Factual memorandum to the Danish Public Accounts Committee on the European Court of Auditors' Annual Report and Statement of Assurance for the financial year 2005

I. Summary

1. The purpose of this memorandum is to inform the Danish Public Accounts Committee of the European Court of Auditors' (the Court) Annual Report. The Annual Report is an account of the financial audit performed by the Court and it includes the Court's Statement of Assurance for the financial year 2005.

2. The Court's Statement of Assurance is divided into 2 sections: One is dealing with the reliability of the accounts, the other with the legality and regularity of the underlying transactions. It will appear from the complete Statement of Assurance that the Court is of the opinion that the EU's annual accounts for 2005 are true and fair. However, the Court has qualified its Statement of Assurance, amongst other because of the inability of the accounting systems used by some of the European Commission's (the Commission) Directorates-General to secure the quality of financial data. And again this year, the Court qualifies its statement on the legality and regularity of underlying transactions in the areas of common agricultural policy, structural measures, internal policies and external actions.

3. Denmark is referred to in the Court's Annual Report in connection with two cases concerning the audit of the EAGGF programme (agricultural subsidies) and the audit of export refunds, respectively. On the background of the audit of EAGGF for 1994-2006, the Court points out that Danish farmers were not informed that the aid was co-financed by the EU and therefore subject to specific eligibility rules. In my opinion, this case is a consequence of the fact that the Court's audit took place long after payment of the refunds had taken place. In connection with the audit of export refunds, the Court concludes that Denmark has not complied with the fundamental requirement that exporters should not have tacit prior warning of checks at the point of loading. The Court also notes that Denmark has previously applied a special procedure to affix customs seals which was, however, not in conflict with current legislation. I agree with the Court's comments on the audit of export refunds.

4. The Court has examined the Commissions' internal control, including the Commission's management representations on Director-General level and the internal standards of control laid down by the Commission. The Court notes that the quality of representations made by the DGs has generally improved. However, the Court also notes that the Court in connection with its audit of the supervisory and control systems in Member States identified a number of significant weaknesses which should have resulted in qualified DG representations.

5. The Court points out that the Commission's budgetary management should take into account the expected profile of payments which may be absorbed by Member States and other Beneficiary States. The Court notes that the Commission has not taken this into account for the first three years of the current programming period for the structural funds (2000-2006). As a result there is a risk that significant levels of spending will continue far beyond the 2000 to 2006 financial perspective period.

II. Introduction

6. The President of the Court presented the Annual Report to the European Parliament's Committee on Budgetary Control (EP-Committee on Budgetary Control) on 23 October 2006. Subsequently, the Court published its Annual Report on 24 October 2006. The Court has also issued 10 special reports on the results of the performance audit conducted in 2005. Denmark is only mentioned in a few tables in three of the special reports, and therefore they shall not be referred to any further. For your guidance, appendix 1 presents an overview of the ten special reports for 2005.

7. The Court's submission of the Annual Report is the first step of the discharge of the EU's annual accounts, cf. figure 1.

Figure 1. EP-Committee on Budgetary Control Discharge Procedure for the Court's Annual Report for 2005
 

Then the EP-Committee on Budgetary Control conducts hearings with relevant EU commissioners. Next the EP-Committee on Budgetary Control discusses a draft for discharge. This step is followed by the Council's recommendation concerning discharge and finally the European Parliament adopts in plenum the decision to discharge the EU's 2005 annual accounts - this is expected to take place on 24 April 2007. During the discharge procedure, Member States are required to prepare responses to the Commission about the comments in the Annual Report on their management of EU funds. In Denmark, the Ministry of Finance assembles comments from the relevant ministries and then forwards an overall response to the Commission concerning the comments made on Denmark.

8. It should be noted that Rigsrevisionen has issued a statement on the audit of EU funds in Denmark which is included in the report on the audit of the Danish state accounts for 2005. I shall inform the Court and the Commission of the statement and I hope, that the Court can use the statement in its work. I intend also to discuss with my colleagues in the other EU SAIs how we may best contribute to the Court's audit of EU funds.

9. In the following, I will refer to the Court's comments in the Annual Report on:

• Denmark, pages 4-5
• Statement of Assurance 2005, pages 5-7
• The Commissions' internal control and budgetary management, pages 8-9
• Administration of the agricultural area - shared management with Member States, pages 9-10
• Administration of structural funds - shared management with Member States, pages 10-11.

III. The Court's comments on Denmark - 2 audits

10. In connection with the audit of the final annual accounts for 2005, the Court has visited Denmark five times in relation with four different audits. Rigsrevisionen participated in all five visits.

The Court's visits to Denmark gave rise to comments to the audit of the EAGGF programme and the audit of export refunds. Denmark is mentioned in the Court's Annual Report in connection with these two cases.

11. The first of the two cases has the Court's audit of EAGGF for 1994-2006 as point of departure. The Court found that a number of farmers had not been informed that the aid was co-financed by EU and therefore subject to specific eligibility rules. The Court's report of 30 March 2006 mentioned six apparent errors concerning the management and control system and 23 apparent errors concerning underlying transactions.

I forwarded my response to the Court in letter of 31 May and again in letter of 23 August 2006, stating that the Court in its final assessment of the apparent errors should take into account that the refunds in question pertained to the period 1994-1999 and were therefore more than five years back in time when the Court performed its audit. Staff, the systems and procedures may all have been adjusted since 1999 and till today which may have made it difficult for the Danish authorities to produce full documentation. I am therefore of the opinion that several of the apparent errors may be attributed to the belated audit, including the documentation that farmers' were informed that aid was co-financed by the EU. The Danish authorities have informed me that the necessary documentation may be produced, but that it will require a significant effort.

12. The other case concerns audit of export refunds. The Court has audited physical checks and/or substitution checks carried out in the 11 Member States from 2004-2006. On that background, the Court concludes that the fundamental requirement that exporters should not have tacit prior warning of checks at the point of loading had not been systematically complied with by Denmark. The Court also points out that substitution checks were not always carried out on consignments which had been customs-sealed without having been physically checked at the point of loading. Denmark is mentioned among the countries that allowed authorised exporters to affix customs seals. The Court also mentions that affixing customs seals on consignments which have not been physically checked is not in conflict with governing law. The Court also notes that Denmark abandoned this procedure from 1 February 2006.

I agree with the Court and the Danish Authorities that missing customs seals are not acceptable. Finally, I find it satisfactory that the Danish authorities have complied with the Court's criticism.

13. In conclusion, the Court has in its Annual Report mentioned 2 cases concerning Denmark. With regard to the EAGGF case, I do not agree with the Court that Denmark has erred. In the export refund case, I agree with the Court's comment that it is unacceptable if consignments lack customs seals.

IV. Statement of Assurance 2005

14. The Court's Annual Report is published every year when the financial year has been closed and it deals with the EU's income and expenditure. The Statement of Assurance, "la déclaration d'assurance" (DAS) is the main feature of the Annual Report and is based on the Court's assessment of all major EU revenue and expenditure areas. The Court's Statement of Assurance is divided into two parts:

• One dealing with the reliability of the accounts
• One dealing with the legality and regularity of the underlying transactions.

The Court has issued its Statement of Assurance for twelve years now and it has been qualified every year.

15. The Statement of Assurance on the reliability of the accounts represents the Court's assessment of whether the EU's final annual accounts are a true and fair presentation of the EU's financial position and assets by year-end. It will appear from the Courts Statement of Assurance that the EU's final annual accounts present fairly, in all material respects, the financial position of the Communities as of 31 December 2005, and the results of transactions and cash flows for 2005. However, the Court has a number of reservations about the accounts and among the reasons stated for the reservations is that:

• the existing financial reporting framework has not been consistently applied and in certain Directorates-General of the Commission, the accounting systems were not able to ensure the quality of financial information.

16. The other section of the Statement of Assurance dealing with the legality and regularity of the underlying transactions represents the Court's assessment of whether revenue, commitments and payments, including expenditure for the common agricultural policy, local authorities and development projects, have been calculated correctly and are in compliance with current regulations. I.e. whether the Court can issue a Statement of Assurance with or without reservations. The Court makes reservations when material errors have been identified, e.g. if recipients have overstated expenditure or for other reasons have not met the eligibility conditions of EU subsidies or reimbursements. It also appears from the Court's Statement of Assurance that underlying transactions taken as a whole are legal and regular in the areas where supervisory and control systems are implemented to ensure adequate risk management. This is the case for revenue, commitments, administrative expenditure and pre-accession strategy with the exception of the SAPARD programme. Still, the Court notes that payments are materially affected by errors in other areas, i.e. the common agricultural policy, structural measures, internal policies and external actions. The Court states its reasons for the reservations made as follows:

• The common agricultural policy expenditure which is not subject to the integrated administration and control system (IACS) or where IACS is not properly applied or has only recently been introduced poses a greater risk because control systems are not as effective.
• The Commission is not maintaining sufficiently effective supervision of Member States with regard to structural measures. Moreover, the Court has noted that two recent programming periods, 1994-1999 and 2000-2006, were both characterised by material irregularities.
• Despite progress made in some areas of internal policy management, internal supervisory and control systems still have weaknesses. Errors are caused by complicated cost reimbursement systems and unclear procedures and instructions governing programmes.
• The Commission's supervisory and control systems regarding external actions have not had any impact at the implementing organisation level which, in the opinion of the Court, can be attributed to the lack of a comprehensive strategy for supervision, control and audit of these organisations.

As last year, the Court has reservations in respect of the management of the majority of the EU expenditure.

17. The Court notes that the Commission since 2002 has worked on a reform of the financial accounting system and that the Commission for the first time in 2005 submitted accrual based accounts. The Court considers the new accounting system a key milestone for the Commission.

V. The Court's comments to the Commission's internal control and budgetary management

18. Internal control systems comprise all the procedures and processes applied in the administration and management of the EU budget and they are designed to ensure that EU funds are collected and spent correctly and in compliance with regulations. The Commission bears the overall responsibility for the management of EU's budget and is also responsible for the determination of control procedures which are to prevent, reveal or adjust errors. Member States need to check that project costs have been stated correctly and meet eligibility conditions. The Commission will supervise that Member States' systems for control of expenditure comply with EU legislation. Member States are required to check that project costs are correctly stated and meet eligibility conditions. The Commission supervises whether Member States' arrangements for verifying expenditure comply with the requirements of EU law. This is shared management.

The accountability chain flows from the final recipients of EU aid through the national government bodies and other subsidiary entities in Member States to the Commission via its Directorates-General. Thus, the Commission remains ultimately responsible for the regularity of structural operations expenditure. The majority of EU's budget is under shared management, including agricultural funds and structural operations funds. The Commission is the only entity responsible for internal control of the part of the budget which is managed directly by the Commission, i.e. internal policies and external actions.

19. The Court has examined the administrative measures taken by the Commission, including the Commission's management declarations on Director-General level and internal control standards. The Court notes that the quality of the declarations of Directors-General has generally been improved. However, the Court also notes that the Court in connection with the audit of the supervisory and control system identified many significant systems weaknesses which should have lead to reservations in the Director-General declarations. The Court also reviewed the application of internal control standards by the Commission. It turned out that Directorates-General comply with 95% of all control standards, but still the Court is of the opinion that the effectiveness of internal control standards may be further improved. The Court recommends that the Commission analyses the effect of application of control standards and then develop specific indicators regarding the effective functioning of controls.

20. The Court points out that effective budgetary management requires a realistic and appropriate budget, taking into account the expected profile of payments which can be absorbed by Member and beneficiary States. The Court notes that the Commission has not taken this into account for the first three years of the current programming period (2000-2006). This means that despite the fact that almost the entire budget for 2005 was spent, the low level of spending at the beginning of programmes in 2002 has resulted in a build up of outstanding budgetary commitments (i.e. commitments which the Commission is legally obliged to meet in the future.) In 2005, outstanding budgetary commitments increased to 119 million euro or 2.4 year's worth of spending. This is an all time high increase of 8% over 2004. As a result there is a risk that significant levels of spending will continue in Member States far beyond the 2000 to 2006 financial perspective period. The Court recommends the Commission to make an analysis of the effect which the completion of current programmes will have on the start of the forthcoming programmes for 2007-2013.

VI. The Court's comments on the management of the agricultural area - shared management with Member States

21. In 2005 agricultural expenditure totalled 48,466 million euro (in 2004 it was 43,579 million euro). Virtually all agricultural expenditure is carried out under shared management. This means that payments to final beneficiaries (farmers, private companies, traders, associations or public entities) are made by Paying Agencies approved by the Member States. Less than 1% of expenditure is managed directly by the Commission. The expenditure declared by Member States is subject to several control systems:

• control of the correctness of the farmers' claims made under IACS
• sector-specific controls, e.g. for olive oil and rural development
• physical checks on subsidised exports of agricultural goods
• scrutiny of commercial documents on the premises of traders and processors of agricultural goods
• clearance procedure related to the closing of accounts, covering all expenditure declared.

The Court notes, as in previous years, that expenditure for the common agricultural policy is still affected by a material level of errors which are not detected or prevented by the supervisory and control systems. The various main categories of agricultural expenditure are affected by different degrees of risk and weaknesses. The expenditure for the common agricultural policy that is managed and controlled by IACS amounts to 25,500 euro in EU-15 and 1,400 million euro in the new Member States. IACS is, if applied correctly, an effective control system for limiting the risk of error or irregular expenditure. The Court notes, that this is not the case in Greece and that the systems are still not reliable in the new Members States audited by the Court.

The Court has reservations about the agricultural expenditure which is not subject to IACS or where IACS is not properly applied or has only recently been introduced.

VII. The Court's comments on the management of structural funds - shared management with Member States

22. Expenditure for structural funds is carried out under shared management, just as the common agricultural policy. In 2005, total expenditure amounted to 32,763 million euro. The current funding period runs from 2000 to 2006 and included 545 structural fund programmes and 1,200 cohesion fund projects. The size of structural fund programmes varies from under 500,000 euro to over 8 billion euro. Project expenditure within these projects may vary significantly from a few hundred euro of aid to a single beneficiary up to several hundred million euro to a major infrastructure project. Projects under the cohesion fund range in size from 50,000 euro to just over 1 billion euro.

23. The Court audited 16 structural fund programmes and 9 completed cohesion fund projects. The Court found material errors in the structural fund expenditure for the accounting year 2005. The Court's audit indicates that the Commission does not maintain effective supervision of controls delegated to Member States and thereby fails to prevent reimbursement of ineligible expenditure. As a result, the supervisory and control systems do not provide the required assurance of the legality and regularity of expenditure. The Court recommends the Commission to spread its audit activity more evenly over each programming period to ensure that procedures for financial corrections are used as an incentive to Member States to improve their supervisory and control systems.

The Court also recommends that the Commission and the Member States make better preparations for the closure of 2000-2006 programmes than they did for 1994-1999 programmes. The lengthy closure process for the 1994-1999 period diverted resources from ensuring that the supervisory and control systems for the current period function effectively. In conclusion, the Court emphasises that structural operations will account for almost half of the total EU budget for 2007 to 2013.

The Court finds that the Commission does not maintain sufficiently effective supervision of the Member States regarding structural measures and has reservations about the expenditure in this area. The Court also emphasises that expenditure for the two recent programming periods, i.e. 1994-1999 and 2000-2006, was not free of significant irregularities.

VIII. Conclusion

24. I have in this memorandum informed the Danish Public Accounts Committee about the Court's Annual Report and Statement of Assurance. It is the opinion of the Court that EU's final annual accounts for 2005 are true and fair. The Court approves the annual accounts, but has a number of reservations. Reservations are related to the Court's assessment that some of the Commission's Directorates-General has not been able to secure the quality of financial data. Moreover, the Court has again this year reservations about the underlying transactions in the following sectors: agricultural policy, structural funds, internal policy and external actions.

25. Denmark is mentioned on two occasions in the Annual Report: In connection with the audit of the programme under EAGGF (common agricultural policy) and the audit of export refunds. On the background of the EAGGF audit for 1994-2006, the Court points out that a number of Danish farmers were not informed that the EU co-financed the aid which was therefore subject to specific eligibility rules. In my opinion, this case is a consequence of the fact that the Court's audit took place long after payment of the refunds had taken place. In connection with the audit of export refunds, the Court concludes that Denmark has not complied with the fundamental requirement that exporters should not have tacit prior warning of checks at the point of loading. The Court also notes that Denmark has previously applied a special procedure to affix customs seals which was, however, not in conflict with current legislation. I agree with the Court's comments on the audit of export refunds.

26. I shall inform the Danish Public Accounts Committee when the European Parliament has considered the final annual accounts for 2005 some time before the end of April 2007.

Henrik Otbo

Exhibit 1

Overview of the European Court of Auditors' special reports for the financial year 2005