Select Committee on European Scrutiny Tenth Report


3 European Agency for Reconstruction: 2003 Accounts

(26297)

15808/04

European Court of Auditors' Report on the annual accounts of the European Agency for Reconstruction for the financial year 2003

Legal base
Deposited in Parliament20 January 2005
DepartmentInternational Development
Basis of considerationEM of 23 February 2005
Previous Committee ReportNone
To be discussed in Council8 March 2005 Ecofin Council
Committee's assessmentPolitically important
Committee's decisionNot cleared; further information requested

Background

3.1 The European Agency for Reconstruction (EAR), which was set up in February 2000, was initially responsible for managing the EU's aid programmes in Kosovo. Following two extensions to its mandate in 2001 and 2002, its operations now also cover Serbia and Montenegro and the Former Yugoslav Republic of Macedonia. The Agency's head office is in Thessaloniki and it has operational centres in Belgrade, Podgorica, Pristina and Skopje. It implements programmes to foster institution-building and good governance, to promote the development of a market economy and essential infrastructure and to consolidate civil society.

The report of the Court of Auditors (ECA)

3.2 The report consists of the Court's Opinion and Observations, together with tables on the Agency's areas of responsibility, powers, governance, resources and activities; information on the implementation of the 2003 budget; and income and expenditure accounts and balance sheets for the financial years 2002 and 2003. It says that "The Court of Auditors has examined the Agency's annual accounts for the financial year ended 31 December 2003 and the underlying transactions. The Court performed its audit in accordance with its auditing policies and standards. These are based on international standards adapted to the Community context. The Court has thus obtained a reasonable assurance in support of the following opinions".

3.3 The key findings are:

Reliability of the accounts

"In the Court's opinion, the Agency's accounts do not present a true and fair view of the Agency's actual economic and financial situation…

"Article 1 of the Agency's Financial Regulation stipulates that its budget should be authorised according to the principle of differentiated appropriations, which distinguishes between commitment appropriations and payment appropriations. Article 3 of this same regulation lays down that total revenue should cover total payments, which implies that the budget should be shown to balance and that implementation should be as close as possible to equilibrium. In practice, however, the Agency's budget as adopted by the Governing Board does not observe the principle of differentiated appropriations, as a result of which the Agency presents as expenditure not only payments for the period charged to the appropriations for the financial year but also all the outstanding payments in respect of commitments for the financial year, irrespective of the extent to which these commitments have been implemented. The accounting out-turn for the financial year therefore bears no relation to the economic reality of the Agency's operations. The cumulative deficit as at 31 December 2003, i.e. 140.95 million euro, is thus largely artificial since it is due to outstanding commitments concerning economic transactions which have not yet been implemented.

"In 2003 the Agency's accounting system still exhibited serious weaknesses. For example, the general accounts were still being kept on a single-entry basis despite all the risks of error that involves for the integrity of the data and in spite of the fact that Article 55 of the Agency's Financial Regulation lays down that the accounts should be kept on a double-entry basis.

"Despite the observation made by the Court in its report concerning the financial year 2002, funds paid out to financial intermediaries under loan programmes have not been entered on the assets side of the balance sheet. The use made of these funds is merely the subject of an information note in the report annexed to the accounts. Since its creation, the Agency has paid out 52.4 million euro under these programmes. Moreover, various programmes which were still being implemented in 2003 provide for the management of funds by contractors to the Agency. The funds thus paid out, which have been identified by the Court, amounted to 43.38 million euro. In both cases, the balances still available at the end of the financial year 2003 should have appeared on the assets side of the Agency's balance sheet.

Legality and regularity of the underlying transactions

"Owing to the lack of the requisite information on the final use of funds entrusted by the Agency to external bodies (both national and international), the Court is unable to express an opinion on the legality and regularity of the underlying transactions for payments of 21.4 millions euros made in 2003 … For the remainder and except for the qualifications set out below, the Court is of the opinion that the transactions underlying the Agency's annual accounts were legal and regular.

"As far as payments are concerned, the Court noted errors relating to the validity of supporting documents, the observance of contractual provisions and delegations of public authority powers …

"With regard to procurement, the Court noted, for one out of five of the operations it has examined, procedural anomalies that call into question the respect of the principle of equality of opportunity between tenderers…"

3.4 The report then continues with its observations. These deal with presentation of the accounts (paras 8-11); with the management of one financial body that the Agency had set up in Kosovo (para 12); with procedural anomalies in respect of payments, the awarding of contracts, documentation needed to assess the legality and regularity of the underlying transactions in the case of agreements the Agency concluded with "public or semi-public, national or international, third parties" (paras 13-15); and with what the Court describes as "the excessive number of authorising officers by delegation and sub-delegation" (para 16).

3.5 The EAR's response is attached to the report, which the ECA adopted on 8 and 9 December 2004.

3.6 In his Explanatory Memorandum of 23 February 2005, the Parliamentary Under-Secretary of State at the Department for International Development (Mr Gareth Thomas) says that:

"the report points to some shortcomings in the EAR's financial practices. Following this criticism, the Enlargement Commissioner, Olli Rehn, appeared before the European Parliament's Budgetary Control Committee (COCOBU) on 10 January. The Agency's Director, Richard Zink, also appeared before COCOBU on 18 January. The following problems were highlighted:

  • Deficiencies in the presentation of accounts — Both the hearing and the report exposed some technical problems which needed to be addressed, but there have been no irregularities or fraud. The EAR has since taken steps to improve the presentation of its accounts in accordance with the requirements of the new accrual-based accountancy rules. It received approval of its new accounting systems in June 2004 by the Commission and its board members. The final accounts for 2003 have been established on the basis of a double entry general accounting system. The Commission is also working to ensure that all future accounting arrangements are compliant with the rules and regulations.
  • Implementation of the budget — The ECA report criticised the agency's budget as not "observing the principle of differentiated appropriations". The Agency has since taken steps to clarify the financial presentation of its operation.
  • Statement of Assurance — Of the over €300m (£207.4m) allocated by the EAR, only €21.4m (£14.8m) given to international organisations was found not to have the relevant documentation. This points to organisational weaknesses of these organisations rather than the EAR. The ECA has requested appropriate recording of these funds in the agencies' financial statements.
  • Contract Management — The ECA highlighted problems likely to affect decisions to award contracts. The EAR has taken action to address these issues, and this has been welcomed by the ECA. The ECA felt the EAR had consistently responded appropriately where irregularities had been identified and their systems now appear to be working satisfactorily."

3.7 He adds that "The Commission is due to submit a report on the future of the EAR to the European Parliament and Council before June 2005. Work is ongoing into potential mechanisms to ensure a more direct responsibility for the Commission over the agencies, which execute EU funds".

The Government's view

3.8 The Minister says:

"The report points to some problems in the financial management of the Agency. We will make clear that we expect to see clear improvements when the 2004 report issues given that:

  • The EAR has already taken corrective action to meet the ECA's criticisms.
  • The 2003 report is the first audit report on EAR to contain adverse remarks. The Commission's 2004 evaluation of the EAR was favourable, highlighting the strength of the agency as a vehicle for relatively rapid disbursement of assistance.
  • There has been no indication of any irregularity or fraud.
  • EAR administers spending in difficult situations, in areas that have weak institutions. The EAR has consistently responded appropriately in the past when irregularities had been identified.
  • DFID will use its position on the EAR board to monitor progress in addressing any concerns raised."

Conclusion

3.9 It is clear from the replies of the European Agency for Reconstruction (EAR) that it has responded promptly and appropriately to the observations of the Court of Auditors (ECA). It is also clear that the issues relate to the application of procedures in circumstances that were far from ideal, especially in post-conflict Kosovo, and to the way in which the accounts were presented at a time of change in accounting systems. But there are aspects of the Minister's Explanatory Memorandum upon which we should be grateful for clarification.

3.10 Most importantly, as the Minister points out, there has been no sign of fraud, but it is not clear why he says there has been "no indication of any irregularity". The Minister says that it was "only" €21.4m (£14.8m) given to international organisations that was found not to have the relevant documentation: nonetheless, this amounts to 7% of the expenditure in question. He also says that action taken to address the issues relating to contract management "has been welcomed by the ECA" and that "the ECA felt the EAR had consistently responded appropriately where irregularities had been identified and their systems now appear to be working satisfactorily", but it is not clear where or when the ECA gave this view. He goes on to say the Commission is due to submit a report on the future of the EAR to the European Parliament and Council before June 2005, but without explaining who commissioned the report or why, or what its terms of reference are. In setting out the Government's view, he says that the ECA has already taken corrective action to meet the ECA's criticisms, but that "we will make clear that we expect to see clear improvements". He also says that this is the first audit report "to contain adverse remarks", but that "the EAR has consistently responded appropriately in the past when irregularities had been identified" — despite what the Court has to say about the Agency's continuing failure to respond to the comments made by the Court in its 2002 report regarding some €95 million of funds paid out to financial intermediaries under loan programmes still not being entered on the assets side of the balance sheet. Finally, he says that "DFID will use its position on the EAR board to monitor progress", even though, it seems, DFID was not able to prevent a situation arising in which, despite the requirement in the EAR financial regulations that the Agency's budget observes the principle of differential appropriation, the board adopted a budget that did not do so (paragraph 8 of the report).

3.11 Pending the Minister's response we shall keep the report under scrutiny.


 
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