million euro at 31 December 2004) was doubtful, because the constituent parts to which it applies were not yet fully identified, as the review of the open files has not been finalised (see paragraph 1.18 of the 2002 and 1.10(b) of the 2003 Annual Report)

1.19.

The review of the open files continued in 2005. The value of 51,5 million euro registered in the balance sheet at year-end 2004 corresponds to 41,2 million euro relating to pre-financing amounts (facility 2), and 10,3 million euro on accounts opened by the various financial institution partners of the ECIP programme. The value reduction of 29,6 million euro applies only to the amount of the pre-financing. The value reduction was estimated by deducting the amount for which recovery is almost certain (11,5 million euro) from the total. The amount of 10,3 million euro was identified thanks to a circularisation exercise made to confirm the situation concerning facilities 3 and 4. It will be transferred to the Commission following the sending of the necessary recovery orders.

1.20.

The current presentation in the balance sheet of the provision for pensions (15) (26 008 million euro at 31 December 2004 according to an actuarial evaluation for staff (25 814 million euro) and for the Members of the Commission, the Judges and Advocates General of the Court of Justice as well as for the Members of the Court of Auditors (194 million euro)) and of the corresponding amount receivable from the Member States has the effect of neutralising the impact on the economic outturn, as it does not show the change during 2004 for the Community institutions’ pension liabilities (see paragraphs 1.31 to 1.32 of the 2002 and 1.10(h) of the 2003 Annual Report).

1.20.

As has been responded previously by the Commission, this accounting treatment for pensions is in accordance with the accounting rules adopted by the Accounting Officer of the Commission following discussion with the Accounting Standards Committee. The issue will be re-addressed when an IPSAS on the treatment of pensions in public sector entities is available.

1.21.

On 17 December 2002, the Commission adopted the Action Plan for the modernisation of the European Communities’ accounting system (16). This was in response to a number of previous observations by the Court and takes into account the provisions of the Financial Regulation adopted in June 2002 (17) requiring, inter alia, the introduction of accrual-based accounting (Article 125). This action plan, which was intended to be fully operational as of 1 January 2005 (18), consists of two strands, one concerning the adoption of the new accounting framework (19), and the other, the development of the information systems required for its implementation (20). A project oversight board and an advisory committee for accounting standards were set up in order to provide support to the Commission’s Accounting Officer, who is responsible for the implementation of the project.

1.22.

Given the fundamental importance of the modernisation project, the Court commenced an audit of the different phases of the Commission’s project implementation, which is ongoing. The Court provides its preliminary findings here, and will report on subsequent stages in future Annual Reports.

1.22.

The new accounting system is operational and the preparation of the 2005 annual accounts (including opening balance sheet) continues to progress since the finalisation of the Court’s audit in May 2005.

1.23.

In the first phase, which covers the transition process during 2004, the Court concentrated on the:

1.24.

On 28 December 2004, the Commission’s Accounting Officer adopted a set of 15 rules (22) as required by Article 133 of the Financial Regulation. These rules cover the key items for accounting and financial reporting based on the internationally accepted standards for the public sector (23), adapted to the specific needs of the Commission and of the European Communities (24). These rules were subsequently transposed into implementing rules and an accounting manual applicable in the institutions and bodies whose accounts are to be consolidated (25), in time for the drawing-up of the accounts for the financial year 2005.

1.25.

With a view on its future work on the opening balance for the 2005 financial year, which by the end of the audit work (May 2005) was not yet completed, the Court limited its first analysis to four accounting rules considered as key for the transition, namely those dealing with financial statements, expenses and payables, pre-financing and provisions, contingent assets and liabilities. The remaining rules will be analysed in later phases of this audit.

1.26.

It was found that these four rules comply in all material aspects with the Financial Regulation as well as with the International Public Sector Accounting Standards (IPSAS), as far as they are covered by them (26). However, due to the complexity of the different areas covered, compliance is, to a certain extent, achieved by remaining rather general in both the basic rules and the more-detailed accounting manual, thereby leaving the interpretation of specific elements to the discretion of the different Directorates-General (see paragraph 1.32). Furthermore, there is a need for clarification concerning guarantees and pre-financing (see paragraph 1.33).

1.26.

The accounting rules as adopted by the Accounting Officer of the Commission had been discussed by the Accounting Standards Committee and are, by their very nature, necessarily more general than specific. This is also the case with the international accounting rules on which they are based, the International Accounting Standards/International Financial Reporting Standards (IAS/IFRS) as well as the International Public Sector Accounting Standards. More detailed instruction and guidance is available in the accounting manual and fiches that are available on the Commission Intranet. The application of these rules is compulsory for the Directorates-General.

1.27.

The development and approval of instructions was not yet finalised by the end of the audit work (May 2005) as, for example, for the cut-off procedure which is currently under preparation. It is important to define the financial year to which generating events should be attributed, as this has a direct impact on the accounting of transactions and the true and fair view of the financial position.

1.27.

The development of such instructions is an ongoing process which has greatly advanced since the finalisation of the Court’s audit. Instructions were prepared in good time. The cut-off procedure was presented and discussed with Directors-General at the end of July and the beginning of August. Finally, as was envisaged, cut-off instructions were finalised and sent to Directorates-General by mid-August. They were also published on the internal website.

1.28.

The Commission has to prepare the accounts according to the new accounting rules for the financial year 2005. This requires reprocessing the closure of the 2004 financial year in order to establish the opening balance for 2005 according to the new accounting rules. Certain data, necessary for the opening balance, do not appear in the accounts at the end of 2004. Therefore, these data must be identified, applying specific procedures, and accounted for in 2005.

1.29.

The following paragraphs deal with the most important elements: pre-financing (advances), which constitutes an asset; invoices/payment requests not paid by the 31 December 2004, which constitute a liability; guarantees, which will be entered in the Annex to the balance sheet; and the legal entities, which are a necessary condition to carry out payments.

1.30.

The Commission estimates the amount of the pre-financing to be entered into the accounts at approximately 64 000 million euro. Five Directorates-General represent more than 90 % of this amount: Directorate-General for Regional Policy, Directorate-General for Employment, Social Affairs and Equal Opportunities, Directorate-General for Agriculture and Rural Development, Directorate-General for Research and EuropeAid Cooperation Office. It was therefore decided to concentrate on these five Directorates-General for the audit of the pre-financing and related issues such as guarantees.

1.31.

By the end of the audit work for this Annual Report in May 2005, not all technical and conceptual issues had been addressed (see paragraphs 1.25 to 1.27). Furthermore, the amounts entered into the system were still provisional, as they had not yet been validated by the Authorising Officers with the result that definitive opening balances for the financial year 2005 were not yet available. Accurate opening balances are a precondition for establishing the financial statements for the year 2005 which show a true and fair view.

1.31.

See replies 1.26 and 1.27.

The process of establishing opening balances is expected to be completed in good time. The first upload of data into the new system was done during the first week of January. Directorates-General have been verifying and correcting the figures and are required to formally validate the definitive opening balances.

1.32.

The procedures concerning the recognition, clearing and measurement of pre-financing in the general accounts differ between the Directorates-General. This could have an impact on the disclosure and consequently on the information given on the economic outturn of the reporting period (27).

1.32.

The many different types of contractual conditions require different procedures for the clearing of pre-financing amounts. The presentation of pre-financing in the financial statements will reflect the economic reality.

1.33.

At the moment, all Directorates-General maintain guarantees at their initial nominal value. However, maintaining this value, irrespective of the amount which can be claimed in case an event gives rise to a call on the guarantee, overstates the total amount backed up by guarantees. Therefore it would be necessary to provide complementary information in the explanatory notes relating to contingent assets and liabilities.

1.33.

All guarantees are first recorded at face value. This amount will only be reduced if the Authorising Officer has accepted a reduction in the guarantee provided. Both the value of the guarantee held and the current net amount guaranteed will be presented in the notes to the financial statements, using information coming from the accounting system.

1.34.

As for pre-financing (see paragraph 1.31), the amounts entered into the system for invoices/payment requests were still provisional by the end of the audit work for this Annual Report in May 2005.

1.34.

See reply to paragraph 1.31.

1.35.

The Court’s audit revealed some risks related to the local systems. It was found (for instance in the Directorate-General for Regional Policy) that local systems and ABAC are not regularly reconciled in order to confirm a successful transfer of data, and (as found in the Directorate-General for Employment, Social Affairs and Equal Opportunities) that certain amounts were registered more than once and communicated to the central system. Furthermore, errors were found resulting from a misinterpretation of data (as found in the Directorate-General for Employment, Social Affairs and Equal Opportunities) where the larger of the cost claim and outstanding commitment was considered as invoice/payment request and loaded into the central system.

1.35.

The discrepancies identified by the Court have been reviewed and corrected. Since the Court’s audit reconciliations have been made by each Directorate-General, which is required to validate its definitive opening balances.

The comments regarding the Directorate-General for Employment, Social Affairs and Equal Opportunities concern errors corrected in May 2005, and the adoption of a prudent provision for cost claims received. IT developments in early 2005 interrupted the Directorate-General for Regional Policy’s regular reconciliation of its local system to ABAC.

1.36.

Starting in 2005, no budgetary transaction can be executed if it does not carry the reference of a legal entity, previously registered and validated in the legal entity file (LEF). The LEF is, generally, an area of low risk since any error occurring in this context blocks any payment. Before the payment process can continue, the LEF-entries have to be corrected and validated.

1.37.

Of the five Directorates-General and Services audited only the EuropeAid Cooperation Office had problems concerning the validation of legal entities due to the nature of the activity, as the necessary documentation could not always be obtained (contractors from all over the world being subject to varying legal systems with the resulting differences in banking procedures, VAT treatment, register of companies etc.).

1.37.

Specific measures have been taken to resolve the particular problems the Directorate-General in question was faced with. Accordingly, these problems should not reoccur.

1.38.

The Accounting Officer has to verify and validate that local systems are capable of providing the central system with data which complies with the new accounting rules (28). Once this procedure is finalised, the central system is no longer allowed to accept data provided by non-validated local systems.

1.39.

This validation is carried out in two phases. In the first, the controls were solely based on management representations. Although initially foreseen for end-December 2004, 40 individual and a final Synthesis report were only available during February 2005.

1.39.

The final report was adopted at the end February 2005, after the Directorate-General for Budget had incorporated comments received from all the Directorates-General. The final version included an overall assessment of the validation exercise in 2004, plus individual assessments for the 40 Directorates-General.

1.40.

Following the Accounting Officer’s review of all 40 systems, some risks were identified for five systems (29) and three other systems (30) were deemed to contain serious problems. However, as modifications could not be implemented in the short term, these systems continued to be used during 2005.

1.40.

Where risks were identified for five systems, the reports concluded that these risks do not currently call into question their ability to provide data for the institution’s accounts or their use to substantiate data in those accounts.

As part of the follow-up work being performed in 2005, an in-depth investigation will be carried out for 13 Directorates-General and offices. This includes the Directorates-General mentioned by the Court as wells as five of the larger Directorates-General (31). This work has already started and will continue until the end of the year. Draft reports on the validation of local systems for these 13 Directorates-General will be issued before the end of 2005.

1.41.

The current validation procedure does not include a mechanism to inform the Accounting Officer about modifications to the local systems which would trigger a new validation according to Article 61 of the Financial Regulation.

1.41.

The Directorate-General for Budget will develop a procedure for the notification of changes to the local systems before the end of 2005, based on the experience gained throughout this validation exercise.

1.42.

In the second validation phase (scheduled still to start in 2005), in-depth checks will be carried out to ensure a sufficient level of data quality and to corroborate the results of the first phase. The requirements of Article 61 of the Financial Regulation will only be fulfilled when, still based on the results of these checks, the Accounting Officer concludes on the final validation of the local systems.

1.42.

During the course of year 2005, further validation of local systems is indeed envisaged. Initially, individual follow-up questionnaires were addressed to the 40 Directorates-General and Services, and replies were received within the deadline, that is to say by end June 2005. A progress report has been compiled and covers 27 Directorates-General, for which no significant problems have been identified. This Progress Report has been sent firstly to the Accounting Officer and will be made available, in due course, to the Court of Auditors.

1.43.

The modernisation of the accounting system had to be planned and implemented within the timeframe imposed by the Financial Regulation. Experience in public administrations undertaking similar reforms (32) shows that projects of this scale are linked to a variety of problems delaying a frictionless implementation. Against this background the Commission has achieved significant progress towards introducing accrual-based accounting.

1.44.

However, as already observed by the Court in previous Annual Reports (33), the timetable established for the necessary adaptations and validations is very ambitious. Indeed, the opening balance 2005, initially forecast to be established by the end of 2004, has not been issued by mid-2005.

1.44.

The modernisation project has met its target date of January 2005 for the new system to be in place, on 1 January 2005, the Commission moved the reporting of the EU budget from cash-based to accrual-based accounts. The Commission is confident that the opening balances will be established in good time.

1.45.

Further progress has to be made, as figures needed for the establishment of the opening balance 2005 are not yet validated by the Authorising Officers of the Commission. Additionally, not all aspects are yet fully covered by the existing rules and instructions are not interpreted coherently by the services concerned. The Accounting Officer should take the necessary measures to ensure coherence and consistency with a view to the presentation of financial information giving a true and fair view. If no timely action is taken by the Commission, the shortcomings identified by the Court may affect the reliability of the 2005 financial statements.

1.45.

The accrual-based accounting system will continue to be developed and improved during 2005 and 2006. The modernisation project has largely met the objectives set for the first eight months of 2005. All services have invested heavily to prepare the information necessary for the opening of accrual-based accounts, and make the necessary adaptations to their local systems to enable the correct bookkeeping of transactions in the new system.

The Commission has, as it has done throughout this modernisation project, every intention in taking the actions necessary to ensure the completion of the work.

1.46.

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 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 financial perspective 2000 to 2006 (34). These specific assessments, which aim to give the discharge authority the possibility to monitor the quality of the management of the funds in each of the major fields of Community intervention (35), are based on four sources of evidence:

1.47.

The objective of the audit of supervisory and control systems is to assess the extent to which they manage the risks concerning legality and regularity of underlying transactions. The testing of transactions seeks to obtain direct evidence on the 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 of the Directors-General, as well as in their Synthesis which is adopted by the Commission. Finally, the work of other auditors (36) is reviewed in order to evaluate the potential relevance for the specific assessments.

1.47.

The Commission welcomes the Court’s assessment of the extent to which the supervisory and control systems manage the risk of irregularity of underlying transactions, and will endeavour to improve them where the Court finds weaknesses. Equally, where the Court's transaction testing indicates that the supervisory and control systems are not operating as intended, the Commission will endeavour to correct the deficiencies, and to recover any damage to the Communities’ budget.

1.48.

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 tends to identify only insignificant findings as regards legality and regularity of underlying transactions and the Court’s assessment of the declarations of Directors-General and authorising officers by delegation (37) confirmed that no or only minor reservations had to be presented (see paragraphs 3.52 to 3.55, 8.31 and 8.32, 8.36 and 8.37, 9.13 and 9.26 to 9.28).

1.49.

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 tends to identify material findings as regards legality and regularity of underlying transactions (see paragraphs 4.55 to 4.62, 5.47 to 5.50, 6.46, 7.39 and 7.40). Furthermore, the Court’s assessment of the declarations of Directors-General confirmed that major reservations were either presented or, in the Court’s view, should have been presented. This is an indication that management itself has to continue its efforts in order to ensure an adequate control of the risk concerning legality and regularity of the underlying transactions (see table 1.2 ).

1.49.

As stated in its replies to the paragraphs referred to by the Court, the Commission considers that the Directors-General had reasonable assurance that the supervisory and control systems in place are sufficient to manage the risk of error and irregularity in the underlying transactions. When significant risks materialise, the EC budget is protected by recoveries from the claimants concerned or, for jointly managed funds, from the Member State concerned. The Commission works constantly to improve these systems, most recently through its analysis of gaps between its present systems and those recommended by the ECA in its Opinion No 2/2004, and in its regulatory proposals for the 2007 to 2013 financial perspectives.

1.50.

The Court has recognised in its annual reports, especially since the presentation of the White Paper on the Commission’s reform in April 2000 (42), that progress has been made in improving the design, implementation and functioning of supervisory and control systems, namely at Commission level (see paragraphs 1.71 to 1.83). This evolution has gone hand in hand with a change in the administrative culture concerning the implementation of the EU budget. Whereas, initially, the primary focus was on budgetary execution, control and audit aspects have gained in importance. Furthermore, greater attention has been given to governance issues (see paragraphs 1.55 to 1.70). The Court’s audit shows, however, that further efforts are needed, in varying degrees, to ensure that supervisory and control systems function effectively, particularly at the level of the Member States (see paragraphs 3.54 and 3.55, 4.55 to 4.62, 5.47 to 5.50, 6.42 to 6.45, 7.39 and 7.40, 8.37 and 9.26 to 9.28).

1.50.

The Commission notes the Court’s positive assessment of the progress made since the beginning of the reform with regard to the control systems and management culture.

It acknowledges that improvements in internal control will always be possible. Further efforts are being made, as the replies of the Commission to the Court’s observations in the relevant chapters of the report show, in particular through the actions to ensure that key controls by Member States are properly implemented.

Moreover, at this point, the Commission is demonstrating its commitment by endeavouring to reinforce implementation of an integrated internal control system in line with the principles set out by the Court in Opinion No 2/2004 on the single audit.

1.51.

Careful monitoring is necessary, in order to assess whether reinforced supervisory and control systems ensure that the risk is adequately managed. This is of particular relevance if one takes into account all relevant developments in the audit environment (namely the enlargement, reforms of the policies, changes in the administrative structures).

1.52.

Management is responsible for the development of the necessary indicators (43). Therefore, the Commission should ensure that supervisory and control systems consistently provide timely, accurate and adequate information on the implementation and effective functioning of key controls and the frequency, nature and impact of errors at the level of underlying transactions which are not prevented, detected and rectified. The Court could then evaluate and comment on the accuracy of the information presented by the Commission and the Member States, and assess the progress achieved (44).

1.52.

The production of static indicators would not necessarily be adjusted to the changing management and control environment in the Commission. With a view to implementing the road map to an integrated control framework (COM(2005) 252/4 of 15 June 2005), an evaluation report on the differences between the internal control framework in the Commission departments and the control principles set out in the Court’s Opinion No 2/2004 relating to Community internal controls has been drawn up. It finds that global rates of error in policies do not always make sense, given the heterogeneity and multi-annual nature of the programmes that make up the policies. It appears more appropriate for each Directorate-General to define its control strategy (in particular ex post), its target indicators and the desired development over time. The Commission acknowledges that this process, which had already started in 2003, could be more formalised in its departments.

The effectiveness of internal controls relies largely on qualitative assessments using tools which cannot always be reduced to simple indicators.

1.53.

The Court’s audits reveal that the design and use of indicators by the Commission is still not sufficient (45) to continuously monitor the quality of internal control systems and the legality and regularity of underlying transactions (see paragraph 1.61) (46).

1.53.

The Commission already has monitoring indicators similar to those of the Court (see note 44) used in the following cases: implementation of the minimum requirements relating to internal control standards in the overview report on internal control, reform measures and reservations by the Directors-General in the annual activity reports (AAR) on the state of play with regard to the reform and the synthesis of the annual activity reports (AAR), and comments on the statement of assurance as part of the discharge, in particular. It recognises that such indicators should be developed further and it proposes to do so in its approach to risk management.

In the Synthesis, the Commission also undertook to analyse existing indicators as part of a peer review by ‘families’ with a view to examining ways to make these indicators more operational management tools.

1.54.

The Court assessed the Commission’s internal control system in the different management areas (see Article 53 of the Financial Regulation), in view of the guarantees it provides as regards the legality and regularity of the underlying transactions. On the one hand, the Court examined the extent to which the management representations, contained in the annual activity reports and declarations by the Directors-General and in the Commission’s Synthesis, are confirmed by the Court’s audit findings and could be taken into account, where necessary, for the DAS. On the other, the Court examined the progress made as regards the implementation of the key elements of the Commission’s internal control (internal control standards and action plans annexed to 2003 annual activity reports and their Synthesis) and assessed the effectiveness of the procedures introduced and tools developed.

1.55.

In its 2004 Synthesis of the annual activity reports (47), the Commission continued its efforts to improve the transparency concerning its obligation to render account of its management, and decided on the appropriate actions to respond to cross-cutting (horizontal) aspects (48).

1.56.

The assessment of the Commission’s internal control system presented in the Synthesis is generally consistent with the analysis of the Court. However, in certain cases the Court’s audit findings indicate that further measures are needed to reach the ‘globally satisfactory’ situation presented in the 2004 Synthesis (modernisation of the accounting system, see paragraphs 1.21 to 1.45; indicators assessing progress, see paragraphs 1.51 to 1.53; annual activity reports and declarations of Director-General, see paragraphs 1.59 to 1.70; action plans, see paragraphs 1.72 to 1.74).

1.56.

In the 2004 Synthesis, the Commission noted that the authorising officers by delegation were able to provide the reasonable assurance required.

In the ongoing improvement process, the Commission had set itself a series of objectives relating to essential cross-cutting questions in connection with the quality of management. By way, in particular, of integrated controls, the certification of integrity, consistency and reliability of the accounts, reinforcement of the presentation of annual activity reports and a common method of risk management, the Commission has undertaken to improve its operation in line with the reform.

1.57.

While the Parliament, in its Discharge resolution 2003, invited the Commission to convert the Synthesis into a consolidated assurance statement on the financial management and controls as a whole, the Commission explained that, the Synthesis report is an act through which political responsibilities are exercised by analysing the annual activity reports. Following the approach by which management responsibilities are decentralised, the Commission does not give any further assurance, as it deems that this is done in the declarations of the Directors-General. The Court recommends that the Commission, as an institution, should assume ‘responsibility for the implementation of the budget as provided for in the Treaty (Article 274) by adopting as its own the Authorising Officers by delegation’s management representations’, (see the Court’s Annual Report for the financial year 2003, paragraphs 1.58 to 1.60).

1.57.

As in the preceding financial years, in adopting the Synthesis of the 2004 annual activity reports, the Commission took stock of the management of its departments and tackled the main horizontal issues raised by the latter in their annual activity reports.

To call for a consolidated declaration of assurance from the entire Commission would run counter to the reform of financial management begun in 2000 with a view to giving responsibility to the authorising officers by delegation. In the Synthesis, the Commission, nevertheless, assumes its political responsibilities by analysing the annual activity reports and expressing its views on the main horizontal issues including measures relating to problems to be resolved at Commission level.

1.58.

The Synthesis Report establishes a reference framework under which the Commission aims, among other things, to obtain, in the medium term, an assurance statement from the Court with only marginal reservations. The Court notes that the Commission’s strategy implies a qualitative change because further improvements are sought, not by launching a new reform but by fully developing the performance potential of the existing systems, concentrating on the following areas:

1.59.

Based on the experience gained in previous years, the central departments of the Commission (Secretariat-General, Directorate-General for the Budget and Directorate-General for Personnel and Administration) drew up general guidelines for the annual activity reports and declarations, which, on the one hand, were used as a circular on the financial year 2004 (49) and, on the other, could serve as a reference for the future financial years.

1.60.

The Court noted an improvement in the quality of the guidelines, as compared to 2003, particularly for the following aspects having a link with legality and regularity:

1.60.

The Commission feels that the provisions in the circular relating to part 3 of the annual reports (management and internal control systems) also make a significant improvement by refocusing the analysis of the departments on the risks inherent in their management environment and the effectiveness of the internal control system instead of on the evaluation of its consistency with the minimum requirements of the internal control standards. The formulation of reservations to the declaration of assurance by the Directors-General is, thus, the logical outcome on the reasoning behind the strengths and weaknesses of the internal control system which ensures consistency between the annual report, the declaration and the reservations, as the Court requested in its 2003 annual report.

1.61.

Despite the progress noted, there remains scope for improvement, in particular the presentation of indicators having a direct link to legality and regularity (see paragraphs 1.51 to 1.53).

1.61.

Although annual reports do not have the sole purpose of supervising the implementation of control systems nor to determine to what extent they ensure the legality and regularity of operations, the Commission is prepared to step up surveillance controls and risk management in the annual activity reports.

See also replies to paragraphs 1.52 and 1.53.

1.62.

As regards the materiality of system weaknesses and their impact on the Directors-General's reasonable assurance, the 2004 circular refers to the basic principles already adopted in January 2003 (50). Difficulties with the application of the proposed criteria were treated in the peer review exercise, which focused on the analysis of the potential reservations of the Directors-General and dealt mainly with:

1.63.

The Court notes that certain progress was achieved, in particular with regard to the clarity of the reservations and their link to material weaknesses. However, no common materiality thresholds were yet established by budgetary area taking into consideration the nature of the operations concerned and the tolerable risk for the area in question (52). Furthermore, the guidelines established to determine a significant system weakness and its potential financial impact require further clarification in order to ensure a coherent and consistent interpretation by the Directors-General.

1.62 to 1.63.

Following the peer review of reservations that could be made, the Commission began to study the possibility of introducing a certain degree of modulation in determining the materiality thresholds for the various management areas. As stated in the report on the evaluation of the differences between the control system in Commission departments and the control principles set out in Opinion No 2/2004 of the Court of Auditors, it is normal that the rates of error found fluctuate depending on the characteristics of the programmes and also over time. This work is one of the measures launched by the Synthesis (Action 8).

For the 2005 annual activity reports, the Commission is going to explore the possibility of adopting a common method for determining the threshold of materiality of weaknesses (see 2004 Synthesis), including those of a systemic nature, with a view to making a more consistent evaluation of their impact on the reasonable assurance for the ‘families’ of shared management, research and internal policies.

1.64.

In their declarations attached to the annual activity reports, the Directors-General state that the internal controls implemented in their departments provide reasonable assurance that the underlying transactions are legal and regular. In the event of material internal control weaknesses or irregularities, they make reservations. The guidelines for the annual activity reports and the Charter for Authorising Officers by Delegation specify that reservations must not make the declaration meaningless and that, in extreme cases (53), the Director-General may not be able to provide the required assurance. In order to remedy weaknesses, action plans, which include deadlines for implementation should be drawn up.

1.65.

The Court’s examination of the declarations of the Directors-General confirms the heterogeneous application of the materiality criteria and the difficulties of their use for the formulation of the reservations by the Commission departments, in particular with regard to system weaknesses (see paragraph 1.63). For example, certain Directorates-General did not clarify appropriately the selected criteria and/or quantify the financial impact in a satisfactory way (54).

1.65.

The Commission notes that the Court itself recognises, in point 1.63, the progress made overall in the formulation of reservations to the declaration of assurance by the Directors-General, a difficult matter and a practice still rather new to the Commission.

As stated in Objective 6 of the Synthesis of the 2004 annual reports, work is continuing towards a common method to determine the materiality of weaknesses, including those of a systemic nature having an impact on the declaration of assurance of the Directors-General by ‘families’ of Directorates-General.

A certain degree of heterogeneity in the assessment of materiality is, however, inevitable given the specific characteristics and context of each area of activity and of the decentralised responsibilities and the related reporting as part of the reform of the Commission.

The declarations are intended to be read in conjunction with the annual activity reports to which they are annexed. These reports give complementary explanations.

1.66.

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 had ensured that the underlying transactions were legal and regular. Of the 40 declarations 18 contain reservations.

1.66.

The determination of the impact of the reservations on the assurance is improving as the practice is consolidated. The Directors-General and Heads of Services have generally 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.

1.67.

The main reservations are shown in table 1.2 . Of the 32 reservations expressed in 2004, the majority (26) concern weaknesses already brought to light in 2003. This confirms that most of the weaknesses identified can be eliminated only in the medium term (see paragraph 1.67 of the Court’s Annual Report concerning the financial year 2003). The reduction in the number of reservations from 49 in 2003 to 32 (55) in 2004 is primarily due to the fact that the Directors-General improved the presentation of declarations by concentrating on weaknesses which represent important risks for the legality and regularity of the underlying transactions.

1.67.

Through its work to improve the content of the declarations and the monitoring of compliance with the standards on which the declarations are founded, the Commission is endeavouring to make the annual declarations an efficient management tool and a reliable indicator of the results which it achieved and its strategy to deal with risks identified so that the Court can use them as a basis for its assurance.

With regard to the impact and scope of the reservations (see table 1.2 and paragraph 1.49), the Commission notes the Court’s observations and will continue to provide more detailed information so that the Court can take them into account to greater advantage in order to support its declaration of assurance.

1.68.

Due to the improved situation (see paragraphs 1.60 and 1.63), the combined impact of the reservations on the assurance given in the declarations was, in general, more clearly defined than in the 2003 financial year. However, the extent of the reservations expressed by some Directorates-General is not always compatible or sufficiently justified in view of the assurance provided (see table 1.2 and paragraphs 4.27 to 4.32, 4.62 and 5.42).

1.68.

The Commission notes that all authorising officers by delegation were able to provide reasonable assurance.

1.69.

The Court’s work shows that the supervisory and control systems in several areas of the financial perspectives, have still not reached a satisfactory level and that further efforts are required in order to strengthen them. Therefore, some weaknesses singled out by the Court during its audits should have been included in the declarations of the Directors-General (see table 1.2 and paragraphs 4.58, 5.46, 6.39 and 7.37).

1.69.

See replies to paragraphs 1.49, 4.58, 5.45, 6.39 and 7.37.

The Directors-General’s assurance in a given year is not based solely on the audit work carried out in the course of the year concerned, but on the assurance built up over previous years’ audit work under the Directorates-General’s audit strategy, as well as the assurance provided from the audit work of Member States.

1.70.

Due to the reinforced guidelines and the peer review, an improvement is noted as regards the annual activity reports and declarations of the Directors-General. However, the Court considers that they can still only serve as a limited source for its assurance because of difficulties of a coherent application of some methodological principles.

1.70.

The Commission considers that the annual activity reports and declarations are already, and will be to a greater degree in the future, a sound source of assurance and an effective management tool, which will make it possible to detect weaknesses and provide an effective remedy. It feels that in 2004, significant improvements were made in the reports and the declarations accompanying them. See also reply to point 1.49.

As stated in the Synthesis, the Commission is also continuing to reinforce consistency in the way its departments apply the guidelines it issues. The road map for an integrated internal control system (COM(2005) 252/4 of 15 June 2005) and the related commitment by all the financial actors concerned will also contribute to providing the Court of Auditors with a sounder basis for its assessment.

1.71.

The Directorate-General for the Budget presented, for the second year, a report providing an overview of the state of internal control in the Commission’s Directorates-General and services in 2004 (56). This report takes stock of the significant progress in implementing internal control since the establishment of the White Paper in March 2000. It also recognises that further efforts are necessary in order to support the move from compliance to an effectiveness approach. Areas identified are reinforcing the monitoring of the effectiveness of internal control of Directorates-General, enhancing supervision procedures on financial management, strengthening of risk management, review and simplification of low value contracts and grants and the creation of an integrated internal control framework. The Court considers that this overview on the internal control system of the Commission gives a balanced presentation of the progress achieved and areas in need for improvement.

1.72.

The Court examined the progress of implementation of the measures foreseen in the consolidated action plan annexed to the 2003 Synthesis report, that have a direct link to legality and regularity (57), as well as the horizontal actions indicated in table 1.3 of its 2003 Annual Report which are not covered by the Synthesis (58).

1.73.

The monitoring of the implementation of the horizontal action plans (as well as of the specific action plans and of the audit recommendations) has been satisfactorily integrated into the working environment of the Commission, in particular through the activity-based management of the Directorates-General (annual management plans and annual activity reports).

1.74.

Table 1.3 provides an overview on the state of implementation of the 19 actions examined by the Court. At the end of the financial year, for six actions, which are in principle completed, further efforts are necessary in order to achieve the foreseen objective or to introduce certain improvements (59). At the end of 2004, five actions were still in the process of implementation (60).

1.74.

The Commission feels that most of the measures referred to by the Court have since been terminated. Monitoring of measures which had not been completed was integrated into the series of objectives of a multi-annual nature set in the 2004 Synthesis affecting essential cross-cutting issues for the quality of management work.

1.75.

Action 87 of the White Paper required the Internal Audit Service (IAS) to review the improvements of the Commission’s internal control system and to carry out a complete cycle of audits of management and control systems in all Directorates-General. Work on this action has been largely executed over a two year period. The audit results presented in the different reports (61) (strengths and achievements, as well as areas in need for improvement) are balanced and confirm, on the whole, the Court’s audit findings.

1.76.

With a view to reinforcing the relations between the IAS and the Internal Audit Capabilities (IACs) set up in all Directorates-General, in February 2004 (62) the Commission obliged the IACs to systematically send their final reports to the IAS and requested that the latter reports twice a year on their key findings. Furthermore, efforts are undertaken to coordinate work programmes and harmonise audit methodologies and reporting structures. The first joint audits took place in 2004. The Court considers that these steps should help to reinforce the internal audit function within the Commission.

1.77.

In addition, the Court invites the Commission to consider the possibility for ensuring synergies between the IAS and the IACs by introducing a logical chain structure (63) within the internal audit function of the Commission, so that the Internal Audit Service can take into account the work done by the IACs.

1.77.

The Commission shares the Court’s concern for fully exploiting possible synergies between the different internal audit actors in the Commission.

The Commission is already taking action in this regard: a clarified information and reporting structure and a common reporting framework, established in Spring 2005, in particular covering the rating of audit observations and recommendations, are important steps in enhancing the effectiveness of the internal audit function for the Commission overall. The work programmes of the Internal Audit service (IAS) and Internal Audit Capacities (IACs) are being coordinated in order to avoid overlaps and this coordination of audit planning will be reinforced for the next programme period. There have been joint IAS and IACs audits.

The IAS has launched a quality assessment of the IACs, starting with a self-assessment exercise in 2005 and leading to an assessment by the IAS in 2006. This has not only the objective of guaranteeing the availability of quality internal audit services for the Directorates-General but also to establish an objective basis for other auditors to rely on audit work done at other levels.

1.78.

Action 3.3.2 of the 2002 Synthesis ‘Management risk assessment’ stipulates that the management of the risks becomes an operational and strategic instrument to decide on the allocation of the financial and human resources within the Commission's departments. To that end, the Central Financial Service (CFS) of the Directorate-General for the Budget, initiated, in 2004, a pilot project in seven Directorates-General in order to test the preliminary version of the risk management framework and corresponding implementation manual, while preparing in parallel the activity planning process and setting their main objectives for 2005.

1.79.

Despite the generally positive result, further efforts are necessary to develop methodological elements and tools for risk analysis and management, which could form a solid structural framework to be applied effectively in all Commission services. An inter-service steering committee is following up the development of the common framework, which should be adopted by the Commission in the second half of 2005, and used for the preparation of the 2006 Strategic Planning and Programming (SPP) cycle. On this basis, adequate annual management plans should allow Directorates-General to reduce risks deemed unacceptable but that could not be avoided nor transferred.

1.79.

The Commission agrees that further efforts are necessary and that the Court observations fairly reflect the Commission’s action plan.

1.80.

The Court analysed the application of internal control standards (64) by 14 of the Commission’s Directorates-General (65). The aim was not only to assess the degree of implementation but also to evaluate their effective functioning as regards the legality and regularity of the underlying transactions (see paragraphs 1.58 and 1.71).

1.81.

The guidelines presented by the CFS on the definition of the internal control standards (baseline requirements) for the 2004 financial year did not introduce significant changes as compared to 2003 (66).

1.82.

In their self-assessments, which are annexed to the ‘Overview on the state of internal control in the Commission DGs and services in 2004’ (see paragraph 1.71), the Directorates-General declare for the 2004 financial year that they comply with 93 % of the baseline requirements defined by the CFS. In general, the analysis of the Court confirms this presentation. Given that the baseline requirements remained essentially unchanged, the Court notes a slight increase in the compliance with the internal control standards, as compared to 2003 (91 %) The analysis of the Court on the implementation of internal control standards is presented in table 1.4 .

1.83.

The innovative element introduced by the guidelines on the annual review of the internal control system for the financial year 2004 consists of the assessment, by the Directorates-General, of the effectiveness of the application of the internal control standards. The Court’s review of the annual activity reports showed, however, that the evaluation is very general and does not make it possible to systematically identify the areas in need of improvement (see paragraph 1.58). A number of the Directorates-General (67) did not sufficiently evaluate the effectiveness of their internal control system. Among the services which presented a sufficient self-assessment, the majority (68) declared that the effective operation of the internal control standards 11 ‘Risk analysis and management’ and/or 17 ‘Supervision’ requires additional effort.

1.83.

The internal control standards have been gradually introduced in the Directorate-Generals since the launch of the reform. Emphasis was shifted in 2004 to effective implementation. A lot of work has already been done in this area, in particular, with regard to the two key standards of supervision and risk management.

However, this is a continuing process and the Commission acknowledges that much remains to be achieved in connection with one of the important innovations of the circular on the 2004 AARs as stated in reply to paragraph 1.60.

1.84.

The Court proposed, in its Opinion No 2/2004, the implementation of a Community internal control framework that should integrate and strengthen the elements already existing, while at the same time adding new aspects in order to increase efficiency and effectiveness of controls (common principles to be applied at all levels of administration in the institutions and Member States, internal controls should provide reasonable (not absolute) assurance on the legality and regularity of the underlying transactions, costs of the controls should be in proportion to the benefits they bring in both monetary and political terms, systems should be based around a logical chain structure where controls are undertaken, recorded and reported to a common standard, allowing reliance to be placed on them by all participants).

1.85.

The Commission adopted as a strategic objective to ensure that the Court obtains reasonable assurance concerning the legality and regularity of underlying transactions (69). Furthermore, the Commission adopted a ‘roadmap to an integrated internal control framework’ (70) with a view to initiating a process leading to a common understanding by the end of 2005, to be formalised in an interinstitutional agreement between the Parliament, the Council and itself, on how the current internal control framework can be improved in order to provide the Court with the reasonable assurance it seeks.

1.86.

The Court welcomes this initiative and the Commission’s commitment to establish an effective Community internal control framework following the recommendations presented in the Court’s Opinion No 2/2004. Effective supervisory and control systems are of major relevance, particularly in a context where a large part of the Community budget consists of expenditure which is intrinsically high risk because it depends on information supplied by beneficiaries, or is subject to extremely complex or imprecise rules.

1.86.

There are necessarily numerous conditions governing the eligibility of operations and expenditure, but the Commission provides guidance and has simplified the rules as far as possible.

2.1.

This chapter analyses issues arising from the implementation of the EU general budget in 2004.

2.2.

The budget of the European Union is approved by the budgetary authority (European Parliament and Council) on the basis of proposals presented by the Commission, and is set within the multiannual framework of the financial perspectives. For most expenditure areas — agriculture, structural operations, external action and pre-accession strategy — the Commission implements the budget in cooperation with Member and other beneficiary States.

2.3.

Within the budget there are separate appropriations for commitments and payments. Appropriations for commitment represent the amounts the Union has available to make budgetary commitments in the current year in order to honour legal commitments (or agreements) to spend during the current or future years (1). Appropriations for payment represent amounts that can be spent during the current year. Most expenditure on structural operations and on internal and external policies takes the form of programmes managed over a number of years (e.g. 2000-2006 for the current Structural Fund programming period). In these cases, legal obligations are not generally reflected as budgetary commitments in the year they are agreed, but as approximately equal yearly tranches over the life of the programmes (2).

2.4.

Detailed information on budgetary implementation for 2004 can be obtained from the Commission document entitled ‘Report on budgetary and financial management - Financial year 2004’ (3). In its 2003 annual report (4), the Court recommended that more detailed information be given on the cumulative state of implementation of Community programmes. Additional data on the cumulative state of implementation of Community programmes has been provided which increases the information value of the report. The Court recommends that in future the presentation could be made more useful by better explaining and analysing the data, and comparing actual with expected performance. In the case of the Structural Funds the information is presented by policy objective. However, it would also be useful to present the information by individual Fund as this would more closely reflect the Commission’s management and accountability structure.

2.4.

The Commission has provided extensive information in the form of an introductory text, tables and graphs on the cumulative state of a number of the most important multi-annual programmes (i.e. the Structural Funds, the Cohesion Fund, Sapard and ISPA). The annual budgets illustrate the expected performance, comparing these with the actual implementation. In future, the Commission will examine the possibility of providing the additional information recommended by the Court in the Report on budgetary and financial management. On the budgetary implementation of the Structural Funds, the Commission has, since 1977, published a detailed annual report. This report comprises, inter alia, a thorough analysis of the cumulative state of implementation, as well as an analysis of the individual Funds. The 2004 report was published in May 2005 and is available online at http://europa.eu.int/comm/budget/furtherinfo/index_pg2_en.htm.

In addition, detailed information on the state of the implementation of the Structural Funds (stating amounts allocated, committed and paid, by objective, Fund and Member State) is published in the Annual Report on the Implementation of Structural Funds which appears in October of the following year, see e.g. the 2003 report (COM(2004) 721 final).

2.5.

Article 185 of the implementing regulations to the Financial Regulation stipulates that the report on budgetary and financial management (5)‘shall give an accurate description […] of the achievement of the objectives for the year, in accordance with the principles of sound financial management’. This requirement has been complied with at a general level. More detailed information is included within the annual activity reports of the directors-general.

2.5.

The purpose of the report is to provide an overview on the evolution of the annual budget and its implementation. In addition, the Commission provides a number of more specialised, detailed annual reports on several policy areas, notably the annual report on budgetary implementation of the Structural Funds.

2.6.

The 2004 budget was originally drawn up for an EU of 15 Member States (6). Total appropriations for commitments fell by 0,3 % and total appropriations for payments increased by 2,3 % compared with the 2003 final budget. Enlargement necessitated an amending budget (7) from 1 May onwards. The updated budget represented increases of 11,5 % and 7,8 % for commitments and payments respectively, compared with the 2003 final budget. The increase in commitments is proportionally larger because they can cover expenditure for more than one year (see paragraph 2.3).

2.7.

Commitment and payment appropriations were below their increased financial perspective ceilings by 4,3 billion euro and 11,8 billion euro respectively. For commitments, the margin occurs mainly in agriculture (2,5 billion euro) and pre-accession strategy (1,7 billion euro) with the other headings being near or slightly over (8) the limits.

2.8.

Amending budgets voted during the year (9) resulted in an overall 1,6 billion euro reduction in appropriations for commitments (due to less than foreseen expenditure on agriculture), and a 2,0 billion euro increase in appropriations for payments, mostly related to extra appropriations for structural operations (see paragraph 2.14).

2.9.

Table 2.1 gives an overview of the budgetary outturn for the 2004 financial year for both payments and commitments. In 2004 the proportion of final appropriations for commitments used (the implementation rate) was 98 %, marginally lower than 2003 (99 %). For payments, the proportion of final appropriations used (the spending rate) was 95 %, an increase on 2003 (92 %, albeit based on a reduced budget (10)) and 2002 (86 %). The increase in spending occurred in all areas.

2.10.

For 2004, the budget surplus (11) totalled 2,7 billion euro (see Table 2.2 ), for the following reasons:

2.11.

The 2004 surplus represents a further reduction compared with 5,5 billion euro in 2003, 7,4 billion euro in 2002 and 15,0 billion euro in 2001. Much of the reduction in the surplus is due to the higher spending rate for structural operations. This reflects not only improved management by the Commission, but also the fact that, as 2004 is well over half way through the 2000 to 2006 spending programmes, the spending rates have increased (see paragraphs 2.14 to 2.16).

2.12.

In its 2002 and 2003 Annual Reports (18) the Court identified poor forecasting of structural operations expenditure by Member States as a significant reason for the Commission not being able to take timely action on management of the underspending and the resulting surplus. Estimates have improved, with the forecasting error rate falling from 50 % in 2003 to 23 % in 2004. However, this still represents an over-forecast of 6,5 billion euro and the Commission itself recognises the scope for further improvement. Unlike in previous years, the Commission’s 2004 report on budgetary and financial management provides no information or analysis of Member States’ estimates.

2.12.

The Commission has provided a detailed report on the Member States’ payment forecasts, including a comparison of the forecasting error rates 1998 to 2004, in the aforementioned annual report on the budgetary implementation of the Structural Funds.

The Commission would like to emphasise that the annual payment budget is not directly based on the Member States’ forecasts, but on the Commission’s own assessment of the likely need for payment appropriations. The Member States’ forecasts are potentially a useful input for this assessment, which is why the Commission is continuing to press for improvement.

2.13.

In the past, significant carryovers of appropriations have been made and not used (19). Of the amount of non-earmarked payment appropriations brought forward from 2003, 23 % were not used (20). A total amount of 2,8 billion euro is being carried over to 2005, comprising 1,5 billion euro in respect of the operational budget (1,2 billion euro in 2003), and 1,3 billion euro in respect of earmarked third party revenues (1,0 billion euro in 2003).

2.14.

A large proportion of the budget — structural operations, some internal policies and external actions — consists of multiannual expenditure programmes running within defined cycles over a number of years (e.g. 2000-2006 in the case of the Structural Funds). The Commission and the Member States encountered significant delays in setting up and starting operation of these programmes, particularly in respect of the Structural Funds. However, in 2004 the programmes largely reached the planned annual level of spending, involving the reimbursement of claims from Member States for payments made to beneficiaries. Indeed, the budgeted payment appropriations for the Structural Funds were not sufficient so an amending budget (21) totalling 3,7 billion euro was requested prior to the year end. Of this amount, 3,3 billion euro related to the current programmes.

2.15.

The current level of spending involves only a limited reduction in the level of outstanding commitments. The information provided in the Commission’s report on financial and budgetary management on the state of implementation of the Structural Funds (see paragraph 2.4) shows that the three policy objectives for the 2000-2006 period were implemented by around 40 % by the end of 2004.

2.15.

The Commission aims to budget accurately for all eligible payment requests, and this may include bringing forward amending budgets where payment flows exceed expectations.

2.16.

Also ongoing is the closure of the Structural Fund expenditure programmes for the previous programming period (1994 to 1999). The Commission has experienced significant problems and delays in closing these programmes and in making final payments (see paragraphs 5.29 to 5.31). Of the 9,1 billion euro of outstanding budgetary commitments at the end of 2003, payments were made on 3,6 billion euro and 2,3 billion euro were cancelled as they will not be used. At the end of 2004, 3,3 billion euro of budgetary commitments remain outstanding for the closure of these old programmes in 2005 and potentially beyond.

2.16.

Member States were obliged to submit payment claims for these programmes at the latest by 31 March 2003. A large number of claims arrived just before the deadline and the variable quality of the accompanying closure documentation made it necessary to make additional enquiries before the claims could be processed. The closure exercise made substantial progress in 2004. This is shown by the reduction in outstanding commitments by two thirds to around 5 % of the total outstanding commitments for the Structural Funds.

2.17.

Outstanding budgetary commitments represent the amounts which the Commission has legally committed to pay in the future. The higher the value of outstanding budgetary commitments, the greater is the demand on the payments budgets in future years. Outstanding budgetary commitments increased by 4,5 % to 110,1 billion euro (see Table 2.3 ). The increase was due to the additional budgetary commitments for the new Member States after enlargement. The underlying outstanding budgetary commitments for the pre-enlargement EU remained stable. Outstanding budgetary commitments for differentiated expenditure as a whole represents 2,2 years of payments at the current spending rate (2,5 years in 2003).

2.17.

The 2,2 years referred to by the Court can be regarded as a normal ratio and close to the n + 2 principle.

2.18.

Graph 2.1 shows the value of outstanding budgetary commitments on differentiated expenditure since 1994. The increase is due to both the change in the system for annual commitments for the Structural Funds, introduced for the 2000-2006 programming period, and the cumulative effect of underspending between 1999 and 2003 which resulted in 40 billion euro of payment appropriations being cancelled (22).

2.19.

In its reply to the 2003 Annual Report the Commission stated the level of outstanding budgetary commitments to be in line with its forecasts (23). In 2002 the Commission undertook an in-depth analysis of the progress of the budgetary execution of the Structural Funds taking into account, and adjusting for, the low rates of spending in 2000 to 2002, and forecasting the level of outstanding budgetary commitments at the end of each year up to 2010 (24).

2.20.

In the event, the level of outstanding commitments at the end of 2004 for 2000-2006 programmes was 3,7 billion euro higher than the Commission predicted in 2002 for the EU 15. Outstanding budgetary commitments for the 1994-1999 programmes were 3,3 billion euro: the Commission’s 2002 analysis expected them to have been completely liquidated. Furthermore there were 2,1 billion euro of outstanding budgetary commitments relating to enlargement, not included in the Commission’s analysis.

2.20.

The higher than forecast level of outstanding commitments for 1994 to 1999 is due to the delay in the closure of these programmes, which was difficult to predict at the time (see reply to point 2.16). The 2002 figures were best estimates based on information available. The difficulties in making these estimates were, to a large extent, due to the fundamental change of the payments system for the new 2000 to 2006 programmes, compared to the previous programmes.

2.21.

Due to the nature of the budgetary process the balance of outstanding budgetary commitments does not reflect the full extent of legal commitments, as most expenditure programmes are subject to specific rules. Financing decisions made at the beginning of the programming period — representing legal commitments to pay — are not translated immediately into budgetary commitments, but are allowed by the Financial Regulation (25) to be committed over the programming period on an approximately equal annual basis. The legal commitments made, but not yet transformed into budgetary commitments, are disclosed as off balance sheet items in the annual accounts (26).

2.22.

At the end of 2004, outstanding budgetary commitments for the Structural Funds 2000-2006 programming period were 60 billion euro, representing 2,2 years’ expenditure at the 2004 spending rate. Legal commitments not yet transformed into budgetary commitments (see paragraph 2.21), total 75 billion euro. As such, total outstanding legal commitments for the Structural Funds 2000-2006 programming period at the end of 2004 were 136 billion euro, which represents nearly five years’ payments at the 2004 spending rate. The total outstanding legal commitments only fell slightly in 2004, due to the effect of the additional legal commitments arising from enlargement. However, in order to liquidate all the outstanding legal commitments from the 2000-2006 programming period by the end of the payment period (2010), the Commission will need to maintain a high spending rate and/or to undertake significant decommitments under the n + 2 rule (see paragraphs 2.24 to 2.26).

2.22.

The Commission considers that the presentation of the ratio of ‘outstanding legal commitments’ relative to payments in a given year is not, in itself, a useful indicator; the ratio of ‘outstanding legal commitments’ relative to payments naturally falls as the end of the programming period approaches. The total level of outstanding commitments should therefore always be seen in the light of the remaining time span for execution of the remaining payments. In this respect, the Commission agrees with the Court’s observations in the last sentence.

2.23.

In respect of the current Structural Funds programming period, Member States can make payments to beneficiaires up to the end of 2008, and the Commission can reimburse Member State claims up to 2010, including closure. Experience with previous periods shows that spending rates fall towards the end of the cycle and closure is problematic (27). There is, therefore, a risk that spending on the current programmes will be delayed even further into the next period, and the start of the new programmes delayed.

2.23.

It is normal that part of the balance for programmes for the current period will be paid in the years 2007 to 2010. Due to the application of the n + 2 rule for the Structural Funds the Commission does not expect to face any significant accumulation of outstanding commitments at the end of the current period.

The closure of 2000 to 2006 programmes should not mean that the start-up of programmes in the next period will be delayed. 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.

2.24.

The Commission considers (28) that the risk of a high level of outstanding budgetary commitments within the Structural Funds is reduced by the year n + 2 rule. This provides that commitments on which no payment has been made within the two years following the year the commitment was made are cancelled automatically. In 2003 the cancellations following application of this rule amounted to 31 million euro. In 2004, the amount involved was higher at 219 million euro, representing just 0,3 % of the balance of outstanding budgetary commitments for the Structural Funds at the end of the year.

2.24.

The Commission maintains its view that the n +  2 rule will stabilise the level of outstanding commitments.

The payments on account made at the beginning of the programming period, representing 7 % of the total 2000 to 2006 envelope of each programme, provide a relatively long-term protection against n + 2 decommitments as advance payments reduce the level of reimbursements needed to avoid automatic decommitments. This protection weakens over time though, which may lead to growing n + 2 de-commitments in the years ahead.

At the same time, the n + 2 rule provides an incentive for faster implementation and more regular submission of payment claims. Therefore, its impact cannot only be judged by the level of decommitments.

2.25.

Of the commitments cancelled following this rule, 76 % related to ESF expenditure in the Netherlands. In practice new commitments from the performance reserve (29) were in some cases allocated to the programmes from which commitments were cancelled, thereby negating the effect of the procedure (30). The lack of cancellations for other Member States reflects increased spending. However, the Court found evidence of claims including ineligible expenditure being submitted by Member States in order to prevent cancellations. This illustrates the real nature of the risk identified by the Court in its 2003 Annual Report (31).

2.25.

The background to the situation described by the Court, regarding the additional commitment from the performance reserve to a programme from which funding had been decommitted under n + 2 is, that given the fact that 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. As there is one Objective 3 SPD in the Netherlands, the Commission had no choice but to commit the reserve to this programme, but of course putting it into the better performing priorities.

The Commission is examining the Court’s evidence found in its audits in Member States of ineligible expenditure being included in claims and will take the necessary measures. It examines this risk in its own audits.

2.26.

Although the Commission considers the year n + 2 rule to be an important budgetary management tool, no analysis on its operation or effect is given in its report on budgetary and financial management.

2.26.

One purpose of the n + 2 rule is to spur execution, and so the effects of the rule can be partly gauged from the information on execution given in the budgetary and financial management report. More detailed information as related to the Structural Funds is included in the aforementioned annual report on the Structural Funds, published in May 2005.

2.27.

While the outturn for 2004 was largely satisfactory for the Structural Funds, many of the persistent problems — delays, increase in outstanding budgetary commitments — in implementing multiannual spending programmes arise from budgeting over the programming period which does not take sufficient account of the ability of Member States to absorb the funds within the timing foreseen. Moreover, commitments, as explained in paragraph 2.21, are made in approximately equal annual tranches over the nominal life of the programme. This neither reflects the expected payment profile, nor the full extent of legal commitments (32), and therefore provides information which can be easily misinterpreted.

2.27.

The budgeting of commitments is a direct consequence of the allocation of resources as decided by the European Council. The annual budgeted commitments normally reflect the programming (or revised programming). As a policy, the Commission aims at forecasting what is actually needed as annual payment approriations.

2.28.

Payments are intended to be made during a period stretching beyond the nominal life of the programme (up to 2010 in the case of the 2000-2006 period). The payment profile varies greatly during the programme cycle with low initial payments as programmes (and the projects they finance) are defined and started, and then higher demand in intermediate years, reducing towards the end. Where two cycles overlap, the years of lower demand at the start of the second cycle are intended, by the Commission, to be compensated for by payments from the end of the first cycle, resulting in a smooth and consistent demand for payment appropriations.

2.29.

In practice, the demand for budgetary payments by the Commission depends on claims from Member States which themselves depend on the ability of beneficiaries to undertake projects and absorb expenditure. The uneven demand over the five years to 2003, resulted in significant underspending (33). Underspending has different consequences for payment appropriations and commitments: unused payment appropriations are cancelled whilst commitments remain outstanding. This difference in treatment results in growing levels of outstanding budgetary commitments (see paragraph 2.18) and the resulting time lag between commitments and payments.

2.29.

A growing stock of outstanding commitments is a normal feature of multi-annual programming such as that in the structural funds. The stock of RAL would ‘normally’ be expected to grow in the early years, stabilise and then fall back down towards the end of the period. There is no particular reason in a system with differentiated appropriations why payments and commitments in any given year should match.

2.30.

The Commission’s report on budgetary management now provides some additional information on the progress of spending programmes. However, the information could still be improved by being more completely explained, by assessing progress against expected performance and by reflecting more closely budgetary management and accountability. Information should also be provided on Member State spending estimates and the operation of the year n + 2 rule for the Structural Funds.

2.30.

As recommended in last year’s report by the Court, the Commission has provided extensive information on the cumulative state and progress of a number of the most important multi-annual programmes. (i.e. the Structural Finds, the Cohesion Fund, Sapard and ISPA).

The Commission is willing to seek to improve the information provided as has been the case in the past, including in the 2004 report. In addition, the Commission draws to the attention of the Court the extensive annual report on the budgetary implementation of the Structural Funds, published by DG Budget in May.

The Commission also refers to its response in point 2.4.

2.31.

Improved spending rates and the resulting reduced surplus are a reflection of better management by the Commission and an increased level of spending within the major expenditure programmes, particularly the Structural Funds.

2.32.

The level of outstanding budgetary commitments continued to rise, and totalled 109 billion euro at the end of 2004. The increase was mainly due to enlargement, with underlying outstanding budgetary commitments relating to the EU-15 falling slightly. The year n + 2 rule, which is intended to manage the situation for the Structural Funds, has resulted in very little decommitment since it was established.

2.32.

The level of decommittments is not in itself a proper indicator of the effectiveness of the n + 2 rule. This rule also has an effect on promoting execution (see also reply to point 2.24).

2.33.

Outstanding budgetary commitments for the Structural Funds are in excess of the Commission’s revised forecasts of 2002. The Court recommends the Commission should consider updating its analysis in order to identify the implications for the current and future period, and identify if any specific action is needed.

2.33.

The pattern of actual execution and the actual level of outstanding commitments are analysed and used as input relevant to assessing payments needs during the preparation of the Preliminary draft budget. At present there are no plans to bring forward a revised Communication.

2.34.

EU budgetary information neither completely reflects the reality of expenditure nor provides sufficiently clear information on the legal obligations of the Union. For the Structural Funds the budget for commitments is based on equal annual instalments, and that for payments is based on smooth and consistent supply-led assumptions for spending, but implemented following irregular demand-led claims from Member States. As already recognised by the Commission, its ability to actively manage the implementation of the budget for multiannual spending programmes is limited (34).

2.34.

For the Structural Funds, the annual commitment appropriations are directly predetermined by the multi-annual programming (i.e. supply-led). To an extent, this also applies to other major multi-annual programmes.

Payment approriations, on the other hand, must be demand-led, with the exception of limited advance payments. Payment appropriations are annually budgeted for, aiming at realistic forecasting of the actual demand on the basis of trends in execution and other relevant information. The basis for the Commission’s estimates of payments needs for the structural funds are generally provided in the Preliminary draft budget. By and large, there was a substantial improvement of the budgeting of payments in 2004.

The amount of the legal commitments for which no budgetary commitments have yet been made is disclosed amongst the contingent liabilities in the Communities’ annual accounts.

2.35.

As unused appropriations for payment, together with their associated financing, cannot be carried forward to meet future demand there is a time lag between the programmed expenditure period (e.g. 2000-2006), and the timing of the actual expenditure. This results in either a high level of spending needed at the end of the programming period — which is difficult to manage — or a high and increasing level of outstanding budgetary commitments and expenditure, with current period expenditure being pushed further into the new period, potentially hampering its start. Without specific attention, the time lag will continue into the future.

2.35.

The Commission has an obligation to budget sufficient payment appropriations, including proposing an amending budget if necessary, as was the case for the Structural Funds in 2004. The budget implementation in 2004 did not increase the RAL, except for the new Member States, which was natural and inevitable for such new operations. For the Structural Funds, the payments are primarily determined by the Member States requests for reimbursements, and the budgeting has to reflect this. The n + 2 rule sets a limit on the back-loading of the programmes regarding payments, and the Commission does not share the concern that the payments relating to the 2000 to 2006 programmes could hamper the start of the subsequent programming period.

The Commission also refers to its response in point 2.23.

3.1.

The revenue of the budget of the European Union consists of own resources and other revenue. As shown in Table 3.1, Graph 3.1 and Graph 3.2 own resources are by far the main source of financing for budgetary expenditure (92 %). There are three categories of own resources: traditional own resources (customs duties, agricultural duties, and sugar levies) (13 %), own resources calculated on the basis of value added tax collected by Member States (15 %), and own resources derived from the Member States’ gross national income (72 %).

3.2.

Traditional own resources are established and recovered by Member States under national legal and regulatory provisions which must meet the requirements of the Community rules (2). The risks to the collection of traditional own resources are evasion of duty by misrepresentation or simply by smuggling, miscalculation or failure to establish duty because of undetected mistakes or weaknesses in systems, and errors or omissions in Member States’ accounting for the duty established.

3.3.

The Court’s audit cannot cover either undeclared imports or those that have escaped customs surveillance. However, as well as direct testing of customs declarations and accounting systems, the Court’s audit work included evaluation of supervisory and control systems, both in the Commission and in Member States, in order to assess whether the arrangements in place gave reasonable assurance of completeness. It consisted of:

3.4.

The Commission may request Member States to carry out inspections of the establishment and making available of traditional own resources, and may also carry out such inspections itself, either in association with the Member State authorities or autonomously (4). Individual inspection reports are addressed to the Member States involved and these reports, together with the replies received, are examined during meetings of the Advisory Committee on Own Resources (5). An overall report on the functioning of the inspections is drawn up every three years and presented to the budgetary authority (6).

3.5.

The Court has reviewed the inspections and has taken the results into account. As in previous years, their methodology was found to be soundly-based and the documentation to be 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 3.23).

3.5.

The Commission will continue to focus on Member States’ management of the B accounts in its own inspections of traditional own resources.

3.6.

The supervisory and control systems for traditional own resources in Member States consist in the first instance of supervision by the customs authorities, as defined by the Community Customs Code (7). Community legislation does not generally prescribe either particular methods or the level of customs control, this being at the discretion of the Member States.

3.7.

The Court examined customs supervision and clearance at selected land frontier posts in eight Member States (8). The audit concentrated on an evaluation of the customs surveillance and control procedures that are intended to ensure that all goods are subject to a customs treatment (9). The procedures for ensuring that goods arriving are properly dealt with were generally considered satisfactory at the border stations visited.

3.8.

The Commission is implementing an action plan (10) to foster more effective customs procedures generally through better use of information technology. Computer systems for the submission and clearance of customs declarations make it possible to automate the calculation of and accounting for duty, as well as various routine checks. Such systems can also be used to select which declarations and consignments should be checked by customs staff whilst clearing the rest automatically, greatly reducing disruption of international trade and the costs of control. The reliability of electronic clearance systems, and the quality of the risk analysis procedures incorporated in them thus have a major effect on the completeness and correctness of traditional own resources. Member States’ systems are at present in different stages of development. In 2003 the Commission inspected electronic clearance systems, found that they were on the whole satisfactory, and recommended that their use should be further developed (11).

3.9.

The Court carried out an examination of the electronic customs clearance systems in 12 Member States (12) and of the supervision and coordination done by the Commission. Its audit did not identify substantial shortcomings either in the actions so far taken by the Commission or in the systems of the Member States visited. However, the Court draws attention to the following issues on which it recommends further action before conventional paper declarations can be dispensed with.

3.10.

Where computer systems are used there need to be tested plans to have fallback systems up and running in the event of disaster. No comprehensive disaster plans existed in three Member States visited, but some back-up procedures and instructions had been prepared. In four Member States a plan existed but had not been tested. These weaknesses represent a risk to the continuity of import and export trade and to the collection of customs duties in the event of a breakdown or other emergency.

3.10.

The Commission agrees with the Court’s comments regarding the importance of fall-back mechanisms. Precautions are needed to avoid disruption of trade, to allow control by the customs authorities and to protect the collection of traditional own resources. The Commission has provided for such procedures in its legislation (Article 353 of Regulation (EC) No 837/2005) on the Community computerised transit system, NCTS. The Commission would also point out that manual systems may be subject to disruption. Where this has occurred, traditional own resources payments have been adjusted, as considered necessary, to ensure that the Community budget does not lose out.

3.11.

In six Member States visited SAD (13) forms may be sent on paper accompanied by a diskette, from which data are loaded into the system without an electronic signature. Legally, only the conventional paper form is binding. In three Member States there were either no formally-established and recorded input control procedures to ensure that the data on the diskette matched the printed form, or the procedures were not always followed. In those circumstances there is a risk that data used in computer processing, including the amounts of import duty, might differ from the data presented on the SAD form.

3.11.

As part of its regular follow-up of points raised by the ECA, the Commission will pursue the introduction of suitable controls with Member States.

3.12.

Where 100 % checking of declarations is not feasible, risk analysis and risk profiles should be used to decide whether an import requires an examination. Risk profiles can best be implemented in a computerised clearance environment. In order to ensure efficiency and a similar level of control at all customs points, the Commission has proposed a number of tools (14), which include a common methodology and common criteria for risk management. The Commission also proposes that frontier customs offices should focus on admissibility and security checks. Fiscal and commercial policy controls are usually to be made at the traders’ premises through audits and on-the-spot checks based on common risk criteria.

3.12.

Given the volume of international trade and the wide range of tasks to be performed by customs services, customs checks will always be selective. Risk analysis has a part to play, not only in the uniform collection of customs duties (and their prompt transfer to the Commission), but also in other tasks. These tasks and the respective tools proposed by the Commission, range from protecting European citizens from threats to their health, safety and security, to the collection of customs duties.

3.13.

The Court has previously reported on the use of risk analysis techniques (15). However, despite the Commission’s support and recommendations, differences still remain between the Member States in the degree to which they make systematic use of risk analysis and risk profiles in targeting controls, even though computerisation of customs processes has made this possible.

3.13.

Following the recent amendment of the Customs Code (Regulation (EC) No 648/2005 of 13 April 2005), the Commission and the Member States are further cooperating to implement a Community-wide risk-management framework.

3.14.

An amendment of the Customs Code (16) introduces an obligation for Member States to use risk management and stipulates the time periods within which the Member States shall use appropriate risk-based controls and when customs controls shall be based on risk analysis using automated data processing techniques. To comply with these new rules additional efforts will be necessary. As the Court found during its audit, in 2004 risk profiles were not used at all in two Member States, leaving decisions about physical or documentary checks to be based mainly on purely personal subjective initiative of the customs officer. In another two Member States risk profiles were used only on part of imports, leaving goods imported under certain simplified procedures without any profile-based targeting of control measures.

3.14.

The two Member States found not to have been using risk analysis by the Court were on the brink of doing so and both introduced systems for imports by the end of 2004. This is an important initial level but adopting a risk-analysis basis for customs control has a much wider-reaching impact. The analysis of risk has a part to play in all types of customs controls, including the selection of importers for authorisation, to use simplified procedures, and the frequency and content of audit-based checks. It is to be expected that, apart from the security and safety issues for which specific targets have been set, Member States will adopt a variety of measures at different speeds depending upon the volume and types of customs traffic they handle.

3.15.

In one Member State fiscal risk profiles at borders have been reduced and substituted for by audit-based fiscal controls made at the economic operators’ premises. This strategy is in accordance with the Commission’s proposal in its communication of July 2003. This approach, however, can weaken customs control, since the frequency of checks on many operators is low.

3.15.

The Commission will remind Member States of the key role that frequency of control can play in the implementation of an audit-based control strategy.

3.16.

Although the importance of random sampling as a supplementary element was generally recognised in the Member States, statistical random selection of goods is not used in six of the Member States visited.

3.16.

The Commission will continue to recommend that the Community risk framework includes a random element in the basis for the selection of consignments or declarations subject to customs controls.

3.17.

Customs authorities should regularly monitor and review the results of customs controls to assess the effectiveness and efficiency of the risk management system using feedback from the customs clearance process to update the analysis and prioritisation of control work.

3.18.

Weaknesses were noted in some customs administrations in recording the results of documentary/physical checks and in reporting to central level. In some cases filters were overridden without justification and management approval. In addition, risk profiles were not always appropriately reviewed to ascertain whether they were effective, or there was a lack of coordination between the branches responsible for setting up filters at different levels (central, regional, local). Insufficient monitoring and review of the functioning of risk profiles and of the results of customs controls lead to lack of feedback from the process, which in turn prevents both timely updating of the risk profiles and optimal prioritisation of the control work done by Customs.

3.17 to 3.18.

The Commission agrees that recording results and reviewing and updating risk profiles are key aspects of properly managing risk and will continue to urge Member States to implement suitable procedures to achieve this.

3.19.

Entitlements without security, and, those which have been challenged and might be subject to change, need not be made available to the Commission if they are instead entered by the Member States in separate accounts (the B accounts). Each Member State provides a quarterly statement of its B accounts to the Commission. The net balance included in the Communities‘balance sheet under’ Amounts owed by Member States’ is 739,4 million euro (2003: 729,3 million euro).

3.20.

At 31 December 2004 the gross balance for the B accounts standing in the Commission’s books was 1 905,0 million euro, 19,4 % less than the equivalent figure at 31 December 2003 (2 364,3 million euro) (17). The major reason for this change is that entries relating to the import of New Zealand butter products have been taken out of the B account following resolution of the case (18).

3.21.

The Court welcomes the adoption of Council Regulation (EC, Euratom) No 2028/2004 (19), which requires Member States to write off amounts of traditional own resources that are not recovered by a specific deadline. The regulation also introduces a requirement for Member States to provide an estimate of the amount standing in their B accounts for which recovery has become unlikely.

3.22.

To recognise the extent to which recovery is unlikely, the Commission has entered in its balance sheet a write-down based on the information newly provided by the Member States. The total write-down is in the range expected by comparison with previous years. However, most of the Member States have not provided information about the methods they used to make their estimates. In consequence, the Court cannot confirm the amount of the write-down, and considers that the Commission should provide guidance with the aim of ensuring a consistent approach throughout. The estimates of the unrecoverable proportion provided by the Member States vary from 10 % (12,8 million euro, in the case of the United Kingdom) to 96 % (118 million euro, in the case of Spain) (20).

3.22.

The Commission considers that, in using the estimates prepared by Member States, it has applied the principle of prudence required by the Financial Regulation. Recovering customs debts depends upon national laws and procedures; only Member States are aware of the solidity of the grounds for demanding payment, whether or not the debtor has assets and the likelihood of the enforced recovery proceedings available to them proving successful. The Commission explained to Member States the underlying principle they should use in preparing their estimates during the ACOR meeting on 9 December 2004. It will remind Member States of their responsibility to produce estimates based on realistic data.

3.23.

As in previous years (21), the Court’s audit and the Commission’s inspections (see paragraph 3.5) found systematic problems with B accounts, such as delays in making entries, erroneous entries, omissions and incorrect cancellations, in several Member States (Belgium, Germany, Ireland, Italy, Cyprus, Poland, Slovakia, Sweden, United Kingdom). In 2003 Germany removed entries totalling 40,1 million euro from its B account, without providing a full explanation of this reduction.

3.23.

The Commission is pursuing these points with the Member States concerned to obtain explanations and corrections of the errors.

3.24.

In the common organisation of the markets in the sugar sector the producers have financial responsibility for the losses incurred from disposing of the surplus production under quota (22). This is implemented by setting levies on the production of sugar, isoglucose and inulin syrup. The levies are calculated by the Commission (479,8 million euro for the marketing year 2002/03) and collected from the manufacturers by the Member States. The Member States retain 25 % of the levies as collection costs (23).

3.25.

The Court followed up previous work on sugar levies and examined the calculation finalised in September 2004 (for the marketing year running from 1 July 2002 to 30 June 2003). The Court found that the system for calculating sugar levies was operating in a generally satisfactory way despite ambiguities in the prescribed calculation method (24), which need to be resolved. The Court also draws attention to the following points, on which corrective action is recommended:

3.25.

(a)

the total amount of sugar levies (479,8 million euro) was erroneously understated by some 6 million euro;

(a)

The corrections will be made automatically during the calculation of the 2005 levies, which must include the calculations and carry-overs from previous marketing years.

(b)

regarding the two main sources of data on which the calculation is based:

(b)

3.26.

In addition it is still the case that, as noted in the Court’s Special Report No 4/91 (27), no conclusive reconciliation between the revenue and the expenditure to be financed by sugar levies is feasible within the Commission’s current system of accounting.

3.26.

There is no need to carry out an accounting reconciliation between resources obtained from the levies and budgetary expenditure, since the calculation method currently provided for in the Council rules does not give the two elements equal status. Comparisons may be made outside the accounting system whenever necessary.

3.27.

In contrast to the revenue from traditional own resources, the VAT and GNI own resources reflect macroeconomic statistics whose underlying data cannot be audited directly. For this reason, the VAT/GNI audit takes 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 seeks to assess the Commission’s system for handling the data until they are ultimately included in the final accounts. The audit thus covers the establishment of the annual budget and its implementation in respect of the monthly payments by Member States. The audit further concentrates on the Commission supervisory and control systems which are intended to provide assurance that the EU revenue is correctly established and collected. Specific aspects of the VAT/GNI own resources are the subject of separate audits.

3.28.

The Court’s separate audits concerning the VAT and GNI own resources covered Commission controls on Member States’ inventories for the European System of Accounts (ESA 95) (28), the calculation of the weighted average VAT rate (WAR) in the Member States’ VAT statements (29) and supervisory and control systems in relation to the compilation of National Accounts at Statistical Offices in Member States.

3.29.

The Commission inspection activities carried out in cooperation with the Member States constitute an essential element of the control system for VAT/GNI-related own resources. The Court examined the work of the units carrying out these inspections.

3.30.

In respect of the VAT own resources, the Commission’s on-the-spot inspections carried out during the financial year 2004 led to 28 new reservations (30)) in respect of specific elements of Member States’ VAT statements (31). The preparation and the reporting of the results of these inspections were of good quality. However, given the limited resources available, the Commission faces difficulties to maintain the same quality and frequency of inspection visits to Member States as before enlargement (32). Furthermore, as far as the follow-up of the audit observations related to reservations is concerned little progress was made (only six reservations were lifted during the year) and thus 107 remained at the end of 2004. These reservations often cover several financial years and four of them date back to VAT statements submitted more than 10 years ago. Their financial impact has not been estimated by the Commission.

3.30.

The Commission’s analysis shows how difficult it is to estimate the financial impact of reservations since they mainly concern cases where reliable data are lacking. They are generally made precisely in order to oblige Member States to seek reliable quantitative data and an acceptable methodology. Finally, the Commission announced in 2003 its willingness to take longstanding reservations to the European Court of Justice where this appears useful. This has already proved effective in the case of two Member States which met the Commission’s wishes while the infringement procedure was still at the preparatory stage. The Commission is aware of the increased workload resulting from enlargement and is examining how to make the best use of its resources to maintain the quality of inspections.

3.31.

Member States that apply differing VAT rates are required to calculate a weighted average rate (WAR) to be used in the calculation of the VAT own resource by the Commission. Any error in this calculation would affect the VAT base used for the calculation of own resources and can consequently affect the amount of VAT own resources paid. The Court examined the Commission’s inspections of this aspect of the system, audited the calculation of the WAR in five Member States (33) and checked its compliance with Community legislative requirements (34).

3.32.

As far as the 29 specific reservations on the WAR are concerned, the Court found that a number of them have been pending for an excessively long period (35). Once a reservation was placed, the Member States had an indefinite length of time to solve the problem.

3.32.

There is no legal sanction that the Commission can use to oblige Member States to improve data sources or methods of calculation rapidly even though infringement procedures provide a possible solution in the longer term. Nevertheless, outstanding reservations are re-examined at each control and successive control reports document the development of discussions on each reservation. In the case of Austria, significant progress has been made that will make it possible to lift the reservation, which was placed both by Austria and by the Commission, once the Commission has received the agreed amendments.

3.33.

On the other hand, the Commission placed no reservation in cases of systematic shortcomings (36) in the WAR calculation.

3.33.

In the Italian example cited in the Court’s footnote, the Commission accepted approximate data to allocate a small number of products to VAT rates. For these products the expenditure is known but there is no specific information available on the allocation to different VAT rates or to exemption. For GFCF, one approximate percentage is used to distinguish between standard and reduced rate. Italy can grant this taxation only for a restricted period of time. During the relevant control, the Commission confirmed the lack of any data to accomplish this calculation. The Commission accepted a split, based on a rough estimate only, exceptionally for a short period of two years, later extended to four. The Commission has already announced in the last control report that this practice will no longer be accepted.

3.34.

Within the Commission, the Directorate-General for the Budget (DG Budget) has delegated a substantial part of the checks on the WAR calculation to Eurostat and certain fiscal aspects of the calculation to the Directorate-General for Taxation and Customs Union (DG TAXUD). Their respective roles and responsibilities were not formally documented at the time of the Court’s audit.

3.34.

The Budget DG retains overall responsibility for the determination of the WAR but receives technical support from Eurostat regarding the weighting of economic sectors and from TAXUD regarding the allocation of goods and services to VAT rates. As a result of the Court’s comment, a Memorandum of Understanding signed by the three Directors-General, specifying these roles and also covering other areas of cooperation, entered into force in September 2005.

3.35.

In respect of the GNI own resources, there was still insufficient direct verification by the Commission of the underlying National Accounts which are the basis for the figures presented in the GNI questionnaires (37). However the Commission has started to set up a unit that will undertake verification of public and National Accounts produced by Member States.

3.36.

Since 2003, Community legislation provides for the transmission of an annual report on the quality of GNI data by Member States to the Commission. The report should supply the information necessary to show how the aggregate GNI figure was reached, and, in particular, describe any significant changes in the procedures and basic statistics used and explain the revision made to earlier GNI estimates. Pursuant to Article 2(3) of Council Regulation (EC, Euratom) No 1287/2003 the content and format of this report should follow the guidelines laid down by the Commission (38).

3.37.

A review of the quality reports submitted in 2004 shows that: