1.1.

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

1.2.

The aim of the work on the reliability of the accounts of the European Communities is to obtain sufficient appropriate evidence to conclude on the extent to which revenue, expenditure, assets and liabilities have been properly registered and that the annual accounts faithfully reflect the financial position as of 31 December 2007, and the results of their operations and cash flows for the year then ended (see paragraphs 1.6 to 1.31).

1.3.

The aim of the Court’s audit work on the legality and regularity of the transactions underlying the 2007 accounts is to gather sufficient appropriate evidence, of a direct or indirect nature, to give an opinion on whether they are in accordance with the applicable regulations or contractual provisions, and have been correctly calculated (see paragraphs 1.32 to 1.54 of this chapter for horizontal issues and chapters 2 and 4 to 11 for details).

1.4.

Once again, the Court assessed the progress made by the Commission in strengthening its internal control system and to the follow-up given to the action plans adopted within the context of the Roadmap towards an integrated internal control framework (see chapter 2).

1.5.

In addition, in the absence of Commission indicators over a series of years and to complement those provided for 2007 (9), the Court presents certain indicators to monitor progress in improving internal controls both overall, and for each income and expenditure area (see annexes to this chapter and to chapters 2 and 4 to 11).

1.6.

The Court’s observations concern the annual accounts for the financial year 2007, drawn up by the Commission's Accounting Officer and approved by the Commission in compliance with Article 129 of the Financial Regulation of 25 June 2002 (10) and sent to the Court on 28 July 2008. The accounts comprise the ‘consolidated financial statements’ — covering, in particular, the balance sheet setting out the assets and liabilities at the end of the year as well as the economic outturn account — and the ‘consolidated reports on the implementation of the budget’ — covering the revenue and expenditure for the year.

1.7.

The 2007 annual accounts are the third set of accounts prepared under the accruals based accounting rules which were introduced by the European Communities in 2005 on the basis of provisions of the Financial Regulation (in particular Articles 123 to 138). In comparison to the 2005 and 2006 annual accounts, the following major changes occurred:

—

the scope of consolidation has been increased from 16 agencies consolidated in 2005 to 26 agencies in 2007 (24 in 2006);

—

the information given on the different forms of recovery of undue expenditure made by the Commission has been regrouped;

—

a reconciliation of the economic outturn to the budgetary outturn has been provided;

—

for the first time this year, the Accounting Officers of the other institutions and bodies provided the Commission’s Accounting Officer with duly signed ‘transmission letters’, most of them materially similar to the management representation letter (11) provided by the Commission’s Accounting Officer.

1.8.

The Commission's Accounting Officer provided the Court with a representation letter confirming that subject to certain limitations the consolidated accounts are complete and reliable (see however paragraphs 1.29 and 1.31) and that most of the Commission’s local systems have been validated (see however paragraphs 1.13 to 1.16).

1.9.

The transition to accruals based accounting, and the resulting significant changes in the structure and in the content of the accounts of the European Communities, require a multiannual adaptation process for the Commission. In its audit of the 2007 accounts the Court paid particular attention to the changes introduced as a result of the ongoing modernisation of the Communities accounting system (12). The audit concentrated on the following elements (13):

—

assessment of whether measures taken within the Commission, in order to remedy weaknesses identified in the new financial reporting framework and accounting systems of certain institutions and Directorates-General (14), contribute to the reasonable assurance that the accounts give a true and fair view. This was done, in particular, by analysing the bases for the validations (according to Article 61 of the Financial Regulation) by the Authorising Officers of the 2007 accounts falling under their responsibility, as well as by analysing the validation of the Accounting Officer for the cut-off methodology and the state of readiness of the local financial management systems which provide data for the Commission’s accounts (see paragraphs 1.13 to 1.18);

—

verification of the reliability of the 2007 accounts, concentrating on elements for which a modified opinion was given in the context of the 2006 Statement of Assurance (15) (pre-financings, invoices/cost statements and cut-off). This was done by carrying out analytical reviews and substantive tests on representative statistical samples (see paragraphs 1.23, 1.24, 1.25 and 1.26).

1.10.

The Commission's Accounting Officer introduced a series of measures in order to consolidate the transition to modernised accruals based accounts. A pilot study was launched in July 2006 on the quality of accounting data and has been completed. As a result, the Commission’s Accounting Officer finalised a series of measures which were disseminated to all Directorates-General in March 2007. Their purpose is to improve the accounting control environment at the level of individual Directorates-General. They include the development of an accounting risk analysis, the deployment of risk-based accounting review exercises, the elaboration of specific accounting manuals and the documentation of year-end accounting closure files. The project applies for the first time to the annual accounts of 2007.

1.11.

These measures have contributed to a strengthening of the financial reporting framework and accounting systems. However, certain weaknesses still exist which put at risk the quality of accounting data (see paragraphs 1.13 to 1.18). Furthermore, it was noted that the guidelines on the accounting control environment, issued by the Commission’s Accounting Officer, were not fully applied by a limited number of operational Directorates-General for the cut-off calculation.

1.11.

Although weaknesses were identified in the quality of some accounting data, these had no material impact on the reliability of the accounts.

1.12.

Table 1.1 contains a follow-up of the Court’s reservations concerning the reliability of the accounts which were expressed in the Statement of Assurance for the 2006 financial year, as well as the other points raised by the Court, which were partly settled or which still need to be addressed in the context of the measures taken by the Commission to consolidate the transition to modernised accruals based accounts.

1.13.

Many Directorates-General use their own local IT-systems for financial management purposes and for the creation of transactions which are sent to the central accounting system (ABAC) via an interface.

1.13.

As the situation is constantly evolving, the accounting services’ validation team needs to keep track of this evolution, and has introduced, as was already mentioned last year, a procedure for the validation of changes in the local systems.

1.14.

For the financial year 2007, the services of the Commission's Accounting Officer carried out a follow-up of the previous year's findings (16). In addition six further services (17) were subject to in-depth reviews as part of a cyclical approach aiming at full coverage of Commission's services on a medium term. Two other services (18) were also subject to review but their reports were not finalised in time for the Commission’s Accountant Global Validation Report for 2007.

1.14.

The accounting services’ validation team follows up matters raised in previous reports in order to ensure that recommendations made are being implemented, thus ensuring that the quality of local financial management systems is constantly improving.

1.15.

The Commission’s Accounting Officer was still not able to validate the local systems of the Directorate-General for Education and Culture (19) and the Directorate-General for External Relations (20), as indicated in his management representation letter (see paragraph 1.8), nor to validate without qualifications the local system of EuropeAid Co-operation Office (21) regarding the financial year 2007. The non-accounting reservation issued for the Joint Research Centre (22) in 2006 was kept for the financial year 2007. The number and importance of horizontal issues and other matters for consideration remain much the same as in previous years (23).

1.15.

Work is still ongoing with the aim to reach the validation for the Directorates-General for External Relations and for Education and Culture.

1.16.

The Court’s audit confirmed that the decisions of the Commission's Accounting Officer were well founded: the issues and matters outstanding were important.

1.17.

Since the transition to accruals accounting, the Commission’s Accounting Officer invited the Commission services to carry out an ex-post testing of their cut-off methodology, where relevant (24), combining data from budgetary sources and from general accounting in order to check the adequacy of methods. Out of the nine Directorates-General examined (25), six were partially concerned by this testing representing under 20 % of the total cut-off amount, one Directorate-General improved its procedures by testing and correcting its cut-off procedures (26), others tested their methodology but corrective actions were postponed (27) and some Directorates-General (28) still have not yet carried out ex-post testing of their cut-off methodologies. This may lead to inaccuracies in the accounting data.

1.17.

The Accounting Officer considered the accounting data to be sufficiently accurate for the final accounts.

1.18.

Some Directorates-General (representing approximately 20 % of the total cut-off amount) establish their cut-off of accrued charges according to a pro rata temporis method (29). However, if the contract dates in the accounting systems used as a basis for the cut-off calculations are incorrect or changes therein are not updated, they affect adversely the reliability of the accounts.

1.18.

The quality-control plan of the main Directorate-General concerned focused on activity dates. 935 contracts have been reviewed, including all contracts with long duration. As a consequence, remaining activity date errors relate to short duration contracts having a much lower impact on cut off than last year's. In the Court’s sample of 20 transactions for this Directorate-General, there are 3 errors due to wrong activity dates. This is an improvement compared to last year.

1.19.

During 2007, the Commission took measures to ensure the complete and correct registration of new pre-financing payments and related guarantees, as well as of new open invoices/cost statements, and the cut-off.

1.20.

The Court’s audit of loans, inventories, long-term receivables, cash and cash equivalents, employee benefits, provisions and financial and other long-term liabilities and reserves did not produce any significant findings. However, a number of errors were identified concerning other elements which are presented hereafter.

1.21.

The European GNSS (30) Supervisory Authority (GSA), a EU Agency created in 2004 (31), officially took over responsibility (32) from the former Galileo Joint Undertaking (GJU) on 1 January 2007. The new body was originally intended to operate as a public private partnership; following a decision of the Council made in November 2007 the Galileo programme is now to be financed from the EU budget. At the end of 2007, despite the signature of agreements (33) between the interested parties (GJU, European Space Agency, Authority), ownership of the projects’ assets from the GJU to the Authority had not been completely transferred and no list of Galileo assets held by the European Space Agency had been established. The Court therefore did not express an opinion on the reliability of the Authority’s accounts for the year ended 31 December 2007.

1.21.

At the end of 2007, despite the signature of agreements between the interested parties (GJU, European Space Agency, GSA), ownership of the projects’ assets had not been completely transferred from the ESA to the European Communities. As there is some uncertainty and delay in the transfer of assets, for reasons of prudence, the European Communities have not recognised the assets of the programme in their balance sheet. It is intended that the assets will be recognised once these transfer issues have been resolved.

1.22.

In the consolidated financial statements of the European Communities, all risk capital operations (218 million euro as at 31 December 2007) are classified as ‘long term investments’ (assets available for sale). They are held at historic cost less any provisions for impairment, as their fair value cannot currently be reliably measured. While such a valuation method is acceptable in the circumstances, it is not applied consistently. The Court found that impairments are only based on write-offs while provisional estimates for impairments were available to the manager of the operations (European Investment Bank) but had not been communicated to the Commission (34).

1.22.

Reporting and accounting standards have evolved significantly over the period of the MEDA mandates which cover these risk capital operations (RCO). The EIB and the Commission have been following developments and are currently reviewing the situation together, looking for the most cost-effective solution and also taking into account information available according to the contracts signed with final beneficiaries many years ago (hence not including current reporting standards). This review has confirmed that the current valuation exercise of the Risk Capital Operations is a very time-consuming and challenging exercise due to the high number and the complex cascade structure of the RCO transactions. The EIB has also underlined that the valuation of the RCO transactions is based, to the extent it is possible, on relevant international accounting principles, notably IAS 39.

1.23.

The Court’s audit of a representative statistical sample of 150 pre-financings registered in the accounting system identified a low level of error in terms of financial impact as regards this item of the balance sheet. However, the frequency of these errors underlines the need for further improvement of the accuracy of the basic accounting data at the level of the operational Directorates-General. The most common types of errors are:

—

pre-financing entries were not recorded in line with the different management types as presented in the notes to the financial statements;

—

pre-financing amounts remained open although they had been used by the beneficiaries before the year-end.

1.24.

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

1.24.

—

some payments were booked as expenses in the economic outturn account whilst they should have been booked as pre-financings in the balance sheet;

—

some pre-financings remain in the balance sheet although the relevant information, such as audit certificates, were available in order to proceed with their clearing by recording the corresponding expenses in the economic outturn account. Furthermore, an inconsistent treatment of clearing of pre-financings has been observed. The Directorate-General for the Information Society and Media proceeds correctly to the clearing of pre-financings in the case of cost claims not accompanied by audit certificates whilst the Directorate-General for Research, in the same circumstances, leaves the pre-financing open.

—

The Commission agrees with the Court that it is best practice to clear open pre-financing amounts with the minimum of delay and its goal is to have all services do this as soon as sufficient supporting documentation is available. In the meantime, year-end bookings ensure that the criticised practice does not affect the reliability of the accounts.

Furthermore, the Directorate-General for the Information Society and Media and the Directorate-General for Research are cooperating to find a common way for dealing with this question in line with the recommendations made by the accounting services.

1.25.

The audit of a representative statistical sample of 150 invoices/cost statements from the population of accounts payable registered in the accounting system identified a low level of error in terms of financial impact as regards this balance sheet item. However, the frequency of these errors underlines the need for further improvement of the reliability of the basic accounting data at the level of the operational Directorates-General. Most of the errors concern invoices or cost statements recorded for the wrong amounts.

1.26.

Significant delays were identified in the treatment of some invoices and cost-claims. This has an impact on the accounts in so far as delays in the eligibility analysis of invoices prevent the triggering of the clearing of pre-financings. This may lead to an inaccurate liability position towards third parties and the booking of an expense amount, based on a cut-off estimate, instead of an amount supported by invoices already received.

1.27.

The recording of payments under the wrong management type has an impact on the accuracy of the breakdown of expenses by management type in the notes to the economic outturn account as well as in the segment reporting (see also paragraph 1.23).

1.28.

Although the explanatory notes to the annual accounts contain information about the fact that some transactions are likely to be corrected at a later date by the Commission’s departments or the Member States, the amounts and areas of expenditure which may be subject to further verification and clearance of accounts procedures (35) are still not identified in the notes.

1.28.

The Financial Regulation and the sectoral regulations regarding agriculture and the structural funds give the Commission the right to make checks on all expenditure for many years after it is incurred. The accounts should not imply that, because of this right, all the expenditure concerned remains to be accepted. Where the amounts of potential recoveries are quantifiable, they are disclosed in notes 5.3 and 5.4 to the consolidated accounts.

1.29.

Following a recommendation of the Court, more information concerning the recovery of undue payments has been presented in the notes to the financial statements. However, the notes to the financial statements do not yet contain complete and reliable information on the financial correction activities made by the Member States. They provide this information in particular in respect of withdrawals, recoveries and pending recoveries in the area of Structural Actions (36). As a result of the high proportion of ineligible expenditure repeatedly indicated in the Court's Annual Reports, and in order to be compatible with the presentation of a true and fair view, the Court considers that appropriate information should be presented in the notes to the accounts on these correction mechanisms.

1.29.

Chapter 6 of the 2007 annual accounts gives an overview of the procedures in place for the recovery of undue payments, and presents a best estimate of the total amount of such recoveries, including recoveries made by Member States regarding agricultural expenditure.

1.30.

Based on the examination of the certifying bodies work (37) the Court reiterates (38) its doubts as regards the accuracy of the receivables from Member States in the area of agriculture. Further the Court notes that the different policies applied to the date of recognition of debts by the Paying Agencies result in an inconsistent presentation of the global value of debts (see paragraphs 5.44 and 5.45).

1.30.

The Commission considers the information which it received on receivables from Member States in the area of agriculture to be sufficiently reliable for clearance and accounting purposes.

1.31.

Furthermore, the notes to the accounts do not disclose the recoveries made by deduction from a subsequent payment (offsetting).

1.31.

As indicated in the notes to the accounts, the information systems did not allow for the identification of this information in 2007. The systems have since been adapted by the Commission during 2008 so that all recoveries made by deduction from a subsequent payment can be identified and explained.

1.32.

Following the introduction by the Commission of Activity Based Budgeting (ABB) and Activity Based Management (ABM), the Court decided to redefine the specific assessments in which it divides the budget for DAS purposes in terms of suitable groups/clusters of ABB policy areas (see Table 1.2 ).

1.33.

The Court uses an assurance model which draws on two principal sources of evidence:

1.33.

(a)

an assessment of the operation of the supervisory and control systems applied in the collection and disbursement of funds from the EU budget by EU institutions, Member States, regions, third countries, etc., aiming to provide representative information on the implementation and functioning of key controls in respect of their ability to prevent or detect and correct errors;

(b)

checks based on representative statistical samples of underlying transactions relating to revenue and to expenditure, down to the level of the final beneficiary, aiming to provide direct evidence on the legality and regularity of payments.

(b)

Under the legislation applicable (46), the Commission operates a control cycle in relation to Community-funded expenditure which is carried out over a period of years. It applies for instance clearance-of-accounts procedures in agriculture, financial correction mechanisms in structural measures, and recoveries in internal policies and external actions. Errors which are detected during the course of a multiannual project and the associated undue payments may be recovered in a later year than the one under examination, such as through reducing the final payment to take account of the shortcoming found.

The application of these procedures by Member States and the Commission, and the other control measures effected provide, with the limitations described in the 2007 annual activity reports, reasonable assurance that the resources assigned to the Commission's activities have been used for their intended purpose and in accordance with the principles of sound financial management. The control procedures put in place give the necessary guarantees concerning the legality and regularity of the underlying transactions.

Thus the Commission assumes its final responsibility for the implementation of the budget laid down by Article 274 of the EC Treaty.

The Commission welcomes the Court’s increased emphasis on examining measures taken to detect and correct errors, principally through financial corrections, clearance and recoveries. The Commission has made substantial efforts to improve the quality of data on recoveries provided by Member States and is currently carrying out work to verify the completeness and accuracy of these data.

Progress has been made in producing reliable evidence of the operation of the multi-annual corrective mechanisms. The Commission has included in the notes to the annual accounts of the European Communities for the financial year 2007 a new chapter about the recovery of undue payments. The objective of this chapter is to give an overview of the procedure in place for the recovery of undue payments and to present a best estimate of the total amount recovered.

1.34.

The principal sources described above can be complemented by two other sources:

(a)

an analysis of the Annual Activity Reports and the declarations of the Commission's Directors-General and their synthesis, stating whether the Commission has reasonable assurance that the systems in place ensure the legality/regularity of the underlying transactions;

(b)

an examination of the work of other auditors, defined as those that are independent of the Community's management and control process (e.g. Supreme Audit Institutions in the Member States or third countries) (47).

1.35.

Errors may relate to a ‘condition for payment’ or to an ‘other compliance issue’. In general, payment conditions are breached when legal requirements of the respective aid scheme or contract are not fulfilled. On the other hand, other compliance issues are specific conditions to be fulfilled, which result from related policy objectives (protection of the environment, good agricultural practices, etc.) or systems requirements (minimum number of controls, prescribed structures and procedures, etc.).

1.36.

The Court classifies errors as being either ‘quantifiable’ or ‘non-quantifiable’. The first category refers to errors, which have a direct and measurable financial impact on the amount of underlying transactions financed from the EU budget (48).

1.37.

Only quantifiable errors are taken into consideration when estimating the financial impact of errors for the population as a whole. Frequency of errors refers in this report to quantifiable and non-quantifiable errors (49).

1.38.

In the area of Revenue, Economic and financial affairs and Administrative and other expenditure, where the supervisory and control systems, taken as a whole, are properly and correctly applied (see paragraphs 4.40 to 4.41, 10.32 to 10.33 and 11.25), the Court estimates that the errors have a financial impact of less than 2 % of the total amounts (see Table 1.3 ). In addition, the Court’s assessment of the declarations by Directors-General and authorising officers by delegation confirmed that no, or only minor reservations had to be presented (see paragraphs 2.6, 2.7 and 2.9 and Table 2.1 ).

1.38.

The conclusions of the synthesis report 2007 state that the internal control systems in place, subject to the limitations described in the 2007 annual activity reports, provide reasonable assurance that the resources assigned to the Commission's activities have been used for their intended purpose and in accordance with the principles of sound financial management.

1.39.

In the area of Agriculture and Natural Resources, Cohesion, Research, Energy and Transport, External Aid, Development and Enlargement and Education and Citizenship, where supervisory and control systems are at best only partially effective, (see paragraphs 5.50 to 5.55, 6.32, 7.40 to 7.41, 8.31 to 8.32 and 9.25), the Court estimates that for these areas the errors have a financial impact of more than 2 % of the total expenditure (55) (see Table 1.3 ). In addition, the Court’s assessment of the declarations by Directors-General and authorising officers by delegation confirmed that major reservations were either presented or, in the Court’s view, should have been presented for the areas in question (see paragraphs 2.6 to 2.11 and Table 2.1 ).

1.39.

The Commission aims to ensure that supervisory and control systems are effective in detecting and correcting errors, with due regard to the costs and benefits of the checks which have to be made on the spot. Its action plan towards an integrated internal control framework has been largely implemented and improvements are gradually being seen. Its full impact is longer term.

1.40.

Compared to previous years the following changes have been noted: a reduction in the sample estimate of the level of error has been identified for the policy areas formerly covered under Internal policies (58) and External actions (59) (see Table 1.3 ). The value of agricultural expenditure covered by IACS has significantly increased through the inclusion of some higher risk spending areas, including olive oil. The Court concludes, however, that IACS continues to be effective in limiting the risk of irregular expenditure where properly implemented and if accurate and reliable data is introduced as regards SPS payments based upon allocated entitlements. The recent introduction in SPS of support schemes, such as those related to olive oil, is a positive development although in the short term might lead to a higher frequency of errors (see paragraph 5.52).

1.40.

The Commission would also point out that for the cohesion area, there was an increase in the proportion of projects in which no errors were found, and the Court’s overall assessment of the supervisory and control systems improved from ‘not effective’ to ‘partially effective’.

1.41.

The Court emphasises that its audits in the areas of ‘Agriculture and Natural Resources’, ‘Cohesion’, ‘Research, Energy and Transport’ as well as ‘Education and Citizenship’ show that complicated or unclear eligibility criteria or complex legal requirements have a considerable impact on the legality and/or regularity of underlying transactions (60).

1.41.

Simplification is a major element of the Commission's better regulation programme. The Member States are also required to simplify the eligibility criteria in their national programmes. However, a certain level of complexity is unavoidable and should be taken into account in future discussions on a tolerable level of risk.

1.42.

Paragraph 1.39 and Table 1.3 show that the majority of spending by value has only partially or wholly ineffective supervision and control, and underlying transactions continue to contain a material level of error. However, the 2007 and previous annual reports identify that:

(a)

Commission internal control arrangements continue to improve (i.e. annual activity reports — see paragraphs 2.8, 2.10 to 2.12 and 2.37) or remain at a high level (i.e., compliance with internal control standards — see paragraphs 2.25 and 2.39);

(b)

the Commission has made progress in implementing its action plan for an integrated internal control framework (see paragraphs 2.29 to 2.36 and 2.39);

(c)

the Commission’s management of the budget has improved over the last few years (see paragraphs 3.4, 3.6, 3.11, 3.15 and 3.30 to 3.32).

1.42.

The Court’s assessment concerns the effectiveness of the supervision and control in preventing errors. The Community internal control framework includes those controls necessary to detect and correct errors, as well as those designed to prevent errors from occurring. The Commission will assess the impact of this framework on the effectiveness of the systems as a whole.

1.43.

The EU budget involves payments made to millions of individual final beneficiaries. Payments are made based on the compliance of the final beneficiaries with legal or regulatory conditions (such as beneficiary or costs meeting sometimes complicated eligibility rules), as well as the accuracy and existence of the underlying activities and/or costs. Some of these funding conditions are determined by Community rules, including rules of general application such as the public procurement directives, while others are decided by the Member States. Final beneficiaries are either paid directly (such as in the case of direct management) or through the reimbursement of claims of eligible spending from Member State authorities (notably in the case of shared management).

1.44.

Payments are legal and regular when these conditions are met, and the right beneficiaries receive the right amounts at the right time. This requires adequate supervision and control. Ensuring that the budget is properly spent — expenditure is legal and regular as well as providing value for money — is the responsibility of the Commission. For around 80 % of spending — cohesion and agriculture — the task of implementation is shared with Member States, which in practice means they have specific obligations to select projects for funding, make payments and operate control systems, which manage the risks effectively and to report on the outcome.

1.45.

Factors affecting whether or not errors occur, or are not prevented or detected and corrected by control systems, are multiple. They include: the complexity of the eligibility rules and obligations with which beneficiaries must comply, and their familiarity with them; the way that claims are made and processed; the number and extent of checks made; the extent of sanctions imposed on over-claiming beneficiaries when errors are detected; and the visibility — and associated deterrent effect — of the control procedures. Therefore, well designed rules and regulations which are clear to interpret and simple to apply, decrease the risk of errors.

1.46.

Whatever management approach is involved, supervision and control arrangements correspond to a framework comprising three broad functional levels:

(a)

primary level controls, which check compliance of final beneficiaries with their regulatory obligations;

(b)

secondary level controls, which check the effectiveness of the primary controls; and

(c)

overall supervision by the Commission, to ensure that Member States and/or Commission Directorates-General meet their obligations and responsibilities in respect of their management of the budget (62).

1.47.

The nature of EU spending means that the main risk of error resides at the level of the final beneficiary, who deliberately, negligently or inadvertently makes claims for reimbursement of expenditure that is ineligible because it does not meet the regulatory conditions, or is not properly documented or incorrectly calculated. This is borne out by the Court’s previous audit findings, as well as those in this annual report (see paragraphs 5.12 to 5.16, 6.22 to 6.27, 7.14 to 7.22, 8.9, 9.8 to 9.11 and 10.16 to 10.19). Not only does the main risk reside at this level, but also errors can often only be detected reliably on the spot, making desk-based checks only partially effective. This — together with the fact that many millions of payments are made each year — means that primary level of controls are expensive to undertake, with overall cost being a direct function of the coverage.

1.47.

The Commission agrees that desk-based checks on claims can only be partially effective in preventing errors. Therefore the Commission's internal control framework increases assurance on the legality and regularity of the expenditure on a multiannual basis through a higher number of on-the-spot audits.

1.48.

On-the-spot checks made at this level often represent only a small proportion (usually 5 to 10 % per year, depending on the area) of individual claims. The Court finds weaknesses concerning the checks in agriculture (see paragraphs 5.27, 5.28, 5.30 to 5.32 and 5.34 to 5.36) and Cohesion policies (see paragraph 6.29), corresponding to weaknesses within Member State authorities. Cases of poor quality primary controls were also identified for direct management, including Commission level checks on reimbursements to research beneficiaries failing to operate satisfactorily (paragraphs 7.29 and 7.30) and poor quality audits carried out by independent auditors on individual claims (see paragraphs 7.32 to 7.33 and 10.29 to 10.30).

1.48.

Whilst it is true that on-the-spot checks are rarely conducted for all beneficiaries of the scheme, the regulatory administrative checks are always carried out in respect of all individual claims. This is because on-the-spot checks are too costly.

1.49.

The nature of primary level controls means that poor performance at this level cannot be compensated for directly by secondary level controls. The effectiveness of the latter is therefore determined by their ability to promote adequate control arrangements at the primary level, rather than the ability to detect and correct individual errors. The Court’s audit work on the 2007 financial year again found that secondary checks by Member States and supervisory checks by the Commission (63), are not achieving the desired level of effectiveness. For example, the Court found weaknesses in:

1.49.

The Commission's supervision is aimed at improving management and control systems so that they prevent or detect and correct errors, as the Court recommends, and also at ensuring that required corrective measures are taken. It is not itself aimed at individual error detection.

(a)

the Commission’s conformity clearance in agriculture (see paragraphs 5.47 and 5.48);

(a)

The Court’s findings referred to in paragraphs 5.47 and 5.48 are inherent in the conformity clearance mechanism in agriculture and, thus, cannot be considered as weaknesses of that mechanism. The Commission considers that the mechanism is functioning well and fully achieves the objective for which it has been designed, which is to exclude expenditure from Community financing which has not been effected in conformity with Community rules.

Moreover, where undue payments to beneficiaries can be identified as a result of the conformity clearance, Member States are required to follow them up by recovery actions against these beneficiaries. However, even where recoveries from beneficiaries are not needed because the financial correction only relates to deficiencies in the Member States’ management and control system and not to undue payments, these corrections are an important means to improve the Member States’ systems and thus to prevent or detect and recover irregular payments to beneficiaries.

See also replies to paragraphs 5.47 and 5.48.

(b)

audits in Cohesion spending (see paragraphs 6.30 and 6.31);

(b)

The Commission considers that in most cases the audits examined by the Court in the Cohesion Policy area led to effective corrective measures and operationally useful results. Furthermore, the Annual Activity Reports of the competent Directorates-General set out in detail the results of the audit activity, in particular remedial actions, suspensions and financial corrections.

See also replies to paragraphs 6.30 and 6.31.

(c)

ex-post financial audits in research, energy and transport (see paragraph 7.34); and

(c)

The Research Directorates-General have significantly increased their audit efforts in 2007 and have met their annual targets.

Attention is now turned towards the correction of the detected errors. The Research Directorates-General are actively striving to improve the monitoring tools and are issuing more precise administrative and financial guidelines. These are expected to improve the efficiency and completeness of the recovery process (including extrapolation and follow-up of the Court’s findings).

(d)

ex-ante declaration of assurance in respect of the quality of management and related monitoring visits (see paragraphs 9.16, 9.17 and 9.20).

(d)

The Directorate-General for Justice, Liberty and Security (DG JLS) has improved its guidance and has set up an action plan for finalising its monitoring visits. See replies to paragraphs 9.16, 9.17 and 9.20.

1.50.

Weak primary and secondary controls cannot be compensated by the Commission’s supervision. The purpose of this supervision is to ensure that adequate primary and secondary level control arrangements are in place, and are being operated effectively. Weaknesses at the lower levels should be identified (for example in the Directorate-Generals’ annual activity reports), and measures taken to remedy the situation (see paragraph 2.40). Supervision occurs at different levels within the Commission, both at Directorates-General involved in shared management expenditure, and at the highest level of the Commission in respect of individual Directorates-General.

1.50.

In agriculture, weaknesses in Member States’ management and control systems are detected through conformity clearance procedures and may lead to financial corrections being imposed on Member States. These corrections are an important means to improve the Member States’ systems and thus to prevent or detect and recover irregular payments to beneficiaries.

1.51.

This process is hampered by factors directly linked to the number of beneficiaries, the complexity of the rules, the difficulty in checking compliance and the dissuasive effect of financial corrections and sanctions.

1.51.

These are inherent risks of certain policy areas which have to be taken into account in determining the control strategy, in particular in the context of multiannual programmes.

1.52.

The Court’s Opinion No 2/2004 recommends that control systems governing Community expenditure should strike an appropriate balance between the cost of controls, and the benefits they bring in terms of reducing the risk of error in transactions to a reasonable level (residual risk). This requires recognition by all participants in the budget process:

1.52.

The Commission agrees with the recommendations in the Court’s Opinion No 2/2004, and is implementing them within its Action Plan towards an Integrated Internal Control Framework, as presented in its progress report (COM(2008) 110 final). It is continuing its work on the costs and benefits of controls under point 10 of this Action Plan and will re-launch the debate on tolerable risk towards the end of 2008.

(a)

not all final beneficiaries can be checked on the spot, and therefore some residual risk of error will always be present. The key issue is to set that risk at an appropriate (tolerable) level, taking into account the nature of the different types of spending, the complexity of existing rules and the dissuasive effect of sanctions available;

(b)

costs of control are an important issue, both for the EU budget and Member or beneficiary states; and

(b)

It is particularly the cost of on-the-spot checks which is high.

(c)

the balance between cost and residual risk for individual spending areas is of such importance that it should be approved by the political level (i.e. by the budget/discharge authorities) in the name of the citizens of the Union;

(d)

if a scheme cannot be satisfactorily implemented at an acceptable level of cost and with tolerable risk it should be reconsidered.

1.53.

Establishing an internal control framework based around these rational principles would allow control systems to be defined in terms of what they should achieve (64) (output targets), as well as agreed criteria against which to judge and audit their performance.

1.53.

The Commission will examine this idea. The current guidance in the Cohesion policy area already encourages a results-oriented approach to controls based on the recording of error rates and their variation over time, and a requirement to monitor and report error rates is mandatory in the legislation for the 2007-2013 period. In agriculture, the results of the checks required under IACS are closely monitored.

1.54.

The Court encourages the Commission to conclude its analysis on the cost of controls and on the different levels of risk inherent in the spending areas (65). A realistic, transparent, rational and cost-effective approach to risk management would, in the Court’s view, be to the benefit of contributors and beneficiaries alike.

2.1.

This chapter reports on the Commission’s progress in 2007 in improving the effectiveness of its supervisory and control systems in its Directorates-General in order to ensure the legality and regularity of transactions financed by the EU budget. In particular, it analyses the extent to which:

2.1.

(a)

the management representations contained in the annual activity reports and the declarations of the Directors-General and in the Commission’s Synthesis report are confirmed by the Court’s audit findings (paragraphs 2.2 to 2.14);

(b)

the Commission has succeeded in increasing assurance on legality and regularity by the use of indicators, relevant materiality criteria and annual summaries (paragraphs 2.15 to 2.23);

(c)

the Commission has made progress on the implementation of internal control standards and on the integrated internal control framework, and the extent to which it has been able to demonstrate their impact on 2007 expenditure (paragraphs 2.24 to 2.36).

(c)

The internal control systems in place, with the limitations described in the 2007 annual activity reports, provide reasonable assurance that the resources assigned to the Commission’s activities have been used for their intended purpose and in accordance with the principles of sound financial management. The control procedures put in place and the follow-up of the Court’s audit findings give the necessary guarantees concerning the legality and regularity of the underlying transactions.

The Commission is taking action to further improve its internal control system in the light of its own experience and to address issues raised by auditors. Actions taken in 2007 included the revision of the internal control standards for effective management, the continued implementation of the Action Plan towards an Integrated Internal Control Framework and revised guidelines for the annual activity reports.

The Commission is tackling issues, such as those highlighted in the reservations of the delegated authorising officers. It will explain more clearly the reasons where there are differences of opinion between the Court’s annual view, required by the EC Treaty, and the managers’ multiannual view, which takes into account the measures taken to detect and correct errors which occur during the year.

2.2.

By adopting the Synthesis Report the Commission assumes its political responsibility for the operational implementation of the budget through its Directors-General (1). The Commission considers that the ‘control procedures put in place give the necessary guarantees concerning the legality and regularity of the underlying transactions for which the Commission takes overall responsibility pursuant to Article 274 of the EC Treaty.’

2.3.

The Commission acknowledges nevertheless that further efforts are needed to resolve a number of weaknesses, in particular those highlighted in the reservations of the delegated authorising officers and those belonging to the budget areas that were not considered satisfactory by the Court of Auditors. In this respect the Court considers that the scope of some reservations should be greater than presented by the Commission’s Directors-General (paragraph 2.12 and Table 2.1 )

2.3.

The Commission welcomes the improved assessment of the Court in table 2.1 concerning the evidence given by the Directors-General in their 2007 annual activity reports for the Court’s DAS conclusions.

2.4.

For the Structural Funds, the Commission indicates that it provided aggregate figures for financial corrections made at national level through withdrawals and recoveries by Member States (8). However, the Commission should put more emphasis in its Synthesis Report on ‘gaps and inconsistencies’ in the data from the Member States. The measures intended to improve the quality of the information should therefore not be limited solely to the Commission, as stated in the Synthesis Report, but also extended to Member States (see also paragraphs 1.42, 2.31 to 2.33 and 3.26 to 3.28).

2.4.

The annex to the 2006 annual report on the Structural Funds, to which the Synthesis Report (COM(2008) 338 final) refers, and the 2007 annual accounts acknowledge that there are gaps and inconsistencies in the data received from Member States.

2.5.

For some of the Commission’s multiannual objectives its assessment is different to that made by the Court. The Commission rates, for example, its objectives of achieving an effective internal control system and of promoting accountability through Annual Activity Reports as completed. However the Court notes that although the internal control standards have been implemented, the effectiveness of a number of supervisory and control systems in preventing or detecting and correcting errors cannot yet be demonstrated (see also paragraph 2.26) and that the scope and scale of some of the reservations in the Annual Activity reports should be broader in order to fully reflect their potential impact (see paragraph 2.12).

2.5.

The Commission’s synthesis report (COM(2008) 338 final, annex 3) rated some of the initiatives to meet the objectives as being completed. This does not imply that the Commission considers that no further actions will be taken to improve the internal control systems or the annual activity reports in future. The Commission is committed to continuously improving its internal control system.

2.6.

In its examination of annual activity reports and the declarations of the Directors-General, the Court has assessed the extent to which they present a fair picture (i.e. with no significant distortions) of the effectiveness of the procedures in place. In particular, whether supervisory and control systems generate the necessary assurance in so far as the legality and regularity of the underlying operations are concerned.

2.7.

A review was carried out on all annual activity reports, complemented by an in-depth analysis on those of 15 Directorates-General.

2.8.

The guidance (9) for the 2007 annual activity reports emphasised the need expressed by the central services of the Commission to clarify the link between the effectiveness of internal control systems and the basis on which the declarations are built. In practice, most Directors-General explained in detail the ‘building blocks’ or key elements on which they have based their assurance.

2.9.

All the Directors-General stated that they had obtained reasonable assurance that the resources allocated to them had been used for the specified purposes and that the internal controls which they had introduced ensured the legality and regularity of the underlying transactions, in a number of cases subject to reservations. The Court assessed the basis for these statements by comparing their coverage and impact with the results of the Court’s own audit.

2.10.

Out of the 40 declarations for 2007, 13 (10) contain one or more reservations, the majority of which refer to weaknesses concerning the legality and regularity of the underlying transactions. The total number of reservations fell from 20 (2006) to 17 (2007), although their combined financial impact increased.

2.11.

For Directorates-General for Regional policy and for Employment, Social Affairs and Equal Opportunities the total estimated financial quantification of the impact of their reservations increased from approximately 140 million euro in 2006 to nearly 725 million euro in 2007 (11). For the Directorate-General for Agriculture and Rural Development the new reservation for 2007 on Rural Development expenditure is based on information from Member States which shows an error rate in excess of 3 %. However, this information had not been validated by the certification bodies or accepted by the Directorate-General. The most significant reservations in the context of the legality and regularity of underlying transactions are shown in Table 2.1 .

2.11.

The annual activity reports of the Directorates-General for Regional Policy, and for Employment, Social Affairs and Equal Opportunities set out both the amounts at risk, namely the payments relating to the systems affected by deficiencies, and the quantification of the financial impact. The latter is made by reference to scales of flat rate corrections for deficiencies in the management and control systems. The Commission considers that this approach gives a fair assessment of the potential financial impact of deficiencies detected.

2.12.

The table shows that the annual activity reports provide clear and unambiguous evidence for the Court’s DAS conclusions for administrative expenditure and for economic and financial affairs only. For most policy areas the annual activity reports are closer to the conclusions of the relevant DAS specific assessment than in previous years, particularly in the case of agriculture and cohesion policies. The Court notes, however, that the scope and scale of these reservations should be broader in order to fully reflect their potential impact and, for a number of policy areas the Directors-General still arrive at a more positive conclusion on the legality and regularity of EU spending than the Court’s own audit findings.

2.12.

While the Court expresses an annual audit opinion on the legality and regularity of the underlying transactions (as required by the EC Treaty), the opinion of the Directors-General focuses on whether funds have been used for their intended purpose, taking account of the mult-annual nature of controls, and their effectiveness in detecting and correcting errors. Directors-General express a management opinion based on information which includes the Commission’s own audit work, reports and observations of the Court of Auditors and, where relevant, the results of Member States’ controls.

2.13.

As regards the policy area Education and Citizenship, the assurance provided by the Directors-General is not compatible in some significant respects with the Court’s findings. The Court found significant weaknesses in the ex-ante declaration procedures under the responsibility of Directorate-General for Education and Culture (see paragraphs 9.17 and 9.25), however these weaknesses are not shown as a reservation of the Director–General. For the Directorate-General for Communication there is a reservation on the lack of structured ex-post controls, but the Court also finds that there are significant weaknesses in ex-ante controls (see paragraphs 9.23 and 9.25).

2.13.

The Directorate-General for Education and Culture (DG EAC) has based its assurance on a comprehensive set of controls and not only on the procedure of assessing the ex-ante declaration.

2.14.

In the policy area External Aid, Development and Enlargement the Court finds that underlying transactions are affected by a material level of error of legality and/or regularity mostly within transactions managed by implementing organisations (see paragraph 8.31) and that the supervisory and control systems are partially effective (see paragraph 8.32). These findings are not adequately reflected by the Directors-General in their reservations.

2.14.

The Court concludes on materiality against a sample of transactions which cuts across several Directorates-General. Yet each Director-General can conclude and report on materiality only for his own area.

2.15.

The Commission has placed particular emphasis on providing regularity indicators in the 2007 Annual Activity Reports (12). Most Directors-General have used the indicative internal control templates to show how relevant legal, regulatory and contractual provisions have been complied with and how these could be connected with reasonable assurance (13). For one Directorate-General, however, the basic data used is not reliable and/or the link with legality and regularity is not clearly established (14). Almost all Directors-General have not included comparable indicators for previous years nor set legality or regularity targets (15).

2.15.

The Commission developed several internal control templates aimed at presenting the control strategies in a harmonised way, but adapted to different management issues or modes. Legality and regularity indicators, aimed at facilitating the monitoring and reporting on legality and regularity of transactions, became mandatory for the 2007 annual activity reports. The Commission considers that this constitutes an important first step but recognises that some improvement will have to be made in terms of reliability and clarity of the indicators. They need to be fully and easily used for follow-up and monitoring purposes.

2.16.

Article 53b(3) of the revised financial regulation (16) provides that: ‘Member States shall produce an annual summary at the appropriate national level of the available audits and declaration’ (17). According to the instructions of the Commission’s Central services, the Directors-General should present a preliminary assessment of the assurance gained from the annual summaries in the 2007 annual activity reports (18).

2.17.

The Court has previously recognised that annual summaries are an additional element of internal control and has encouraged the Commission to add value to the process by identifying common problems, possible solutions and best practices and using this information in its supervisory role (19).

2.18.

The Court’s audit showed that as at 31 March 2008, 25 of the 27 Member States had submitted an annual summary. Of this 25, a total of eight Member States did not comply with the minimum requirements of the Financial Regulation and the Implementing Rules (20) and a further 12 Member States only partially. In addition, only 15 of these 25 Member States provided a statement on the completeness and accuracy of the information provided of which two related to the 2007-2013 programming period for which only advances had been paid with little attendant risk.

2.18.

The Commission welcomes the Court’s conclusion that the Commission adequately supervised the annual summary process by issuing clear guidelines and pursuing non-compliance promptly.

2.19.

The disparity of presentation and the frequent absence of a statement on the completeness and accuracy of the underlying data have meant that the annual summaries do not yet provide a reliable assessment of the functioning and effectiveness of the supervisory and control systems.

2.19.

Overall the outcome of the first round of annual summaries has been positive in that almost all Member States finally complied with the requirements and the Commission considers this provides a good basis for improving the quality of the summaries for the next round. The Commission will present a revised guidance note to Member States with recommendations aimed at obtaining a higher quality of their annual summaries for 2008.

2.20.

The Court considers that, for this first year of annual summaries, the Commission has adequately supervised the process both by issuing clear guidelines and by pursuing the reasons for non-compliance with deadlines and criteria for scope or quality.

2.21.

Most Directorates-General have established materiality criteria (21) in line with Commission guidelines and have adapted them to their particular management modes, their internal control environment and control systems in Member States (22).

2.22.

Following a recommendation of the Court in its Annual Report 2006 (23) the four main Directorates-General responsible for the implementation of the EU budget under shared management arrangements (24) have reviewed the method for assessing the functioning of the management and control systems for structural actions in Member States. The Directors-General now consider all programmes or systems for which an adverse audit opinion has been issued by an appropriate body as containing, ‘significant deficiencies’, unless there is reliable audit evidence, from a different source, to the contrary (25).

2.23.

One Directorate-General applied materiality thresholds which are not compatible with the other information and assurance given elsewhere in its Annual Activity Report (26).

2.23.

The central services of the Commission have committed themselves in the Synthesis Report to providing further guidance to the Directorates-General to address more clearly the link between the error rates, materiality and reservations.

2.24.

The Court examined the application of selected internal control standards (ICS) by a number of the Commission's services. The examination aimed to assess not only the degree of implementation of the minimum requirements (baselines), but also to evaluate the effectiveness of the systems ensuring the legality and regularity of underlying transactions. The latter is particularly important for 2007 as it enables conclusions to be drawn about the success of the Commission's efforts in this field before the general revision of the standards effective as from 2008.

2.24.

The Commission is aiming to show that the implementation of the standards is effectively contributing to management assurance. This principle underlies the 2007 revision of the internal control standards (effective from 2008).

2.25.

The Court’s assessment of the implementation of the internal control standards for the 2007 financial year shows that the Directorates-General comply on average with 96 % (2006, 95 %) of the baseline requirements (see Table 2.2 ). The Commission has thus implemented ICSs to a consistently high degree since 2004.

2.25.

The Commission adopted its internal control standards in the year 2000 as part of the reform launched that year. The standards and their associated minimum requirements were intended to enable the maturity of the Commission’s internal control systems to be measured. The success of this approach is demonstrated by the consistently high level of compliance reported both by the services and by the Court in recent years.

2.26.

Despite this achievement the Commission has been unable to comprehensively demonstrate for 2007 that supervisory and control systems are sufficiently effective in mitigating the risk of error in certain policy areas such as Agriculture and Natural Resources (paragraph 5.51), Cohesion (paragraph 6.32) (27), Research, Energy and Transport (paragraph 7.41), External Aid, Development and Enlargement (paragraph 8.32) and Education and Citizenship (paragraph 9.25).

2.26.

The Commission acknowledges that measures have to be taken in order to increase the effectiveness of the internal control and supervisory systems for certain policy areas. This is a continuing process and involves the further improvement of control systems including all control levels.

2.27.

In 2007 the Commission decided to replace the current ICS structure by basic principles and by more detailed related requirements corresponding essentially to the former ICS and baseline requirements (28). An analysis of the eight ICS relevant for the Court’s assessment in 2007 reveals no material changes in their new format.

2.27.

The aim of the revision of the standards was to clarify and simplify their implementation: the new standards cover the same areas but use a language more accessible to all staff. The new framework also removed overlaps between the previous standards and emphasises the effectiveness of the control systems.

2.28.

One of the components of the revised ICSs is the Internal Control Effectiveness Assessment whereby Commission services are required to judge and demonstrate the effectiveness of their internal control systems in practice. This will be based on a prioritisation of certain standards and an annual risk assessment by management. However, as the ICSs are interdependent and together form a control framework, the Commission must also be in a position to demonstrate each year the effectiveness of the internal control system as a whole.

2.28.

The requirement to report on effectiveness operates at two levels:

—

showing that the standards themselves (covering financial and non-financial issues) are effectively implemented within Commission services; and

—

showing that the systems in place within the Commission are effectively managing the risk of error in the underlying transactions, which is subject of this observation.

2.29.

December 2007 marked the end of the two year period set by the Commission for the implementation of its Action Plan towards an Integrated Internal Control Framework (29). The Commission’s summary report for 2007 (30) provides a confident assessment of progress made in the implementation of the actions at this date, whilst indicating that the evidence of the effectiveness of the actions in terms of reducing the level of error in the underlying transactions may still be some way off.

2.29.

The Action Plan aims to addressing specific gaps in the internal control framework. The 16 actions were intended to be implemented over a two year period to 31 December 2007. This objective was largely achieved (the remaining actions are planned to be completed by the end of 2008).

2.30.

On the basis of the Court’s analysis (see Table 2.3 ), the Commission has made progress in the implementation of its Action Plan in 2007. Overall, at the end of 2007 a total of 21 (2006-2007) sub-actions have been implemented and 14 (2006-2019) remain in various stages of progress.

2.30.

The Court’s analysis largely confirms the Commission’s own analysis in its progress report of 27 February 2008 (COM(2008) 110 final). The implementation of the actions is a continuing process and is being pursued vigorously. The impact of the actions is necessarily posterior to their implementation over the years 2006 and 2007. A first impact report will be made in early 2009.

2.31.

In March 2007 sub-action 11N was introduced aiming at assessing whether recovery and off-setting systems were working effectively, by identifying amounts recovered in both 2005 and 2006 and their coherence with errors identified during controls.

2.32.

Despite considerable efforts, the Commission was not able to present complete and reliable figures for 2005 and 2006. Moreover, the Commission was not able to demonstrate that the figures eventually presented related to the years in question, took into account all recoveries initiated by Member States and could be reconciled transparently to published financial statements.

2.32.

Chapter 6 of the notes to the annual accounts for 2007 gives the best estimate of recoveries (see also reply to paragraph 3.29). In the area of cohesion policy, the Commission publishes figures for financial corrections which result from its own control activity. Improvements have already been achieved as regards the reliability of this data. It is taking steps to improve the reporting by Member States of the corrections following their control activity to ensure its future completeness.

2.33.

The Commission’s initiative to record in the central financial and accounting system complete data on recoveries by the Commission as from 2008 is a positive development. The Court notes, however, that this opportunity has been lost for 2007.

2.33.

The cost of retroactively updating all credit note records and recovery order records for 2007 was considered prohibitive.

2.34.

The Commission has made a first assessment of the impact of the action plan as at February 2008 (34). Overall, it rates the actions as beginning to show an impact with smaller variations noticeable between individual sub-actions (see Table 2.3 ). To increase transparency the Commission should clarify the basis for its impact assessment.

2.34.

From 2009, the emphasis of reporting will shift from implementation towards impact measurement. The Commission will provide more information on the assessed impact of each action in its first impact report in early 2009 with reference to specific impact indicators for each action. The Commission can however already demonstrate real impact on some actions, for example:

—

(for action 3) the internal control templates and the enhanced peer review process, along with clearer guidelines to Directorates-General, has led to a measurable improvement in the annual activity reports, as shown in the Court’s Table 2.1;

—

(for action 8N) the case study has led to improvements in the reports provided to Supreme Audit Institutions which has in turn led to more SAIs making use of these in their work;

—

(for action 12) the audit strategy for Research Framework Programme 6 has been recognised by the Court as ‘likely to contribute to more effective operation of this [ex post] control’.

2.35.

Whilst the Court recognises that a large part of the Action Plan has been implemented it does not find evidence for an improvement which is directly and measurably linked to the actions especially those related to the legality and regularity of transactions. To the extent that the impact can be objectively measurable, the Court considers that this can only be assessed over a longer time frame.

2.35.

Any simplification of the rules, and all improvement to the Commission’s controls, will take time to have an effect on the prevention of errors. Furthermore, many measures concern ex-post controls, and the recovery of errors in years after they have occurred. The Commission agrees with the Court’s view that impact can only be assessed over a longer time frame as set out in the Commission’s February 2008 report on the Action Plan (COM(2008) 110 final); see also response to paragraph 2.29.

2.36.

The Court notes that the Commission intends to present a first annual report in early 2009 on the impact of the Action Plan.

2.37.

For 2007, the Court has identified further progress in the Commission’s supervisory and control systems, in particular, the improvement of the process of preparation of the annual activity reports and declarations (paragraph 2.8), the impact of the relevant reservations on the assurance given in the Directors-General declarations (paragraphs 2.10 to 2.11) and a move towards greater consistency with the conclusions of the DAS specific assessments (paragraph 2.12).

2.37.

The Commission welcomes the progress identified by the Court and is committed to continuing its efforts. For example, the internal process of ‘peer review’ examination before the finalisation of the annual activity reports helped ensure the consistency and robustness of the reports. This process will be further enhanced for the 2008 annual activity reports, as announced in the Synthesis Report.

2.38.

The Court’s audits however identified for some annual activity reports and declarations continuing weaknesses in the scope and scale of reservation and in the assessment and functioning of the supervisory and control systems (paragraphs 2.13 to 2.14).

2.38.

The Commission has instructed its services to take vigorous action to address the causes of reservations in the 2007 Annual Activity Reports and will closely monitor progress, with special attention to recurring reservations. During 2008, further guidance will be provided to services to promote consistency in the treatment of reputational risks and the link between error rates, materiality and reservations.

2.39.

The Commission has been able to demonstrate a consistently high degree of implementation of internal control standards since 2004 (see paragraph 2.25) and by the end of 2007, had implemented more than two thirds of the sub-actions in its action plan towards an integrated internal control framework (paragraph 2.30).

2.40.

However, the Court notes that the Commission is not able to demonstrate that its actions to improve supervisory and control systems have been effective in mitigating the risk of error in large areas of the budget. The Court does not yet find evidence to support the impact of the action plan claimed by the Commission.

2.40.

Over recent years, the improvements made in the legislative frameworks for Community funding programmes, the improvement of control conditions, the simplification of financial rules and the addition of the annual summaries in shared and centralised indirect management have been initiatives designed to improve the internal control framework and to mitigate the risk of error in underlying transactions.

2.41.

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

2.41.

(a)

ensuring that annual activity reports and declarations present a consistent assessment of supervisory and control systems which is compatible with the reservations (paragraphs 2.12 to 2.14);

(a)

While the Director-General remains solely responsible for the annual activity report and for any reservation(s) made, the ‘peer review’ of draft annual activity reports exercise was reinforced for the 2007 exercise. The annual activity reports and declarations do now largely present a consistent assessment of supervisory and control systems, taken as a whole, and not only their effectiveness in preventing errors. This is compatible with the reservations. Furthermore, the Commission is improving the annual activity reports process in certain areas, notably to ensure full consistency between services and it will continue its efforts in this respect.

See also replies to paragraphs 2.12 to 2.14.

(b)

collaborating with Member States to improve the information provided in Annual Summaries and demonstrate how this information has been used to gain assurance or add value to the assurance provided in Annual Activity Reports (paragraph 2.19);

(b)

The Commission will present a revised guidance note to Member States with recommendations to improve the quality of their annual summaries for 2008.

See also reply to paragraph 2.19.

(c)

completing an appropriate follow-up of the relevant measures of the action plan towards an integrated internal control framework in view to ensure a real impact on the supervisory and control systems (paragraph 2.35), in particular in relation to Sub-action 1 (simplification), Sub-actions 10a and 10b (cost-effectiveness) and Sub-action 11N (recovery systems) (paragraph 2.31).

(c)

A report on the impact of the Action Plan as at end-December 2008 will be presented in early 2009. The Commission will also follow-up on the results of actions 4, 10 and 11 in a Communication in November 2008 which aims to re-launch the discussion on tolerable risk.

For the cohesion policy, the Commission has made substantial efforts to improve the quality of data provided by Member States and is currently carrying out work to verify the completeness and accuracy of this data.

See also reply to paragraphs 2.31 and 2.35.

2.42.

The Court recommends that the legislative authorities and the Commission be prepared to reconsider the design of future expenditure programmes by giving due consideration to the following:

2.42.

(a)

simplifying the basis of calculation of eligible costs and making greater use of lump sum or flat rate payments instead of reimbursement of ‘real costs’,

(a)

The Commission agrees that extra simplification is needed with regard to cost eligibility issues.

The Commission has already committed under its Action Plan towards an Integrated Internal Control Framework to make proposals for simplified rules in future legislative rounds. It does not however act alone and would also need the Legislative Authority to ensure that simplification measures are included in future legislation.

The Commission has undertaken to ensure that future legislative proposals include clear and straightforward rules as concerns extended use of lump sum or flat rate payments.

The current rules for Cohesion Policy already allow flat-rates in some circumstances and the Commission will explore the scope for extending this practice, which is presently applicable to only a limited number of cost categories. For capital projects, they are inappropriate because of tendering rules and value-for-money considerations.

As regards research, the Commission agrees that further simplification is needed with regard to cost eligibility issues, particularly for personnel and indirect costs. It draws attention to the legal limitations of the 7th Framework Programme (FP7) and to the difficulties to define lump sums and flat-rates which are representative.

Furthermore, the ex ante certification of cost calculation methodology introduced in FP7 is a major step towards simplification. The Commission refers to the issues discussed in its reply to paragraphs 7.20-7.21.

(b)

re-defining control systems in terms of their output (the risk objective and the resulting acceptable level of error) rather than input as is currently the case (the number of checks to be undertaken),

(b)

The Commission accepts this recommendation, and will examine how to implement it in practice.

(c)

making progress in taking forward the concept of tolerable risk

(c)

The Commission will make a Communication on this issue in Autumn 2008 aimed at re-launching the inter-institutional discussion on tolerable risk.

3.1.

This chapter analyses issues arising from the implementation of the EU general budget in 2007, the first year of the multiannual financial framework 2007 to 2013. It covers in particular the rate of budgetary implementation and the level of outstanding budgetary commitments with a special focus on the application of the n + 2 rule. This chapter also discusses financial corrections and recoveries in respect of system weaknesses or incorrect payments in previous years, which have to be taken into account in the budget process.

3.2.

A central task in the Commission's budgetary management is to ensure that the funds that the Council and Parliament have allocated according to the EU's political priorities are spent in accordance with rules and following the principles of sound financial management. The analysis of the implementation of the budget is only one aspect of correct budget implementation. The budget should also adhere to the principles of economy, efficiency and effectiveness, which are more the subject matter of the Special Reports issued by the Court than of this Annual Report.

3.3.

The budgetary appropriations adopted for 2007 (voted budget and amending budgets) totalled 126,4 billion euro in commitments and 113,8 billion euro in payments, an increase of respectively 5 % and 6 % compared to the final budget 2006. Overall, the total budgetary commitment appropriations of the year were 2,5 billion euro below the financial framework ceiling, while payment appropriations remained below by 10 billion euro (see Diagrams III and IV in Annex I ).

3.4.

The seven amending budgets voted during the year resulted in an overall 0,167 billion euro decrease in appropriations for commitments and a 1,65 billion euro decrease in appropriations for payments. The latter is mostly a reaction to lower than expected spending in the areas of Competitiveness (0,5 billion euro), Cohesion Policies (0,7 billion euro) and Agriculture and Natural Resources (0,5 billion euro). Reducing appropriations for payments in this way reflects good budgetary management as it demonstrates the ability to react to changes and reduces the budgetary surplus (1) (allowing own resources to be returned to Member States).

3.5.

Diagrams III and IV in Annex I give detailed information on appropriations for commitments and payment appropriations for payments as well as their respective actuals in 2007 per heading in the financial framework as well as by ABB policy area.

3.6.

The Commission produces a series of documents (in part overlapping) containing inter alia the following information on the implementation of the budget of the European Communities (2):

3.6.

The documents to which the Court refers are produced for different purposes (see reply to paragraph 3.20).

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the budgetary surplus decreased from 1,9 billion euro in 2006 to 1,5 billion euro in 2007;

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utilisation rates for both commitments and payments, at 96 % and 98 % respectively, remain at a similar high level as in 2006 (99 % and 96 %);

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1,2 billion euro of unused payment appropriations (excluding assigned revenue) were not cancelled but carried over from 2007 to 2008 or reprogrammed, a similar level to last year;

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for the area of ‘Cohesion’ (included in the Titles 04, 05, 11 and 13 (3)) the 0,745 billion euro reduction in payment appropriations resulted in a final utilisation rate of almost 100 %, (it would have been 97 % had the amending budget not been adopted). Member States’ payment forecasts have improved in recent years. The overall over-estimation was reduced from 33 % in 2006 to 18 % in 2007.

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While Member States continue to improve the accuracy of the forecasts, they remain too inconsistent to be used for budgeting purposes. However, with further improvement, they could become a useful tool to help ensure continued high utilisation rates.