FINAL ANNUAL ACCOUNTS OF THE EUROPEAN COMMUNITIES

FINANCIAL YEAR 2005

Volume I

CONSOLIDATED FINANCIAL STATEMENTS AND CONSOLIDATED REPORTS ON IMPLEMENTATION OF THE BUDGET

(2006/C 264/01)

CONTENTS

Principal events and key points

PRINCIPAL EVENTS AND KEY POINTS

THE CHANGE TO ACCRUAL ACCOUNTING AND ITS IMPACT

Why change?

The European Communities undertook to fall into line with the approach adopted by many States, and supported by international bodies such as IFAC (1) and OECD, by modernising their accounts. This entailed a change from a system of accounts focusing on a cash-based description of budget expenditure and revenue operations to an accrual accounting system.

The objective was to provide better information to management for their decision making and to improve the transparency and quality of the accounting information presented annually. The new system should ensure that both the internal users of the system and the external readers of the accounts have more reliable and relevant information.

The work done

The work started in earnest in 2003 with the commencement of the ‘modernisation of the accounting system’ project, which had the aim of placing the European Communities at the forefront of the international movement towards the modernisation of public sector accounting.

As planned, in January 2005 the new accounting system came into use, together with a new set of accounting rules and a new chart of accounts. Thus these are the first set of financial statements prepared under the new accrual accounting rules (the budget accounts are still based on movements of cash.) These new rules and methods are inspired by internationally accepted standards for the public sector — the IPSAS — and, for accounting transactions that are not yet covered by IPSAS, on the relevant International Accounting Standards (‘IAS’)/International Financial Reporting Standards (‘IFRS’.) These rules have been adopted by the Accounting Officer of the Commission after receiving the opinion of an Advisory Expert Group for Accounting Standards that provided independent professional guidance. The IT architecture was updated to ensure that each accounting event, and not just cash movement, would be fully registered when it occurs. Improvements will continue to be made to the IT systems to further the integration of systems and to provide better management reporting. Finally, the scope of consolidation was extended in 2005 to include the various Communities' agencies for the first time.

The end result was the preparation of a balance sheet at 31.12.2004 based on the new accounting rules.

The main impact of the changes

The first impact to be noted is that the balance sheet and off-balance sheet presented here in relation to the prior year (2004) will differ from those published in the 2004 annual accounts, since they are prepared under different rules. The Communities have thus taken the original 2004 figures, as prepared under the old rules and made adjustments to bring them into line with the new rules.

The application of accrual accounting principles essentially means that income and expenditure is recorded in the accounts when it is earned/incurred and not just if cash is received/paid. The four biggest impacts on the financial statements of this change of accounting rules were as follows:

A full explanation of the impact of the changes is given in PART I, Section E2.

Amounts to be called up from Members States

Based on new rules, the Communities must evaluate and recognise in its financial statements the expenditure to be financed by the general budget but which has not yet been declared by the year-end. Thus very many expenses are recognised under accrual accounting rules in the year N although they may be actually paid in year N+1 using the budget of year N+1. Nevertheless, the Communities only call up resources from the Member States when they need money to pay an amount due, so as to give Member States maximum flexibility in managing their public finances. This inclusion in the accounts of the Communities' liabilities, coupled with the fact that the corresponding amounts needed to fund these are only recognised in future years, results in liabilities greatly exceeding assets at the year-end.

To present the facts of this situation in the most comprehensible way for the reader of the accounts, a vertical balance sheet showing the Communities' assets first, then its liabilities was adopted. The difference represents principally the amounts to be called up from Member States. The existence of negative net assets simply reflects the difference between cash-based accounting and accrual accounting for an entity which is financed according to its cash-flow needs. It does not take into account the obligation of Member States to provide the necessary resources in the future to pay for the expenditure incurred when it falls due. It should be remembered that the Communities cannot make a payment unless it was foreseen in the budget and all budgeted expenditure is covered by budgeted revenue from the Member States (see PART I, Section E, note 3.20).

A new structure

While the budgetary reporting was unaffected by the move to accrual accounting, the new financial statements include much more information than before. Most significantly there are now an economic outturn account, a cashflow table and a statement of changes in net assets to add to the restructured balance sheet and off-balance sheet.

MAIN POINTS OF NOTE IN THE 2005 ANNUAL ACCOUNTS

PART I

CONSOLIDATED FINANCIAL STATEMENTS OF THE EUROPEAN COMMUNITIES AND EXPLANATORY NOTES

CONTENTS

A.   BALANCE SHEET

B.   ECONOMIC OUTTURN ACCOUNT (including Segment Reporting)

SEGMENT REPORTING

This report gives the split of the operating revenues and expenses by policy area, based on the Activity Based Budget structure, within the Commission. These policy areas can be grouped under three larger headings — Activities within the European Union, Activities outside the European Union and Services & other.

‘Activities within the European Union’ is the largest of these headings as it covers the many policy areas within the European Union. ‘Activities outside the European Union’ concerns the policies operated outside the Union, such as trade and aid. ‘Services & other’ are the internal and horizontal activities necessary for the functioning of the Communities' Institutions and bodies.

The consolidated agencies are integrated into the same policy area as the Commission activity from which they receive their main Communities' subsidy. Other Institutions, aside from the Commission are grouped in a specific policy area. The various policy areas represent gross figures before consolidation eliminations and the consolidation eliminations are done globally in one column.

Note that own resources and contributions are not split amongst the various activities as these are calculated, collected and managed by central Commission services. They are shown here so as to allow for comparison of the net result with the Economic Outturn Account.

SEGMENT REPORTING — SUMMARY

SEGMENT REPORTING — ACTIVITIES WITHIN THE EU

SEGMENT REPORTING — ACTIVITIES OUTSIDE THE EU

SEGMENT REPORTING — SERVICES & OTHER

C.   CASHFLOW TABLE

D.   STATEMENT OF CHANGES IN NET ASSETS

E.   NOTES TO THE FINANCIAL STATEMENTS

1.   ACCOUNTING POLICIES

1.1   LEGAL PROVISIONS AND THE FINANCIAL REGULATION

The accounts are kept in accordance with Council Regulation (EC, Euratom) No 1605/2002 of 25 June 2002 (OJ L 248 of 16 September 2002, p. 1, with a corrigendum in OJ L 25 of 30 January 2003, p. 43) on the Financial Regulation applicable to the general budget of the European Communities and Commission Regulation (EC, Euratom) No 2342/2002 of 23 December 2002 laying down detailed rules for the implementation of this Financial Regulation.

Article 133 of the Financial Regulation states that the Accounting Officer of the Commission adopts the accounting rules and methods to be applied by all the institutions and bodies. Thus, he adopted the new Communities' accounting rules on 28 December 2004. These new accrual-based accounting policies are inspired by International Public Sector Standards (IPSAS) or by default, International Financial Reporting Standards (IFRS) as respectively issued by the International Public Sector Accounting Standard Board (IPSASB) and International Accounting Standard Board (IASB). These rules have been adopted by the Accounting Officer of the Commission after receiving the opinion of an Advisory Expert Group for Accounting Standards that provided independent professional guidance.

The valuation and accounting rules adopted by the Accounting Officer of the Commission are applied in all the European Institutions and bodies currently falling within the scope of consolidation in order to establish a uniform set of rules for accounting, valuation and presentation of the accounts with a view to harmonising the process for drawing up the financial statements and consolidation.

The Commission's Accounting Officer must submit the consolidated provisional accounts to the Court of Auditors for audit by 31 March of the following year. The Commission must adopt the final consolidated accounts by 31 July and they are then published in the Official Journal by 31 October together with the Court of Auditors' statement of assurance.

Both the provisional and final annual accounts for 2005 are presented as follows: Volume I contains the consolidated accounts, and Volume II the Commission's accounts.

1.2   ACCOUNTING PRINCIPLES

The objective of financial statements is to provide information about the financial position, performance and cashflows of an entity that is useful to a wide range of users. For a public sector entity such as the European Communities, the objectives are more specifically to provide information useful for decision making, and to demonstrate the accountability of the entity for the resources entrusted to it.

If they are to present a true and fair view, financial statements must not only supply relevant information to describe the nature and range of an Institution's and Agencies' activities, explain how it is financed and supply definitive information on its operations, but do so in a clear and comprehensible manner which allows comparisons between financial years. It is with these goals in mind that the present document has been drawn up.

The accounting system of the European Institutions and Agencies comprises general accounts and budget accounts. These accounts are kept in euro on the basis of the calendar year. The budget accounts give a detailed picture of the implementation of the budget. They are based on the modified cash accounting principle. (8) The general accounts allow for the preparation of the financial statements as they show all charges and income for the financial year and are designed to establish the financial position in the form of a balance sheet at 31 December.

Article 124 of the Financial Regulation sets out the accounting principles to be applied in drawing up the financial statements:

As the financial statements for 2005 have been prepared on a different basis than in 2004, i.e. full accrual accounting, in accordance with the Communities' accounting rules, adjustments were made to the original balance sheet at 31 December 2004 so as to arrive at the opening, accrual based, balance sheet at 31 December 2004 (for example, the inclusion of pre-financing amounts). These adjustments are explained in more detail in note E2.

1.3   CONSOLIDATION

The scope of consolidation of the European Communities comprises 26 controlled entities, one associate and one joint venture. The complete list of consolidated entities can be found in note E10. In comparison with 2004, the scope of consolidation has been extended by 16 controlled entities in order to comply with the updated European Communities' accounting rules.

Controlled entities

Controlled entities are all entities over which the European Communities have the power to govern the financial and operating policies so as to be able to benefit from these entities' activities. This power must be presently exercisable. The most common indicator of control, majority of voting rights, is in most of the cases not applicable for the European Communities as there are normally no capitalistic links between the entities.

The European Institutions falling within the scope of consolidation have been created through their founding treaties. They represent the basis of the organisational structure of the European Communities and contribute incontestably to the European Communities' objectives. These Institutions can therefore be considered as being under the exclusive control of the European Communities.

Under the same approach, all Communities Agencies created through a secondary act of legislation are considered as under the exclusive control of the European Communities and therefore are, for the first time, included in the consolidation scope. Furthermore the European Coal and Steel Communities in Liquidation (ECSC) is also considered as a controlled entity. However, the Office for Harmonisation in the Internal Market (Alicante) and the Community Plant Variety Office (Angers), which do not receive any subsidies from the General Budget of the Communities, are not consolidated in the 2005 accounts.

Controlled entities are consolidated using the full consolidation method. All inter-company transactions and balances between European Communities' controlled entities are eliminated. Unrealised gains and losses on inter-entity transactions are not material and have therefore not been eliminated.

Associates

Associates are all entities over which the European Communities have significant influence but not control, generally accompanying a shareholding of between 20 % and 50 % of the voting rights. Investments in associates are accounted for by the equity method of accounting and are initially recognised at cost.

The European Communities' share of their associates' post-acquisition profits or losses is recognised in the economic outturn account, and their share of post-acquisition movements in reserves is recognised in reserves. The cumulative post-acquisition movements are adjusted against the carrying amount of the investment. Distributions received from an associate reduce the carrying amount of the investment.

Unrealised gains and losses on transactions between the European Communities and their associate are not material and have therefore not been eliminated.

The accounting policies of associates may differ from those adopted by the European Communities for like transactions and events in similar circumstances. For practicable reasons, no adjustments were made to the associates' financial statements used in applying the equity method.

In cases where the European Communities hold 20 % or more of a venture capital fund, the Communities do not seek to exert significant influence. Such funds are therefore treated as assets available for sale and the equity method is not applied.

Joint ventures

A joint venture is a contractual arrangement whereby the European Communities and one or more parties (the ‘venturers’) undertake an economic activity which is subject to joint control. Joint control is the contractually agreed sharing of control over an economic activity. Interests in jointly controlled entities are accounted for by the equity method of accounting and are initially recognised at cost.

The European Communities' interest of the profits or losses of their jointly controlled entities is recognised in the economic outturn account, and their interest of movements in reserves is recognised in reserves. The cumulative movements are adjusted against the carrying amount of the interest.

Unrealised gains and losses on transactions between the European Communities and their jointly controlled entity are not material and have therefore not been eliminated.

The accounting policies of joint ventures may differ from those adopted by the European Communities for like transactions and events in similar circumstances. For practicable reasons, no adjustments were made to the joint ventures' financial statements used in applying the equity method.

Non-consolidated entities

Not consolidated in the accounts of the European Communities are the funds managed by the Communities on behalf of both the Joint Sickness Insurance Scheme for staff of the European Communities, and the European Development Fund. At 31 December 2005 the total assets of both were EUR 260 million and EUR 3,5 billion respectively — see note E 11.

1.4   CURRENCY AND BASIS FOR CONVERSION

Functional and reporting currency

The consolidated financial statements are presented in euros, which is the European Communities' functional and reporting currency.

Transactions and balances

Foreign currency transactions are translated into euros using the exchange rates prevailing at the dates of the transactions.

Foreign exchange gains and losses resulting from the settlement of foreign currency transactions and from the translation at year-end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the economic outturn account.

Year-end balances of monetary assets and liabilities denominated in foreign currencies are converted into euros on the basis of the exchange rates applying on 31 December 2005:

Different conversion methods apply to the following headings:

Changes in the fair value of monetary securities denominated in foreign currency and classified as available-for-sale are analysed between translation differences resulting from changes in the amortised cost of the security, and other changes in the carrying amount of the security. Translation differences are recognised in the economic outturn account, and other changes in carrying amount are recognised in the fair value reserve. Translation differences on non-monetary financial assets and liabilities held at fair value through profit or loss are recognised in the economic outturn account. Translation differences on non-monetary financial assets classified as available-for-sale are included in the fair value reserve.

1.5   BALANCE SHEET

1.5.1   Intangible fixed assets

Acquired computer software licences are capitalised on the basis of the costs incurred to acquire and bring to use the specific software. These costs are amortised over their estimated useful lives (4 years). Internally produced intangible assets are currently expensed in the economic outturn account.

Costs associated with developing or maintaining computer software programmes are recognised as expenses as incurred.

1.5.2   Tangible fixed assets

Property, plant and equipment

All property, plant and equipment are stated at historical cost less depreciation (excluding land, works of art and assets under construction) and impairment. Historical cost includes expenditure that is directly attributable to the acquisition of the items.

Subsequent costs are included in the asset's carrying amount or recognised as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the European Communities and the cost of the item can be measured reliably. All other repairs and maintenance are charged to the economic outturn account during the financial period in which they are incurred.

Land, works of art and assets under construction are not depreciated. Depreciation on other assets is calculated using the straight-line method to allocate their cost to their residual values over their estimated useful lives, as follows:

The assets' residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date. An asset's carrying amount is written down immediately to its recoverable amount if the asset's carrying amount is greater than its estimated recoverable amount.

Gains and losses on disposals are determined by comparing proceeds with carrying amount. These are included in the economic outturn account.

Leases

Leases of tangible assets, where the European Communities have substantially all the risks and rewards of ownership, are classified as financial leases. Financial leases are capitalised at the inception of the lease at the lower of the fair value of the leased asset and the present value of the minimum lease payments. Each lease payment is allocated between the liability and finance charges so as to achieve a constant rate on the finance balance outstanding. The rental obligations, net of finance charges, are included in other liabilities (long and short-term.) The interest element of the finance cost is charged to the economic outturn account over the lease period so as to produce a constant periodic interest rate on the remaining balance of the liability for each period. The assets acquired under financial leases are depreciated over the shorter of the assets' useful life and the lease term.

Leases where the lessor retains a significant portion of the risks and rewards inherent to ownership are classified as operating leases. Payments made under operating leases are charged to the economic outturn account on a straight-line basis over the period of the lease.

1.5.3   Impairment of non-financial assets

Assets that have an indefinite useful life are not subject to amortisation and are tested annually for impairment. Assets that are subject to amortisation are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognised for the amount by which the asset's carrying amount exceeds its recoverable amount. The recoverable amount is the higher of an asset's fair value less costs to sell and value in use.

1.5.4   Investments

Investments in Associates and interests in Joint Ventures

Investments in associates and interests in joint ventures are accounted for by using the equity method.

Investments in Venture Capital Funds

Classification and measurement

Investments in Venture Capital Funds are classified as available-for-sale assets and accordingly, should be carried at fair value with gains and losses arising from changes in the fair value (including translation differences) recognised in the fair value reserve.

Fair value considerations

Since they do not have a quoted market price in an active market and in the absence of any reliable valuation technique, investments in Venture Capital Funds are valued on a line-by-line basis at the lower of cost or attributable net asset value (‘NAV’) as reported by the fund manager up to the balance sheet date, thus excluding any attributable unrealised gain that may be prevailing in the underlying investment portfolio. Investments in Venture Capital Funds in existence for less than two years at balance sheet date are valued based on the same principles, except in the case of unrealised losses due only to administrative expenses where, in view of the early stage of the underlying investment portfolio, these unrealised losses are not taken into account.

It should be noted that a ‘fair value method’ has been recently developed by the European Investment Fund in compliance with IAS 39. However, this method can only be applied to the European Communities' investments in venture capital funds at the year-end 2005. Indeed, based on the data collected in 2004, it is not possible to restate the value of investments in Venture Capital Funds at previous year-end. Consequently and for comparability reasons, the current valuation method, as described in the above paragraph, has been consistently applied at year end 2005. The fair value resulting from the application of the ‘fair value method’ is disclosed in note E 3.3.3.1 for information purposes only. The change from the current valuation method to this ‘fair value method’ will be effective on 1 January 2006 and the related adjustment will be recognised in the fair value reserve.

Under the ‘new method’, the fair value of investments in Venture Capital Funds is achieved by applying the aggregated Net Asset Value (‘NAV’) concept, which implicitly assumes that if the NAVs of the funds can be considered as compliant with IAS 39, then the aggregation of the NAVs of all funds will itself be compliant with IAS 39.

In accordance with this method, the funds are classified into three categories:

For Categories I & II, unrealised gains from the fair value measurement are recognised in reserves and unrealised losses are assessed for impairment so as to determine whether they are recognised as impairment losses in the economic outturn account or as changes in the fair value reserve.

The fair valued attributable NAV is determined through applying either the European Communities' percentage ownership in the fund to the NAV reflected in the most recent report or, to the extent available, the precise share value at the same date, submitted by the respective Fund Manager.

Investments belonging to category III are valued at cost less impairment.

Other investments

Classification

The European Communities classify their investments in the following categories: financial assets at fair value through profit or loss; loans and receivables; held-to-maturity investments; and available-for-sale financial assets. The classification of the investments is determined at initial recognition and re-evaluated at each balance sheet date.

(i)   Financial assets at fair value through profit or loss

This category has two sub-categories: financial assets held for trading, and those designated at fair value through profit or loss at inception. A financial asset is classified in this category if acquired principally for the purpose of selling in the short term or if so designated by the European Communities. Derivatives are also categorised as held for trading unless they qualify for hedge accounting. Assets in this category are classified as current assets if they are expected to be realised within 12 months of the balance sheet date.

(ii)   Loans and receivables

Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. They arise when the Communities provide money, goods or services directly to a debtor with no intention of trading the receivable. They are included in non-current assets, except for maturities within 12 months of the balance sheet date.

(iii)   Held-to-maturity investments

Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturities that the European Communities has the positive intention and ability to hold to maturity. During this financial year, the European Communities did not hold any investments in this category.

(iv)   Available-for-sale financial assets

Available-for-sale financial assets are non-derivatives that are either designated in this category or not classified in any of the other categories. They are included in non-current assets unless the Communities intend to dispose of the investment within 12 months of the balance sheet date.

Initial recognition and measurement

Purchases and sales of financial assets at fair value through profit or loss, held-to-maturity and available-for-sale are recognised on trade-date — the date on which the European Communities commit to purchase or sell the asset. Loans are recognised when cash is advanced to the borrowers. Investments are initially recognised at fair value plus transaction costs for all financial assets not carried at fair value through profit or loss. Financial assets carried at fair value through profit or loss are initially recognised at fair value and transaction costs are expensed in the economic outturn account.

The fair value of a financial asset on initial recognition is normally the transaction price (i.e. the fair value of the consideration received). However, when a long-term loan that carries no interest or an interest below market conditions is granted, its fair value can be estimated as the present value of all future cash receipts discounted using the prevailing market rate of interest for a similar instrument with a similar credit rating.

In the case of loans to officials granted by the ECSC in liquidation, the transaction price is used as fair value at inception independently from any preferential interest rate granted, for practicable reasons and based on materiality considerations.

Investments are derecognised when the rights to receive cash flows from the investments have expired or have been transferred and the European Communities have transferred substantially all risks and rewards of ownership.

Subsequent measurement

Available-for-sale financial assets and financial assets at fair value through profit or loss are subsequently carried at fair value.

Gains and losses arising from changes in the fair value of the ‘financial assets at fair value through profit or loss’ category are included in the economic outturn account in the period in which they arise.

Changes in the fair value of monetary financial assets denominated in a foreign currency and classified as available-for-sale are analysed between translation differences resulting from changes in amortised cost of the asset and other changes in the carrying amount of the asset. The translation differences are recognised in the economic outturn account, and other changes in carrying amount are recognised in the fair value reserve. Changes in the fair value of non-monetary financial assets classified as available-for-sale are recognised in the fair value reserve.

When financial assets classified as available-for-sale are sold or impaired, the cumulative fair value adjustments previously recognised in the fair value reserve should be recognised in the economic outturn account.

Interest on available-for-sale financial assets calculated using the effective interest method is recognised in the economic outturn account. Dividends on available-for-sale equity instruments are recognised when the European Communities right to receive payment is established.

The fair values of quoted investments in active markets are based on current bid prices. If the market for a financial asset is not active (and for unlisted securities), the European Communities establish a fair value by using valuation techniques. These include the use of recent arm's length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis, option pricing models and other valuation techniques commonly used by market participants.

In cases where the fair value of investments in equity instruments that do not have quoted market price in an active market is not reliably measurable, these investments are valued at cost less impairment.

Loans and receivables and held-to-maturity investments are carried at amortised cost using the effective interest method. In the case of loans granted on borrowed funds, the effective interest method may not be applied separately to loans and borrowings, based on materiality considerations. The transaction costs incurred by the European Communities and then recharged to the beneficiary of the loan are directly recognised in the economic outturn account.

Impairment of financial assets

The European Communities assess at each balance sheet date whether there is objective evidence that a financial asset is impaired. A financial asset is impaired and impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset and that loss event (or events) has an impact on the estimated future cash flows of the financial asset that can be reliably estimated.

(i)   Assets carried at amortised cost

If there is objective evidence that an impairment loss on loans and receivables or held-to-maturity investments carried at amortised cost has been incurred, the amount of the loss is measured as the difference between the asset's carrying amount and the present value of estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset's original effective interest rate. The carrying amount of the asset is reduced and the amount of the loss is recognised in the economic outturn account. If a loan or held-to-maturity investment has a variable interest rate, the discount rate for measuring any impairment loss is the current effective interest rate determined under the contract.

The calculation of the present value of the estimated future cash flows of a collateralised financial asset reflects the cash flows that may result from foreclosure less costs for obtaining and selling the collateral, whether or not foreclosure is probable.

If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised, the previously recognised impairment loss is reversed through the economic outturn account.

(ii)   Assets carried at fair value

In the case of equity securities classified as available-for-sale, a significant or prolonged decline in the fair value of the security below its cost is considered in determining whether the securities are impaired. If any such evidence exists for available-for-sale financial assets, the cumulative loss — measured as the difference between the acquisition cost and the current fair value, less any impairment loss on that financial asset previously recognised in the economic outturn account — is removed from reserves and recognised in the economic outturn account. Impairment losses recognised in the economic outturn account on equity instruments are not reversed through the economic outturn account. If, in a subsequent period, the fair value of a debt instrument classified as available-for-sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised, the impairment loss is reversed through the economic outturn account.

1.5.5   Stocks

Stocks are stated at the lower of cost and net realisable value. Cost is determined using the first-in, first-out (FIFO) method. In exceptional cases, the Weighted Average Cost formula (WAC) can be applied. The cost of finished goods and work in progress comprises design costs, raw materials, direct labour, other direct costs and related production overheads (based on normal operating capacity). Net realisable value is the estimated selling price in the ordinary course of business, less the costs of completion and selling expenses.

When stocks are held for distribution at no charge or for a nominal charge, they are measured at the lower of cost and current replacement cost. Current replacement cost is the cost the European Communities would incur to acquire the asset on the reporting date.

1.5.6   Pre-financing amounts

Pre-financing is a payment intended to provide the beneficiary with a cash advance, i.e. a float. It may be split into a number of payments over a period defined in the particular pre-financing agreement. The float or advance is repaid or used for the purpose for which it was provided during the period defined in the agreement. If the beneficiary does not incur eligible expenditures, he has the obligation to return the pre-financing advance to the European Communities. The amount of the pre-financing is reduced (wholly or partially) by the acceptance of eligible costs and amounts returned.

At year-end outstanding pre-financing amounts are valued at the original amount(s) paid less: amounts returned, eligible amounts cleared, estimated eligible amounts not yet cleared at year-end, and value reductions.

Interest on pre-financing is recognised as it is earned in accordance with the provisions of the relevant agreement. An estimate of the accrued interest revenue, based on the most reliable information, is made at the year-end and included in the balance sheet. Guarantees related to pre-financing amounts are disclosed in the off-balance sheet as contingent assets.

1.5.7   Receivables

Receivables are carried at original amount less write-down for impairment. A write-down for impairment of receivables is established when there is objective evidence that the European Communities will not be able to collect all amounts due according to the original terms of receivables. The amount of the write-down is the difference between the asset's carrying amount and the recoverable amount, being the present value of expected future cash flows, discounted at the market rate of interest for similar borrowers. The amount of the write-down is recognised in the economic outturn account statement. Also recognised is a general write-down in value of 20 % per year for outstanding recovery orders not already subject to a specific write-down.

See also note 1.5.13 below concerning the treatment of accrued income recognised at year-end

1.5.8   Cash & cash equivalents

Cash and cash equivalents are defined as short-term assets. They include cash in hand, deposits held at call with banks, other short-term highly liquid investments with original maturities of three months or less, and bank overdrafts. Bank overdrafts are shown within financial liabilities under current liabilities on the balance sheet.

1.5.9   Employee benefits

Pension obligations

The European Communities operate defined benefit pension plans. A defined benefit plan is a pension plan that generally defines an amount of pension benefit that an employee will receive on retirement, usually dependent on one or more factors such as age, years of service and compensation.

The liability recognised in the balance sheet in respect of defined benefit pension plans is the present value of the defined benefit obligation at the balance sheet date less any fair value of plan assets. The defined benefit obligation is calculated by independent actuaries using the projected unit credit method. The present value of the defined benefit obligation is determined by discounting the estimated future cash outflows using interest rates of high-quality corporate bonds that are denominated in the currency in which the benefits will be paid, and that have terms to maturity approximating to the terms of the related pension liability.

Actuarial gains and losses arising from experience adjustments and changes in actuarial assumptions are recognised immediately in the economic outturn account.

Past-service costs are recognised immediately in income, unless the changes to the pension plan are conditional on the employees remaining in service for a specified period of time (the vesting period). In this case, the past-service costs are amortised on a straight-line basis over the vesting period.

1.5.10   Provisions for risks and charges

Provisions for risks and charges are recognised when the European Communities have a present legal or constructive obligation as a result of past events, it is more likely than not that an outflow of resources will be required to settle the obligation, and the amount can be reliably estimated. Provisions are not recognised for future operating losses.

The amount of the provision is the best estimate of the expenditures expected to be required to settle the present obligation at the reporting date. Where the provision involves a large number of items, the obligation is estimated by weighting all possible outcomes by their associated probabilities (‘expected value’ method).

Where the effect of the time value of money is material, the amount of the provision is the present value of the expenditures expected to be required to settle the obligation. The discount rate used is a rate that reflects current market assessments of the time value of money and the risks specific to the liability but not the risks for which future cash flows estimates have been adjusted.

1.5.11   Financial liabilities

Financial liabilities include borrowings and held for trading liabilities.

Borrowings are composed of borrowings from credit institutions and debts evidenced by certificates. Borrowings are recognised initially at fair value, being their issue proceeds (fair value of consideration received) net of transaction costs incurred, then subsequently carried at amortised cost using the effective interest method; any difference between proceeds, net of transaction costs, and the redemption value is recognised in the economic outturn account over the period of the borrowings using the effective interest method. They are classified as non-current liabilities, except for maturities less than 12 months after the balance sheet date.

In the case of loans granted on borrowed funds, the effective interest method may not be applied separately to loans and borrowings, based on materiality considerations. The transaction costs incurred by the European Communities and then recharged to the beneficiary of the loan are directly recognised in the economic outturn account.

Held for trading liabilities include derivatives that do not qualify for hedge accounting when their fair value is negative. They follow the same accounting treatment as held for trading assets, see note 1.5.4.

1.5.12   Payables

A significant amount of the payables of the Communities are not related to the purchase of goods or services — instead they are unpaid cost claims from beneficiaries of grants or other Communities funding. They are recorded as payables for the requested amount when the cost claim is received and, after verification, accepted as eligible by the relevant financial agents. At this stage they are valued at the accepted and eligible amount.

Payables arising from the purchase of goods and services are recognised at invoice reception for the original amount and corresponding expenses are entered in the accounts when the supplies are delivered and accepted by the European Communities.

1.5.13   Separation of accounting periods — accrued and deferred income and charges

As part of the move to accrual accounting, one important aspect is the exercise of ensuring that transactions made during the year are recorded in the correct accounting year — a cut-off exercise: transactions must be recognised in the period to which they relate.

In particular an assessment has to be made concerning eligible expenses incurred by beneficiaries of Communities' funds but not yet reported to the Communities (accrued charges). Different methods are used depending on the type of activities and information available so as to arrive at the best estimate of these amounts. Conversely, some expenses are recorded in current year although they relate to subsequent periods (deferred charges) and those have to be identified and included in the relevant period.

Revenue should also be accounted for in the period to which it relates. At year-end, when an invoice is not sent and the service has been rendered or the supplies have been delivered or a contractual agreement exists (i.e., by reference to a treaty), the amount should be assessed and recognised in the financial statements as an accrued revenue.

In addition, at year-end, when an invoice is sent although it does not relate to the reporting period, the amount should be deferred and recognised as a decrease in revenues. The objective is to reduce revenues for the amount equal to the deferral.

Since this is the first year of such an exercise, and given the particularities of the Communities' activities, there are no benchmark methods available to compare these methods of estimation to.

1.6   ECONOMIC OUTTURN ACCOUNT

1.6.1   Revenue

Exchange revenue

Revenue from the sale of goods is recognised when the significant risk and rewards of ownership of the goods are transferred to the purchaser.

Revenue associated with a transaction involving the provision of services is recognised by reference to the stage of completion of the transaction at the reporting date.

Non-exchange revenue

This makes up the vast majority of the Communities' revenue and includes mainly direct and indirect taxes and own resource amounts. In addition to taxes the European Communities may also receive payments from other parties, such as duties, fines and donations.

GNI based resources and VAT resources

Receivables and related revenues are recognised when the European Communities send out a call for funds to the Member States claiming their contribution. They are measured at their ‘called amount’. As VAT and GNI resources are based on estimates, they may be revised as changes occur until the final data are issued by the Member States. The effect of a change in estimate is included when determining the net surplus or deficit for the period in which the change occurred.

Traditional own resources

Receivables and related revenues are recognised when the relevant monthly A statements (including duties collected and amounts due that are guaranteed and not contested) are received from the Member States. At the reporting date, revenue collected by the Member States for the period but not yet paid to the European Communities are estimated and recognised as accrued revenue. The quarterly B statements (including duties neither collected nor guaranteed, as well as guaranteed amounts that have been contested by the debtor) received from the Member States are recognised as revenue less collection costs (25 %). In addition a value reduction is recognised for the amount of the estimated recovery gap in the economic outturn account.

Fines

Receivables and related revenues are recognised when the Communities' decision imposing a fine has been taken and it is officially notified to the addressee. If there are doubts about the undertaking's solvency, a value reduction on the entitlement should be recognised.

After the decision to impose a fine, the debtors have two months from the date of notification:

However, the principal of the fine must be paid within the time limit laid down as the appeal does not have suspensory effect (Article 242 of the EC Treaty). The debtors have two options; they can present a bank guarantee for the amount or pay the fine provisionally.

If the undertaking appeals against the decision, and has already provisionally paid the fine, the amount is recorded as a contingent liability. However, since an appeal against a Communities' decision by the addressee does not have suspensory effect, the cash received is used to clear the receivable. If a guarantee is received instead of payment, it is recorded as a contingent asset.

If there is a risk that the Court of First Instance may not rule in favour of the Communities, a provision is recognised to cover this risk in the cases where provisional payment has already been received. If a guarantee had been given instead, then the receivable outstanding is written-down as required. The accumulated interest received by the European Communities on the bank accounts where received payments are deposited is recognised as revenue, and any contingent liability is increased accordingly.

Interest income and expense

Interest income and expense are recognised in the economic outturn account using the effective interest method. This is a method of calculating the amortised cost of a financial asset or a financial liability and of allocating the interest income or interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument (or, when appropriate, a shorter period) to the net carrying amount of the financial asset or financial liability. When calculating the effective interest rate, the European Communities estimate cash flows considering all contractual terms of the financial instrument (for example, prepayment options) but do not consider future credit losses. The calculation includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs and all other premiums or discounts.

In the case of loans granted on borrowed funds, the effective interest method may not be applied separately to loans and borrowings, based on materiality considerations. The transaction costs incurred by the European Communities and then recharged to the beneficiary of the loan are directly recognised in the economic outturn account.

Once a financial asset or a group of similar financial assets has been written down as a result of an impairment loss, interest income is recognised using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss.

Dividend income

Dividend income is recognised when the right to receive payment is established.

1.6.2   Expenditure

Exchange expenses arising from the purchase of goods are recognised when the supplies are delivered and accepted by the European Communities. They are valued at original invoice cost.

Non-exchange expenses are specific to the European Communities and account for the majority of its expenditure. They relate to transfers to beneficiaries and can be of three types: entitlements, transfers under agreement and, discretionary grants, contributions and donations.

Transfers are recognised as expenses in the period during which the events giving rise to the transfer occurred, as long as the nature of the transfer is allowed by regulation (Financial Regulation, Staff Regulations, or other regulation) or a contract has been signed authorising the transfer; any eligibility criteria have been met by the beneficiary; and a reasonable estimate of the amount can be made.

When any request for payment or cost claim is received and meets the recognition criteria, it is recognised as an expense for the eligible amount. At year-end incurred eligible expenses already due to the beneficiaries but not yet reported are estimated and recorded as accrued expenses.

1.7   CONTINGENT ASSETS AND LIABILITIES

Contingent assets

A contingent asset is a possible asset that arises from past events and of which the existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the European Communities. A contingent asset is disclosed when an inflow of economic benefits or service potential is probable.

Contingent assets are assessed continually to ensure that developments are appropriately reflected in the financial statements. If it has become virtually certain that an inflow of economic benefits or service potential will arise and the asset's value can be measured reliably, the asset and the related revenue are recognised in the financial statements of the period in which the change occurs.

Contingent liabilities

A contingent liability is a possible obligation that arises from past events and of which the existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the European Communities; or a present obligation that arises from past events but is not recognised because: it is not probable that an outflow of resources embodying economic benefits or service potential will be required to settle the obligation or, in the extremely rare circumstances where the amount of the obligation cannot be measured with sufficient reliability.

A contingent liability is disclosed unless the possibility of an outflow of resources embodying economic benefits or service potential is remote.

Contingent liabilities are assessed continually to determine whether an outflow of resources embodying economic benefits or service potential has become probable. If it becomes probable that an outflow of resources embodying economic benefits or service potential will be required for an item dealt with as contingent liability, a provision is recognised in the financial statements of the period in which the change of probability occurs.

Commitments for future funding

A commitment for future funding represents a legal or constructive commitment, usually contractual, that the European Communities have entered into and which may require a future outflow of resources.

Guarantees

Guarantees are possible assets or obligations that arise from past events and whose existence will be confirmed by the occurrence or non-occurrence of the object of the guarantee. Guarantees thus qualify as contingent assets or liabilities. A guarantee is settled when the object of the guarantee no longer exists. It is crystallised when the conditions are fulfilled for calling a payment from the guarantor.

1.8   USE OF ESTIMATES

In accordance with generally accepted accounting principles, the financial statements necessarily include amounts based on estimates and assumptions by management based on the most reliable information available. Significant estimates include, but are not limited to, amounts for pensions, provisions for future charges, valuation of publications stocks, financial risk on inventories and accounts receivables, accrued income and charges, contingent assets and liabilities, and degree of impairment of fixed assets. Actual results could differ from those estimates. Changes in estimates are reflected in the period in which they become known.

2.   IMPACT OF THE TRANSITION TO ACCRUAL ACCOUNTING

2.1   BASIS OF PREPARATION

The Communities' opening balance sheet has been prepared in accordance with the new accounting rules adopted on 28 December 2004, which apply for the first time for the financial year 2005.

2.2   PRESENTATION OF THE FINANCIAL STATEMENTS

The annual accounts include the following primary statements: balance sheet, economic outturn account, statement of changes in net assets and cashflow table.

2.3   EQUITY RECONCILIATION

OPENING BALANCE SHEET

The table above summarises the impact of the changes made to restate the balance sheet as at 31 December 2004 under the new accounting rules.

The presentation of the balance at 31 December 2004 (before restatement) differs slightly to that published in the Financial Statements 2004. This is due to the reclassification of certain balances within the balance sheet, made necessary to allow a relevant comparison with the restated figures. The original net assets figure of EUR 14,5 billion (then called ‘Own Capital’) at 31 December 2004 corresponds to the published figure.

Almost the entire impact is noticed in the accounts of the Commission and to a much lesser extent in the ECSC in liquidation. The first time inclusion of the Agencies in the consolidation scope has had a limited impact on the consolidated accounts, the main being an increase in cash balances.

2.3.1   Tangible fixed assets

The main change in accounting policy for tangible fixed assets relates to depreciation policy. Under previous rules, newly acquired assets were depreciated for a full 12 months in the year in which they were purchased (regardless of the date of acquisition). In accordance with the new rules depreciation is applied from the month of acquisition. Historically therefore assets had been ‘over-depreciated’. This and other changes in accounting policies have led to an increase in the net value of tangible fixed assets, by EUR 69 million in the Commission, and EUR 137 million in the Parliament. The balance of the increase primarily relates to the inclusion of the Agencies for the first time.

2.3.2   Investments

The investment portfolio of the Guarantee Fund and of the ECSC in liquidation, made up of debt securities, was previously recorded at the lower of cost (or in case of premiums/discounts, amortised cost using linear method) or market value. These securities are now classified as available-for-sale assets and consequently carried at their fair value. The impact of the valuation at fair value has been accounted for in the fair value reserve and amounted to EUR 88 million.

The Guarantee Fund was holding three floating rate notes issued by the European Communities for an amount of EUR 21 million, including accrued interests, as at 31 December 2004. These debt securities have been duly eliminated against the corresponding debt evidenced by certificates issued by the Macro Financial Assistance (MFA) program (see note 2.3.8).

The debt securities, amounting to EUR 38 million, held within the context of budgetary instruments managed by fiduciaries on behalf of the European Commission were included in the net asset calculation of these instruments and as such, classified as short-term receivables as at 31 December 2004. Under the new accounting rules, the components of the budgetary instruments are now classified in the relevant headings of the annual accounts according to their nature and when applicable, residual maturity.

Derivative financial instruments with a positive fair value including accrued interest (EUR 33 million) are recognised as held-for-trading assets whilst previously they were only disclosed as off balance-sheet items. The balance of the movement (EUR 33 million) relates to other reclassifications, revaluations and the inclusion of accrued interest under this heading.

2.3.3   Loans

Loans with special conditions were previously recorded at cost less any provision for impairment. Under the new accounting rules, these loans granted at preferential rates are initially recognised at fair value which, in the case of loans carrying interest below market conditions, corresponds to the net present value of expected cash flows discounted at the average prevailing EIB lending rate of interest for borrowers in the respective countries, then subsequently measured at amortised cost. The provisions for impairment, if any, are based on the provisional or definitive write-offs as provided for under the respective finance contract. The combined impact of the valuation of these loans at their amortised cost (EUR -152 million), on one side, and, of their entire classification as non-current assets since all have final maturities above one year after the balance sheet date (EUR 20 million), on the other side, has been accounted through the accumulated deficit account and amount to EUR -132 million.

Housing loans of the ECSC in liquidation granted at preferential rates were previously recorded at their outstanding nominal amount less any provision for impairment. Under the new accounting rules, these loans are initially recognised at fair value which corresponds to the net present value of expected cash flows discounted at the market rate of interest prevailing for bonds with similar maturities issued by the member states where the borrowers are located, then subsequently measured at amortised cost. The provisions for impairment, if any, are based on the provisional or definitive write-offs as provided for under the respective finance contracts. The impact of the valuation of these loans at their amortised cost amounts to a negative EUR 21 million.

Loans granted from borrowed funds have also been classified as non-current assets when their final maturity was above one year after the balance sheet date, increasing the balance of long-term loans by EUR 123 million and decreasing the one of short-term receivables by the same amount (see note 2.3.5).

2.3.4   Pre-financing

Financial statements of the European Communities published prior to 2005 included, within short term receivables, a limited number of amounts concerning pre-financing payments made on specific projects (financial intermediaries). During 2004 an inventory of all open pre-financing amounts paid out up to 31 December 2004 was prepared by every Institution and body.

The balance shown for pre-financing as at 31 December 2004 is, however, this total amount outstanding to beneficiaries at that date less accrued charges. These accrued charges represent the estimate of the actual utilisation by the beneficiaries of the pre-financing amounts at this date, for which no cost statements have yet been received by the European Communities.

As many of the projects funded by the European Communities Structural Fund actions are long-term in nature, the related advances are available for more than one year. Thus these pre-financing amounts are shown under both long-term and short-term asset headings.

2.3.5   Receivables

Long-term receivables have greatly decreased as the guarantee from Member States in relation to the Commission's pension obligations towards staff does not meet the accounting criteria, set down by the new accounting rules, necessary to be recognised as an asset. Originally this had amounted to EUR 26 billion at 31 December 2004.

Short term receivables have increased due to the inclusion of accrued own resource income of EUR 2,3 billion at 31 December 2004. The overall movement on the balance however is offset by the transfer of previously included pre-financing amounts, net assets of the budgetary instruments managed by fiduciaries on behalf of the European Communities and portions of loans with final maturity above one year after the balance sheet date, and accrued interest, to separate headings.

2.3.6   Cash and cash equivalents

The biggest impact of the inclusion of the Agencies was under this heading, being EUR 339 million.

Current accounts and short-term deposits, amounting to EUR 323 million, held within the context of budgetary instruments managed by fiduciaries on behalf of the European Communities were included in the net asset calculation of these instruments and as such, classified as short-term receivables as at 31 December 2004. Under the new accounting rules, the components of the budgetary instruments are now classified in the relevant headings of the annual accounts according to their nature and when applicable, residual maturity.

2.3.7   Provisions

The balance on provisions has been revised upward by the application of a more precise discount rate to the dismantling provision for the JRC (EUR 59 million). Following a more detailed review of pending legal cases there has also been an increase in the specific provisions made for these.

The significant change has been that the provisions previously recognised concerning the Guarantee Fund (EUR 1,086 million) and the ECSC in Liquidation (EUR 328 million) no longer meet the requirements to be classed as a provision under the new rules and so are removed from this heading. Reserves for the same amounts are instead recognised.

Additionally financial provisions (EUR 239 million) have been recognised within the context of budgetary instruments whilst previously they were only disclosed as off balance-sheet items. Finally, provisions relating to legal cases of EUR 81 million and provisions of EUR 21 million from other Institutions and agencies were included for the first time (see note 3.13).

2.3.8   Financial liabilities

As with loans granted, borrowings with final maturity above one year after the balance sheet date have been classified as non-current liabilities, increasing the balance of long-term borrowings by EUR 109 million and decreasing short-term borrowings by the same amount.

Moreover, debts evidenced by certificates issued by the Macro Financial Assistance (MFA) program and recorded as long-term borrowings were subscribed to by the Guarantee Fund. These debts have been duly eliminated against the corresponding assets held by the Guarantee Fund.

Derivative financial instruments with a negative fair value (EUR 19 million) are recognised as held-for-trading liabilities whilst previously they were only disclosed as off balance-sheet items.

2.3.9   Accounts payable

The biggest impact (EUR 70.6 billion) on the balance sheet has been under this heading and it is due primarily to two main exercises introduced by the modernisation project — the recording of invoices and accrued charges:

2.3.10   Reserves and accumulated surplus/deficit

In accordance with new accounting rules, the adjustment to fair value of available-for-sale assets is now accounted for through the fair value reserve (EUR 88 million). The biggest effect on reserves was however the inclusion of the Guarantee Fund reserve (EUR 1,086 million), which corresponds to the 9 % target amount and, of other reserves of the ECSC in liquidation (EUR 328 million). Previously these amounts had been recognised as a provision.

All changes, other than fair value adjustments, required to restate the opening balance sheet where made through the accumulated surplus/deficit account, thus the large impact on its balance.

3.   NOTES TO THE BALANCE SHEET

I.   NON CURRENT ASSETS

3.1   INTANGIBLE FIXED ASSETS

Intangible fixed assets are identifiable non-monetary assets without physical substance. To be entered on the assets side of the balance sheet, they must be controlled by the entity and generate future economic benefits for the European Communities.

Intangible Fixed Assets

3.2   TANGIBLE FIXED ASSETS

3.2.1   Land and buildings

In some countries the value of the land occupied by Delegations cannot be distinguished from the value of the building.

In December 2005, together with the Parliament, the Commission bought a building in Copenhagen with a value of EUR 9,9 million. Each party owns 50 %, although the Parliament paid the full amount for the building and the Commission will repay its share to the Parliament during the life of the building. In the same month, the two Institutions also jointly signed an acquisition contract worth EUR 7,4 million for a building in The Hague, but since the building was not put into use until 2006, it does not appear in the balance sheet at 31 December 2005.

3.2.2   Plant and equipment

For approximately 20 % of the Delegations, there is no information available about tangible fixed assets at 31 December 2005. An initiative is underway since January 2003 to improve the quality and exhaustiveness of the information provided by the Delegations and this, as well as a specific inventories project launched in 2004, should help to resolve this problem in the future. Furthermore, the integration of the delegations' transactions directly in the central accounting system in 2007 will also improve this situation.

Adjustments as a direct result of these projects total EUR 3,6 million and are shown under the heading ‘other changes’ in the table below. The total net amount of tangible fixed assets included for the Delegations at 31 December 2005 is EUR 72,3 million.

3.2.3   Finance leases (and similar rights)

The main building occupied by the Publications Office is not included in the balance sheet since it is classified as an operating lease. Although the Office has two purchase options (in October 2006 and in 2010) with values based on the market value, it is not considered that the risks and rewards incident to ownership of the asset are substantially transferred to the Office. The classification will be reviewed later in 2006, when the first purchase option may be taken up.

On 21 September 2005 the Commission signed a 27 year finance lease contract for a building in Brussels valued to EUR 50 million.

The Economic and Social Committee (ESC) and the Committee of the Regions (CoR) have entered the finance leasing contracts for their Belliard building in Brussels on the assets side of the balance sheet. It is co-financed on the following scale: ESC: 50 % — CoR: 50 %. The 27 year financial lease these two Committees signed in May 2004 for another Brussels building has been included in the restated opening balance sheet for 2005. It is co-financed on the following scale: ESC: 40 % — CoR: 60 %.

3.2.4   Fixed assets under construction

On March 2003 the Council signed a contract for the construction and acquisition of the LEX building in Brussels. The estimated price upon completion is EUR 258 million as at 31 December 2005. EUR 64 million has been paid in 2005 as an advance for this construction and EUR 59 million in previous years — in total EUR 123 million.

In October 2004 the Parliament signed a financial lease with a purchase option for a building complex in Brussels and the construction began during 2004. In November 2004 an advance payment of EUR 40 million was paid. Until the signature of the provisional approval report the Parliament has the right to make additional advance payments and which so far have been done as following (in Euro millions):

Tangible Fixed Assets

Charges still to be paid in respect of finance leases and similar entitlements are shown in long-term and short-term liabilities in the balance sheet. They break down as follows:

Finance Leases & Similar Rights

3.3   INVESTMENTS

This heading covers investments made with a view to establishing permanent links and/or seen as supporting the activities of the European Communities. It also includes the net assets of the Guarantee Fund.

Investments

3.3.1   Investments in associates and interests in joint ventures

Associates and Joint-Ventures

European Investment Fund (EIF)

The EIF is the European Union's financial institution specialising in risk capital and guarantees to SMEs. Under the Council Decision of 6 June 1994 the European Communities, represented by the Commission, subscribed for a total of ECU 600 million of the EIF's capital, being 600 shares. This represents 30 % of the EIF's capital. The Commission has paid all the called-up capital, which amounts to 20 %. Payments outstanding on the non-called up capital (80 %) total EUR 480 million.

Under an agreement between the Commission and the European Investment Bank (EIB) signed in 2000, on 30 June 2005, the Commission was entitled to sell its shares to the EIB at a fixed unit price of EUR 315 000. However, the Commission did not exercise its put option. On the same date, a new Share Purchase Undertaking Agreement entered into force. Under this new agreement, the Commission is entitled to sell its shares at any time to the EIB at the price corresponding to the EIF valuation divided by the total number of issued shares. The formula will be based on the elements contained in the annual report and annual accounts established for the financial year in which the sale notice is given and approved by the general meeting.

The value of the put option is close to nil since the formula used for determining the sale price of the shares is similar to the one used to determine the net equity of the EIF and since, in the absence of a full fair value exercise, the so-determined net equity of the EIF is deemed to be the best approximation of its fair value. It should also be noted that the Commission has no intention to sell its shareholding in the EIF as long as the Commission will continue to develop its venture capital funds and guarantee programs in co-operation with the Fund. The put option was granted to the Commission by the mother company, the EIB, for the sole purpose of giving equal rights to each shareholder of the EIF.

The equity method is used to value the Communities' share in the EIF, in accordance with the accounting rules. Under the equity method the shareholding is initially recorded at cost and is then adjusted to take into account changes subsequent to the investor's acquisition of a share of the net assets of the controlled entity. The result of adjustments reflects the investor's share of the results of the controlled entity.

Under the equity method, the shareholding is valued at 30 % of the EIF's own capital. The EIF's balance sheet for 2005 shows a total of EUR 618,6 million of own capital, including profits of EUR 42,9 million for the year. The Communities' share is 30 % of this amount (EUR 185,6 million), of which EUR 12,9 million concerns the result for 2005. A dividend of EUR 3,3 million relating to the financial year 2004 was received in 2005.

It should be noted that while the EIF is working towards the application of International Financial Reporting Standards (IFRS) for its annual accounts, its 2005 accounts do not yet fully comply with these rules, particularly with regard to the issue of fair value accounting.

Galileo Programme

For the implementation of the development phase of the Galileo programme, a joint undertaking, within the meaning of Article 171 of the Treaty, was set-up by the Council Regulation 876/2002 for a period of 4 years (2002 to 2006.) The aim of this legal entity is to ensure the unity of the administration and the financial control of the Galileo programme for its development, and to this end to mobilise the funds assigned to that programme. The founding members are the European Communities, represented by the Commission, and the European Space Agency (ESA). The Commission, through grants given under the trans-European networks (TEN) budget, makes available to the Galileo undertaking the requested funds to co-finance the related activities of the development phase.

The Communities have subscribed for EUR 520 million of the capital of this entity and at 31 December 2005 EUR 438 million had been paid, with the balance, EUR 82 million uncalled.

As with the EIF, it is accounted for using the equity method of consolidation. For 2005 the Communities' share of the loss of the joint undertaking was EUR 103,8 million. Thus the value of the investment at 31 December 2005 was EUR 141,5 million being the investment of EUR 438 million less the accumulated share of the losses, EUR 296,5 million.

3.3.2   Guarantee Fund

Council Regulation (EC, Euratom) No 2728/94 of 31 October 1994 set up a Guarantee Fund for external actions to repay the Communities' creditors in the event of default by beneficiaries of loans granted or guaranteed by the Communities. This facility covers loans guaranteed by the Communities as a result of a Council Decision, in particular European Investment Bank (EIB) lending operations outside the European Union and loans under macro-financial assistance (MFA loans) and Euratom loans outside the European Union.

In accordance with Article 6 of the Regulation the Commission entrusted financial management of the Fund to the EIB under an agreement signed between the Communities and the EIB on 23 November 1994 in Brussels and on 25 November 1994 in Luxembourg.

Regulation (EC, Euratom) No 2728/94 on the Guarantee Fund, as amended by Council Regulation (EC, Euratom) No 1149/1999 of 25 May states that with effect from 1 January 2000 the Fund is endowed by payments from the Communities' general budget equivalent to 9 % of the capital value of the operations, the proceeds from interest on investments made from the Fund's assets, and sums recovered from defaulting debtors for whom the Fund has had to activate its guarantee. The same Regulation sets the target amount at 9 %. In accordance with the Regulation, ‘if, at the end of a year, the target amount is exceeded, the surplus shall be paid back to a special heading in the statement of revenue in the general budget of the European Communities.’

The Inter-institutional Agreement of 6 May 1999 on budgetary discipline and improvement of the budgetary procedure provided that the general budget of the European Communities should include a guarantee reserve to cover loans to third countries. This reserve is intended to cover the requirements of the Guarantee Fund and, where necessary, activated guarantees exceeding the amount available in the Fund, so that these amounts may be charged to the budget.

This reserve of EUR 1 231,2 million corresponds to the target amount (9) for the Guarantee Fund calculated on the basis of the amount outstanding at 31 December 2005. The entry on the assets side of the Commission's balance sheet of EUR 1 324,7 million before elimination of MFA debt certificates represents the Fund's net assets at 31 December 2005. The difference between the amount of the Fund shown on the assets side and the amount of the reserve corresponds to the surplus to be repaid to the budget, i.e. EUR 93,5 million.

Net assets of the Guarantee Fund

The Guarantee Fund holds three floating rate notes issued by the European Communities for an amount of EUR 14,6 million, including accrued interest, as at 31.12.2005 (2004: EUR 20,8 million) these bonds were issued by the non budgetary instrument MFA. From an accounting point of view, both assets (GF) and liabilities (MFA) have to be eliminated at the Communities level.

The risk management policies of the Guarantee Fund are described in notes E 7.6 to E 7.9.

3.3.3   Other investments

3.3.3.1   Available-for-sale assets

This heading includes investments and participations purchased to help beneficiaries develop their business activities.

European Bank for Reconstruction and Development (EBRD) investment

The EBRD was given initial capital of EUR 10 billion, of which 3 % was subscribed by the Communities. The proportion of this capital called up is 30 %. On 15 April 1996, at their annual meeting, the Bank's governors decided to double the amount of authorised capital. Under this decision, the Communities have subscribed for 30 000 additional shares with a face value of EUR 10 000 each. This operation involves called-in shares and callable shares in the following proportions: 22,5 % of the subscribed shares represent the number of called-in shares and the remainder will be callable shares.

At balance sheet date, the Communities' subscription to the EBRD's capital amount to EUR 157,5 million, of which EUR 147,5 million have been called up and partially paid. Payments outstanding on called up capital (EUR 9,5 million) are recorded under long-term liabilities and accounted for at amortised cost. As the long-term liability to be recorded can be compared to a long-term borrowing that carries no interest, the fair value of such liability on initial recognition has been estimated as the present value of all future cash payments discounted using the prevailing market rate of interest on that date for a similar instrument (similar as to currency, term, type of interest rate and other factors) with a similar credit rating.

Payments outstanding on non-called up capital amount to EUR 442,5 million and are included as contingent liabilities in the off-balance sheet.

As the EBRD is not quoted on any stock exchange and in view of the contractual restrictions included in the EBRD's articles of incorporation relating, amongst others, to the sale of participating interests, capped at acquisition cost and only authorised to existing shareholders, the 3 % European Communities' shareholding in the EBRD is valued at cost less any write-down for impairment.

ECIP programme

This heading covers Communities' contributions to the provision of equity and subordinated loan capital for joint ventures set up under the European Community Investment Partners Programme (ECIP) in Asia, Latin America, the Mediterranean region and South Africa. The ECIP programme that has been in existence for many years, but which was halted early, the only extension being its winding-up. The programme cannot be definitively wound up until the last joint venture has been completed. Most of the operations have already been wound up, recovered or converted into definitive grants and work on the remaining open files is ongoing. A review of open files is currently ongoing to assess the recoverability and thus the value of the investments.

Eurotech Capital, Venture Consort and JOP

The purpose of the Eurotech Capital instrument is to encourage the private funding of trans-national high-technology projects developed by small and medium-sized undertakings through a network of risk-capital investors. It covers payments made since 1990 in the form of pre-financing repayable under certain circumstances when contracts run out. The Communities' contributions do not constitute equity stakes in the relevant venture capital companies. Rather they represent a fixed proportion of certain investments of these venture capital companies in third companies. These contributions are reimbursable according to conditions specified in the contracts between the Communities and these venture capital companies.

The purpose of the Venture Consort instrument is to promote the trans-national syndication of risk-capital operators in small and medium-sized enterprises. It covers contributions since 1985 for investments in small and medium-sized enterprises (SMEs) engaging in innovatory projects.

The purpose of the Phare-Tacis Joint Venture programme (JOP) is to foster the creation and development of joint ventures in the countries of Central/Eastern Europe and former Soviet states.

Since all three are risk capital operations, and even if some amounts may be reimbursed, it is very difficult to assess the real present value of the contributions. In accordance with the principle of prudence, a 100 % write down has been made for the value of these contributions, which are therefore entered in the balance sheet at zero.

Other financial instruments

The ‘SME Finance Facility/SME financing mechanism’ under the trusteeship of the EBRD is designed to encourage investment funds to grow and to retain over the long term the capital investments they make in SMEs in the Phare candidate countries. The programme is financed jointly by the Commission budget, the European Bank for Reconstruction and Development (EBRD), the Council of Europe Development Bank (CEB), in association with the Kreditanstalt für Wiederaufbau (KfW) and the European Investment Bank (EIB).

The ‘Growth & Employment — ETF Start up facility’ (1998-2000 programme) and ‘MAP Equity — ETF Start up facility’ (2001-2005 programme), under the trusteeship of the EIF support the creation and financing of start-up SMEs by investing in suitable specialised venture capital funds.

Shares were received in 1998 by the ECSC in liquidation as part of the restructuring plan of Eurotunnel. These shares were divested in 2005.

AVAILABLE FOR SALE INVESTMENTS

If the ‘fair value method’ developed in 2005, as described in note E 1.5.4 , had been applied at 31 December 2005, then the investments of the ‘Growth & Employment — ETF Start up facility’ (1998-2000 programme) and ‘MAP Equity — ETF Start up facility’ (2001-2005 programme) would have amounted to EUR 60 million and EUR 9,8 million, respectively.

3.3.3.2   Held for trading assets

The European Communities use derivative instruments in the form of currency and interest rate swaps or hedging purposes.

Currency and interest rate swaps are commitments to exchange one set of cash flow for another. Swaps result in an economic exchange of currencies or interest rates (for example, fixed-rate for floating-rate) or a combination of all those (i.e. cross-currency interest rate swaps). Swaps, as detailed below, are used to match the cash flows of loans with the cash flows of related borrowings.

These derivative instruments become favourable (assets) or unfavourable (liabilities) as a result of fluctuations in market interest rates or foreign exchange rates relative to their terms. The extent to which instruments are favourable or unfavourable and thus the fair values of derivative financial assets and liabilities can fluctuate significantly from time to time.

The ECSC in liquidation (ECSC) entered into the following swap agreements:

The fair value of the interest rate swap was obtained by discounting the net fixed cash flows using zero-coupon swap rates on the balance sheet date.

The valuation of the combined instrument was performed in two steps: first, the interest rate swap component was valued by discounting the cash flows (fixed and floating) that would result from reversing the swap position on the balance sheet date (discounting is performed using zero-coupon swap rates on that date); then, the cross-currency interest rate swap was valued by discounting the cash flows (fixed and floating) that would come from returning the two floating branches of the swap with a standard interest rate swap, taking into account the final nominal exchange transaction at maturity of the swap.

The fair value (including accrued interests) of the swaps with final maturity of more than one year after the balance sheet date is detailed below:

Held for trading assets

3.4   LOANS

This heading covers loan amounts owed to the European Communities maturing in over one year.

3.4.1   Loans granted from the European Communities budget and the ECSC in liquidation

This item principally covers risk capital operations and loans with special conditions granted as part of co-operation with non-member countries as well as housing loans granted by the ECSC in liquidation from its own funds.

Risk Capital Operations

Risk capital operations are loans granted to financial intermediaries to finance equity investments. These finance contracts do not have the basic and constituent characteristics of a loan as there is no fixed reimbursement schedule nor interest rate agreed for the principal consideration and therefore, are assimilated to indirect equity investments for valuation purposes. They are held at historic cost less any provisions for impairment, as there are no quoted market prices available in an active market and their fair value cannot currently be reliably measured. The provisions for impairment as at the balance sheet date are based on the provisional or definitive write-offs communicated by the financial counterparts.

Loans with Special Conditions

Loans with special conditions are loans granted at preferential rates. They are initially recognised at fair value which, in the case of loans carrying interest below market conditions, corresponds to the net present value of expected cash flows discounted at the average prevailing EIB lending rate of interest for borrowers in the respective countries, then subsequently measured at amortised cost. The provisions for impairment, if any, are based on the provisional or definitive write-offs as provided for under the respective finance contracts.

Housing loans of the ECSC in liquidation (ECSC)

Housing loans are loans granted by the ECSC from its own funds in accordance with articles 54 and 54.2 of the ECSC Treaty. These loans are granted at a fixed rate of 1 % and consequently, considered as loans at preferential rates. They are initially recognised at fair value which corresponds to the net present value of expected cash flows discounted at the market rate of interest prevailing for bonds with similar maturities issued by the member states where the borrowers are located, then subsequently measured at amortised cost. The provisions for impairment, if any, are based on the provisional or definitive write-offs as provided for under the respective finance contracts.

3.4.2   Loans granted from borrowed funds

Under the Communities' Treaties, the Council, acting unanimously, has the power to adopt guarantee or borrowing programmes if it considers this necessary to attain the objectives of the Communities. Communities borrowings are direct commitments by the Communities itself and not by any individual Member State. This item includes loans granted by Macro Financial Assistance (MFA) and Euratom and the ECSC in liquidation.

In accordance with the accounting policy described in note E 1.5.4, loans are initially recognised at fair value, then subsequently measured at amortised cost. The fair value of a financial instrument on initial recognition is normally the transaction price. However, if part of the consideration given or received is for something other than the financial instrument, the fair value of the financial instrument is estimated using a valuation technique. The objective of using a valuation technique is to establish what the transaction price would have been on initial recognition in an arm's length exchange motivated by normal business considerations. In the specific case of Euratom and MFA loans, the borrower benefits from a AAA interest rate, when under normal conditions, a spread reflecting his creditworthiness or that of any party guaranteeing the loan would have been applied. The valuation technique here used by the Communities takes into account the historical risk-free yield curve and assumes that borrowers are allocated to credit classes. The historical credit spread for the relevant credit class and maturity is used to infer the average risk-neutral hazard rate, based on a recovery rate that is appropriate for bonds. The average risk-neutral hazard rate is then used with a recovery rate appropriate for Communities' loans, to value the loan cash flows. Based on this valuation technique, the lower bound value of a defaultable bullet loan with maturities of between 1 year and 20 years, for various values of spreads consistent with the grading of the borrowers and recovery rates consistent with actual expected recovery rates on Communities sovereign loans and, assuming a risk-free yield of 4 %, is always close to par. Consequently, it was considered as reasonable to initially recognise the Communities loans at par.

Macro Financial Assistance (MFA) loans

MFA is a policy-based financial instrument of untied and undesignated balance-of-payment and/or budget support to partner third-countries. It takes the form of medium/long term loans or grants or an appropriate combination of both and generally complements financing provided in the context of an IMF-supported adjustment and reform program.

MFA is exceptional in nature and is mobilised on a case-by-case basis. It is in principle reserved for countries geographically close to the EU territory which respect democracy and human rights and with which the EU has important political, economic and commercial ties. The assistance is released on the basis of the fulfilment of economic and financial policy conditions.

Based on materiality considerations, the effective interest rate method is not applied separately to loans and borrowings. The transaction costs are directly expensed in the economic outturn account.

Euratom loans

Euratom is a separate legal entity of the European Union represented by the European Commission. The financial objective of this entity is to grant loans to Member States and non-Member States as follows:

Based on materiality considerations, the effective interest rate method is not applied separately to loans and borrowings. The transaction costs are directly expensed in the economic outturn account.

ECSC in liquidation loans

This item mainly includes loans granted by the ECSC in liquidation on borrowed funds in accordance with articles 54 and 56 of the ECSC Treaty as well as two unquoted debt securities issued by the European Investment Bank (EIB) as substitute of a defaulted debtor. These debt securities will be held till their final maturity (2017 and 2019) in order to cover the service of related borrowings.

The changes in carrying amount correspond to the change in accrued interests plus the amortisation of the year of premiums paid and transaction cost incurred at inception, calculated according to the effective interest rate method.

The effective interest rates (expressed as a range of interest rates) were as follows:

Effective interest rates on loans granted from borrowed funds

LOANS GRANTED FROM THE EUROPEAN COMMUNITIES BUDGET & THE ECSC IN LIQUIDATION

LOANS GRANTED FROM BORROWED FUNDS

3.5   LONG-TERM PRE-FINANCING

Pre-financing is a payment intended to provide the beneficiary with a cash advance, i.e. a float. It may be split into a number of payments over a period defined in the particular pre-financing agreement. The float or advance is either used for the purpose for which it was provided during the period defined in the agreement or it is repaid — if the beneficiary does not incur eligible expenditures he has the obligation to return the pre-financing advance to the European Communities. Thus pre-financing paid is not a definitive expense until the relevant contractual conditions are met and so is recorded as an asset on the balance sheet when the initial payment is made. The amount of the pre-financing asset is reduced (wholly or partially) by the acceptance of eligible costs and amounts returned. When a pre-financing amount is fully or partially accepted by the Communities, following analysis of the eligibility of a cost claim received, then the accepted amount of eligible expenditure is removed from the balance sheet and taken as an expense in the economic outturn account. In this way, interim or final payments are intended to reimburse expenditure incurred by the beneficiary on the basis of a statement of expenditure. This may clear the pre-financing amount in whole or in part.

Pre-financing is valued at its estimated recoverable amount. The Communities reviews its pre-financing for ‘value reductions’ whenever events, changes in circumstances or information indicate that the carrying amount of the asset might not be recoverable. This assessment takes into consideration the existence of a related guarantee attached to the pre-financing. The expected irrecoverable pre-financing, or the amount for which recovery has ceased to be probable, is recognised as a value reduction or charge in the economic outturn account. The corresponding amount is recognised as a decrease in the pre-financing carrying value in the balance sheet.

At year-end outstanding pre-financing amounts are valued at the original amount(s) paid less: amounts returned, eligible amounts cleared, estimated eligible amounts not yet cleared at year-end, and value reductions. Guarantees related to pre-financing amounts are disclosed in the off-balance sheet as contingent assets.

Interest is generally earned on all pre-financing paid out, except for amounts paid to Member States or as pre-accession aid. This interest is recognised as it is earned in accordance with the provisions of the relevant agreement. An estimate of the accrued interest revenue, based on the most reliable information, is made at the year-end and included in the balance sheet. The ownership of this interest designates the two categories of pre-financing existing — European Communities and Third Party. The difference between the two categories is that the interest generated by ‘European Communities’ pre-financing amounts remains the property of the Communities and so must be returned to the Communities, while that earned on ‘Third Party’ pre-financing is the property of the beneficiary.

Long-term Pre-financing amounts

As many of the projects funded by the European Communities Structural Fund actions are long-term in nature, it is necessary that the related advances are available for more than one year. Thus these pre-financing amounts are shown as long-term assets. The Commission makes a payment on account amounting to 7 % of the total contribution from the Structural Funds once the programme is adopted. The payment on account will have to be reimbursed if no expenditure is declared within 18 months. The Commission then makes interim payments to reimburse actual expenditure certified by the Member State. The balance of 5 % is paid on the closure of the programme once all the documents required are submitted and approved by the Commission. Payments are posted to the earliest open commitment.

3.6   LONG-TERM RECEIVABLES

Long-term receivables

The building contribution is primarily the financial contribution by the Belgian State to the purchase and fitting-out of the D3 building for the Parliament, which came to EUR 176 million and is to be paid over ten years ending in 2008. At year-end EUR 42.3 million is due greater than one year (2004: EUR 62 million), while a further EUR 21.4 million (2004: EUR 21.1 million) falls due within one year.

Amounts to be received from Member States refer to amounts due to the ECSC in liquidation from former accession countries. The total contribution amounts to EUR 170 million and is to be paid in four instalments on the first working day of each year, starting in 2006, in the following amounts: 15 %, 20 %, 30 % and 35 %. The net present value of these contributions was EUR 158,8 million at year-end (2004: EUR 155,7 million), being split up between long-term receivables, EUR 134,8 million (2004: EUR 155,7 million) and short-term receivables, EUR 24 million (2004: zero).

Also included above is an amount of EUR 20,1 million relating to loans given by the ECSC in liquidation to officials of the European Communities. These loans are financed by the ECSC in liquidation from its own funds and are currently managed by the Commission. EAR (the European Agency for Reconstruction and Development) credit schemes refer primarily to Counterpart Funds and Credit Line Schemes advanced.

II.   CURRENT ASSETS

3.7   STOCKS

STOCKS

The increase in the balance of scientific material is because 2005 includes raw material amounts of EUR 10 million for the first time. The large increase in fissile material stocks is because there is no value reduction made in 2005 as a result of a change in accounting estimates — previously an impairment was made if there had not been any movements in the stock during the year, where as now stocks are valued at the lower of cost and net realisable value. This is also a reason for the increase in the scientific material for re-sale. Another reason for the increase in these stocks is that EUR 20 million of stock in production is now included under stock for re-sale.

The Commission keeps a stock of production material, valued to EUR 6,9 million, mainly consisting of building maintenance material and spare parts used by the Joint Research Centres.

The stock of publications held and/or managed by the Publications Office for which a charge is made (paying stock) is valued at zero following an analysis made in 2001. Publications not destined for resale are valued on the base of average cost of stocks for re-sale. Stocks with low turnover have been written down by 33 % per year.

3.8   SHORT-TERM INVESTMENTS

Short-term investments consist of available-for-sale securities, which are purchased for their investment return or yield, or held to establish a particular asset structure or a secondary source of liquidity and may therefore be sold in response to needs for liquidity or changes in interest rates. Also included are held for trading assets.

3.8.1   Short-term available-for-sale assets

Short-term available-for-sale assets

SME Guarantee Facility — ETF start-up Growth & Employment

All investments are AAA floating rate bonds denominated in EUR and quoted in active markets. At 31 December 2005 the nominal value of debt securities with a remaining duration to maturity of less than one year amounts to EUR 4 million (2004: EUR 24 million.) A new bond was purchased in 2005.

Ten Risk Capital EIB

Investments made under the TEN Risk Capital Facility (to date only one totalling EUR 3 million) are undertaken by the establishment of a joint special purpose entity (jointly held by the EIB and the Galaxy Fund, the TEN RCF partner), under the name of GALAXY — A28 for Trans-European Network projects involving private sector investments. These investments represent an equity holding in the special purpose entity, and therefore should be recorded appropriately as an equity investment in the Communities' balance sheet.

ECSC in liquidation

As stipulated in the internal prudential rules of the ECSC in liquidation, the investments are to be confined to securities issued by first-ranking entities. All investments are debt securities denominated in EUR and quoted in an active market. Details of the investment portfolio by issuer type and by rating are described in note E.7.13. At 31 December 2005 debt securities (expressed at their fair value) reaching final maturity in the course of 2006 amount to EUR 237,4 million (2004: EUR 200,1 million).

3.8.2   Short-term held for trading assets

Short-term held for trading assets

The Macro Financial Assistance (MFA) swap agreement, as detailed below, was entered into to match the cash flow of a loan with a floating interest rate and a final maturity on 22 December 2008, on one side and, the cash flow of the corresponding borrowing with a fixed interest rate and a final maturity on 22 December 2005, on the other side. The swap agreement was structured in two ‘tranches’: the ‘swap tranche’, where both floating and fixed rate legs were active, ended on 22 December 2005, the second ‘tranche’ with only the floating rate leg being a forward floating borrowing starting on the same date.

SWAPS

The fair value of the ‘swap tranche’ was obtained by discounting the cash flows (fixed and floating) that would result from reversing the swap position on the balance sheet date (discounting is performed using zero-coupon swap rates on that date).

3.9   SHORT-TERM PRE-FINANCING

The split of amounts outstanding between management types reflects the pre-financing payments made during the year 2005 (comparative figures are not available for 2004.) The historic pre-financing amounts are those first included in the opening balance sheet and are shown separately on a single line.

Accrued charges represent the amount of eligible costs that were estimated to have been incurred by the beneficiaries of the outstanding pre-financing amounts at year-end, but not yet reported to the Communities. These amounts are taken as expenses in the Economic Outturn Account. See also note 3.5 for further explanations concerning long-term pre-financing.

Short-term Pre-financing amounts

3.10.   SHORT-TERM RECEIVABLES

Short-term receivables

3.10.1   Long-term receivables falling due in less than one year

These amounts totalling EUR 45,9 million (2004: EUR 50,8 million) represent primarily the loans with remaining final maturities less than 12 months after the balance sheet date (see note 3.4 above for more details) and the financial contribution by the Belgian State to the purchase and fitting-out of the D3 building for the Parliament (see note 3.6 above.) Also included are the short-term contributions owed by former accession countries to the ECSC in liquidation (see note E.3.6 above.)

3.10.2   Current receivables

Current receivables

3.10.2.1   Customers

These are recovery orders entered in the accounts at 31 December 2005 as established entitlements to be recovered and not already included under other headings on the assets side of the balance sheet.

In respect of imposed fines of EUR 4 274,7 million at 31.12.2005 a total of EUR 2 103,3 million was collected provisionally. The balance of EUR 2 171,4 million is included under this heading, of which EUR 1 465,7 million was covered by bank guarantees. The provisional payments (and related interest) are applied against the related receivable and included as restricted cash under the cash heading. The bank guarantees are entered as contingent assets in the off-balance-sheet. The amount shown in the off-balance-sheet as contingent liabilities totals EUR 4 427,4 million, being the total outstanding claims pending judgement plus interest earned on payments received pending final judgement.

3.10.2.2   Receivables from Member States

Advances to Member States

In 2004 this amount concerned advances paid by the Commission to various Member States from the Emergency Veterinary Fund for certain animal disease eradication costs incurred.

EAGGF Guarantee receivables

This item covers the amounts owed by beneficiaries of EAGGF Guarantee as declared and certified by the Member States and entered in the debtors ledger at the end of the year (15 October 2005) in accordance with Regulation (EC) No 2761/99 less 20 % of the amount, which the Member States are allowed to retain to cover administrative costs. The Member States are not required to make the amounts available to the Commission unless they are recovered.

Additionally, and in accordance with the principle of prudence, the European Commission must estimate and record the part of the EAGGF Guarantee that is unlikely to be recovered. The declared estimate of the write-down is EUR 873,9 million (as estimated by the Member States), which accounts for 59,3 % of the total amount to be recovered at 31 December 2005 (57,4 % at 31 December 2004.) The Commission relies on the estimates of the Member States based on the assumption that the paying agencies are in a better position to assess the amounts likely to be recovered. The findings of the certifying bodies concerning management of amounts owed are handled under the 2005 clearance procedure, including any proposal for the application of financial corrections. The fact that this adjustment is entered in the accounts does not mean that the EC is waiving future recovery of the amounts covered by the write-down.

Receivables from Member States

VAT

This item covers the amounts of VAT paid by the Communities and recoverable from Member States.

Own resources

The separate account contains traditional own resources which, under Article 6(3)(b) of Regulation No 1150/2000, have been established by the Member States but not made available to the Communities as they have not yet been recovered or guaranteed or because they have been challenged. Council Decision No 2000/597/EC, Euratom of 29 September 2000 on the system of the European Communities' own resources allows Member States to withhold 25 % of traditional own resources as collection costs.

Each Member State sends the Commission a quarterly statement of these accounts, with the following particulars for each type of resource:

When the traditional own resources from the separate account are recovered, they must be made available to the Commission at the latest on the first working day following the 19th day of the second month following the month during which the entitlement was recovered.

This figure overestimates the Communities' actual entitlements since the separate account for traditional own resources largely consists of amounts where actual recovery is unlikely. For previous years the Commission calculated a write-down of the entitlements in the separate account by using a statistical method. From 2004 onwards this write-down is based on estimations made by Member States themselves. In order to ensure that the separate account provides a better picture of the actual budgetary situation Article 6(4)(b) of Council Regulation (EC, Euratom) No 1150/2000 was amended by Council Regulation (EC, Euratom) No 2028/2004 of 16 November 2004. This Article states now: ‘Together with the final quarterly statement for a given year, Member States shall forward an estimate of the total amount of entitlements contained in the separate account at 31 December of that year for which recovery has become unlikely.’

Based on the estimations sent by Member States, a write-down of EUR 728,3 million has been deducted from the item for receivables from Member States on the asset side of the balance sheet. However, this does not mean that the Commission is waiving recovery of the amounts covered by this value adjustment. Even where recovery looks very unlikely, if not virtually impossible, this does not necessarily mean that the amounts in question are lost to the Community budget as traditional own resources. This is because non-recovered entitlements are lost only if the Member State has exhausted all the avenues it is required to pursue in order to secure recovery. Where the Member State fails to do this, it is held financially liable and required to pay the amount into the Community budget in accordance with Article 17(2) of Regulation No 1150/2000.

Other own resource amounts at 31 December 2005 concerned amounts due from Portugal that had not been paid when due in December 2005.

Other receivables from Member States

Other receivables from Member States include EUR 74 million of recovery of expenses from the regions. Included under ‘other’ in 2004 was an amount of EUR 170 million relating to contributions due from the new Member States to the Research Fund for Coal & Steel (see note 3.6.)

3.10.3   Sundry receivables

The main amount included here relates to advances granted under the MEDIA programme, EUR 36,5 million (2004: EUR 41,7 million). Using the prudence principle and based on the risks and uncertainty involved, a value reduction of EUR 24,5 million (2004: EUR 28,1 million) has been applied.

Amounts due from personnel are EUR 4,2 million (2004: EUR 12,6 million.)

3.10.4   Accrued income and deferred charges

The most significant accrued income amounts represent accrued income relating to traditional own resources (agricultural duties, sugar levies and custom duties). At 31 December 2005 these amounted to EUR 2,3 billion compared to EUR 2 billion the previous year. Also included here is late interest income, accrued bank interest and accrued interest on pre-financing amounts.

The main amounts under deferred charges at 31 December 2005 are anticipated payments of EUR 89,5 million (EUR 108 million in 2004) for budgetary compensation to new Member States, pre-paid office rental of EUR 29,7 million (EUR 49 million in 2004), EUR 62,3 million paid for bilateral fisheries agreements with third countries (EUR 61,7 million in 2004) and EUR 62,8 million pre-paid expenses concerning the European schools.

3.11   CASH AND CASH EQUIVALENTS

Cash & cash equivalents

Unrestricted cash covers all the funds which the Communities' keeps in its accounts in each Member State and EFTA country (treasury or central bank), as well as in current accounts, imprest accounts, short-term bank deposits and petty cash.

Restricted cash refers to amounts received in connection with fines issued by the Commission for which the case is still open. These total EUR 2,25 billion and are kept in specific current accounts that are not used for any other activities.

Cash & cash equivalents include the following for the purposes of the cash flow statement:

III.   NON CURRENT LIABILITIES

3.12   EMPLOYEE BENEFITS

Employee benefits

Pensions

At 31 December 2005, the rules concerning the Pension Scheme of European Officials (PSEO) were defined by the latest version of the Staff Regulations of Officials of the European Communities (in force since 1st May 2004). The rules regarding the staff pensions are directly applicable in all Member States. The arrangement covers various types of pensions and allowances (seniority, invalidity, survival).

In accordance with article 83 of the Staff Regulations, the payment of the benefits provided for in the pension scheme constitutes a charge to the Communities' budget. Member States guarantee the payment of these benefits collectively according to the scale fixed for the financing of this expenditure. In addition, officials contribute one third to the long-term financing of this scheme via a compulsory contribution.

The liabilities of the PSEO were the subject of an actuarial valuation by independent experts on 31 December 2005 on the basis of the applicable rules of the statute. This evaluation covered the benefits connected with retirement, invalidity and survival, as well as invalidity allowance. It was carried out in accordance with the methodology of International Accounting Standard 19 (IAS 19). This accounting standard requires the employer to determine his actuarial commitment on an ongoing basis, taking into account both the promised benefits during the active lifetime of employees, and foreseeable increases in salaries.

The actuarial valuation method used to calculate this liability is known as the projected unit credit method. The main actuarial assumptions used in the valuation were as follows:

Liabilities cover the rights previously defined for the following persons:

The population of the PSEO at 31 December 2005 was extracted from the Eurostat database. The results obtained within the framework of this study were compared with the estimates based on the previous actuarial valuation on 31 December 2004.

The principal facts are:

The calculations of gross pensions and family allowances are based on the provisions of the Staff Regulations.

Also included in the above amount is the liability relating to the pension obligations towards members and former members of the Commission and Court of Auditors, as well as the judges and former judges of the Court of Justice and the Court of First Instance. The amounts used in 2005 represent the pension amounts paid, from the 2005 budget, to retired staff (widows, orphans, etc.) during the year.

3.13   LONG-TERM PROVISIONS FOR RISKS AND CHARGES

Long-term provisions for risks and charges

Legal cases

This is the estimate of amounts that are likely to be paid after 2006 in relation to a number of ongoing legal cases. The largest (EUR 60 million) concerns the estimate of amounts that will probably have to be paid out for 18 court cases pending at 31 December 2005 in relation to the financial corrections for EAGGF Guarantee expenditure. A further EUR 37,2 million is provided for 5 other court cases concerning agricultural expenditure

Decommissioning of JRC nuclear facilities

In 2002 a consortium of independent experts conducted a study into the estimated costs of the decommissioning of the JRC nuclear facilities and waste management programme. Their estimate of EUR 1 145 million (including EUR 76 million as an estimate of the cost required for the ‘green field’ option, i.e. total destruction of all the buildings) is taken as the basis for the provision to be included in the accounts. To fully apply the Communities' accounting rules, this provision is indexed for inflation (at a rate of 2,5 %) and then discounted to its net present value (using the Euro zero-coupon swap curve). At 31 December 2005, this resulted in an amount for the provision of EUR 1 016,4 million, less the costs incurred to date of EUR 81,5 million, giving EUR 934,9 million split between amounts expected to be used in 2006 (EUR 51 million) and afterwards (EUR 883,9 million.)

In view of the estimated duration of this programme (around 30 years), it should be pointed out that there is some uncertainty about this estimate, and the final cost could be different from the amounts currently entered.

Financial provisions

Under the SME Guarantee Facility 1998 implemented as part of the European Union's Growth and Employment Initiative and the SME Guarantee Facility 2001 implemented under the Multi-annual Programme for enterprise and entrepreneurship (MAP), the European Investment Fund (EIF) is empowered to issue guarantees in its own name but on behalf of and at the risk of the Communities.

The financial risk linked to the drawn and undrawn guarantees is capped as follows:

As at the balance sheet date, financial provisions correspond therefore for both facilities to the payment obligations towards to financial intermediaries minus the net payment demands made up that date. Due to the time value of money, long-term financial provisions are discounted to their net present value (using the Euro zero-coupon swap curve).

The financial provisions are annually adjusted in view of any variation of the utilisation of guarantees or any change in the net payment demands made by the financial intermediaries. The total increase in financial provisions (long-term and short-term) in 2005 is EUR 27,4 million, divided into the effective additional provision of EUR 51,7 million less the payments made for the guarantee calls amounting to EUR 27,9 million, and an increase of provision due to the effect of time of EUR 3,6 million.

3.14   FINANCIAL LIABILITIES

3.14.1   Borrowings

This heading includes borrowings due by the European Communities maturing in over one year.

The detailed movements in borrowings during 2005 are as follows:

Borrowings