Select Committee on European Union Fiftieth Report


CHAPTER 3: The quality of internal control systems within the Commission

39.  Given our extensive scrutiny of European financial management and the number of concerns raised with us in the evidence, we have devoted considerable effort on this occasion to reviewing the systems operating within the Commission. We have also reviewed the progress which has been made in redesigning and upgrading these systems. At the heart of this are questions raised with us over the Commission's systems, mechanisms and procedures. Most important among these are questions over the Commission's:

  • Accounting system and supporting software;
  • Internal audit and control systems;
  • Signing off procedures;
  • New system of internal devolved management which was introduced by the Prodi-Kinnock reforms;
  • Risk management capabilities; and
  • Debt recovery procedures.

We consider each of these questions below. We suggest that these are issues which should be covered by the Court of Auditors in an annual report which is separate from the much broader remit of the post Maastricht Statement of Assurance.

The Commission's accounting system

A COMMITMENT TO IMPROVEMENT

40.  A secure and reliable accounting system is a pre-requisite for good financial management and the prevention and detection of fraud. The Court of Auditors has made many observations in each of its annual reports on the weaknesses in the Commission's accounting system and the problems with its software. In response the Commission has over the years introduced a number of improvements. These include:

According to Mr Gray, the Commission now not only aspires to but respects International Federation of Accountancy (IFAC) public sector accounting standards[28].

41.  In July 2006 the Commission published a report[29] describing the progress made in the transfer to full accruals accounting and other steps to modernise the accounting system. In the Government's accompanying Explanatory Memorandum the Minister, Ed Balls MP (Economic Secretary to HM Treasury), welcomes the efforts made by the Commission in successfully meeting the deadline to implement accruals based accounting. He notes that this has "made the EU one of the leaders in public accounting terms"[30] and that this should give the EU's citizens greater confidence that European funds are being managed properly.

42.  We recognise the commitment which the Commission has shown to improving its accounting system, particularly with regard to the introduction of accruals based accounting. We were pleased to hear from the Accounting Officer that the Commission now respects internationally recognised rules; and from the UK Minister that the EU is now one of the leaders in public accounting terms.

Segregation of duties

43.  The evidence we heard from Mr Gray addresses the distinction between those in the Commission who authorise payments and those who execute payments as introduced by the Prodi-Kinnock reforms. In the system as currently operating, the authorisation of a payment requires a four stage process of checks by authorising officers followed by formal authorisation. At that point a request is sent to the accounting officers who actually make the payment.

44.  This system was introduced in preference to a centralised ex ante authorisation procedure. This centralised system had been roundly criticised as "deresponsibilising" (Q 342) those tasked with approving expenditure. For Lord Kinnock, the primary aim of the reforms he introduced was to "introduce and sustain individual responsibility throughout the Commission"; and the existence of an ex-ante central financial control function "meant that responsibility could be allocated elsewhere and was allocated elsewhere" (Q 471).

45.  Lord Kinnock went on to rebut those calling for a return to the ex ante authorisation procedure arguing that "if even a modified system of centralised financial control was reintroduced it would demolish the whole construction of and emphasis on the bearing of individual responsibility" (Q 471). Indeed the current authorisation process as described to us is similar to that which operates in UK Government departments.

46.  We therefore support the Commission's system of payment authorisation and execution as introduced by the Prodi-Kinnock reforms. We consider that segregating the authorisation and execution of payments is appropriate.

Continuing criticism

47.  However, the criticism of the Commission continues. For example, Ms Andreasen's evidence makes a number of allegations regarding the practice of financial management within the Commission. She claims that:

48.  In his evidence Ashley Mote MEP additionally charges that:

  • Retrospective adjustments are made to the accounts;
  • There are unspecified provisions in the balance sheet;
  • EU employee pension liabilities are recorded on both sides of the balance sheet;
  • Loans and debts are written off;
  • "There is no paper trail recording transactions, agreements, payments, receipts or evidence of the goods or services paid for" (p 58); and
  • "There is a significant element of corruption within … the Commission's administration" (Q 251).

He goes on to assert that there is "still no consolidation of accounts or central control….The Commission's accounts are merely the sum of the numbers provided by the directorates" (p 58).

49.  During our inquiry we heard considerable evidence on the Commission's financial management. None of that evidence supports the allegation that there is a significant element of corruption within the Commission.

Double entry bookkeeping and the Commission's accounting software

50.  On the question of double entry book keeping and the software to support it, there is a genuine divergence of opinion among the professionals at the very top of the Commission's financial management hierarchy. According to Mr Gray, the current Accounting Officer, the Commission has always had a double entry system for the general accounts. He considers that the Commission has been using standard "rock solid" (p 86) SAP software since 1997-98 which does not allow anything else. He also notes that the previous systems also complied in this respect.

51.  This is not the view taken by either Mr Muis or Ms Andreasen, both former Accounting Officers. In her evidence, Ms Andreasen claims that in the Commission, the introduction of a transaction at Directorate General level "does not require a debit and a credit" (Q 371). Both Mr Muis and Ms Andreasen argue that the records entered by the Directorates General into the general accounts are inadequate for genuine double entry book keeping. Furthermore they contest that the software systems developed locally in the Directorates General were fragile[31]. According to Mr Muis these local systems were left intact by the accounting reforms.

52.  The Commission's July 2006 report addresses a number of issues which are relevant to this debate. These include updating the accounting software, the security of the software and the use of different software by the individual Directorates General and by the Commission at the central level. The report supports Mr Muis' assertion that the organisation and technology underpinning the local systems operating in the Directorates General were "untenable in the long run" (Q 419). It states that a feasibility study conducted in 2005 proposed updating the central budget management software so that it would be capable of incorporating local budgetary lines which are currently managed using different software. The July 2006 report notes that this new software is expected to be in operation by the end of 2006[32].

53.  In spite of the improvements which have been made to the accounting system there are areas which remain in need of attention. We are concerned that there remains a question over whether local accounting systems in the Directorates General are indeed compliant with the standards needed for double entry book keeping. All accounting systems operating in the Commission should fully support double entry accounting. We expect the Commission to investigate these allegations and to publish a full account of its findings.

Internal audit and control

54.  Building an internal audit and control system was a cornerstone of both the Prodi-Kinnock reforms and the Commission's earlier SEM 2000 programme. In the context of the change to the system authorising payments, these reforms saw internal audit as the essential ingredient ensuring that controls and systems in the Directorates General are working properly. To this end the reforms established an Internal Audit Service (IAS) which takes a view of the whole Commission, together with internal audit capabilities specific to each Directorate General. These two structures are complemented by an Audit Progress Committee tasked with reviewing and supervising the work of the Internal Audit Service.

55.  In his evidence Mr Gray described the distinction between the auditing functions in some detail:

As well as acknowledging good progress, the Internal Audit Service report for 2005 "identified major remaining weaknesses in the design and set up of control systems, and in the effective implementation of standards and controls"[34].

56.  Evidently then, there is still work to do. In this context, both the Court of Auditors' Opinion 2/2004 and the Commission's Roadmap identify improvements needed. The Court's Opinion noted that there were unclear and inconsistent control objectives within the Commission. These resulted from a number of factors:

  • The piecemeal growth of the system of controls;
  • A lack of coordination between control agencies in their activities;
  • A dearth of information on the costs and benefits of controls; and
  • An inconsistent application of controls both by the Commission and Member State agencies.

The Opinion proposed a new internal control system based on an effective chain of controls operating to common standards. Under the system:

  • Each level of control is given clearly defined objectives;
  • These controls are to be applied, documented and reported openly and transparently within a clear and simple legislative framework;
  • The Commission is to define the minimum requirements for each level;
  • The type and intensity of the checks carried out should be set by reference to their costs and benefits; and
  • The Commission is given responsibility for promoting improvements in partnership with the Member States[35].

57.  Following this critique from the Court, the Commission issued its Roadmap to an Integrated Internal Control Framework. This identified actions in ten areas for the Commission internally. We summarise these in Box 2 above.

58.  We will return to some of these issues. First, there is a lengthy charge sheet on the fundamentals of internal audit from Mr Muis in his written evidence. This is of great concern to us as we expressed our aspirations for the Commission's internal audit system when we reported in 2001. In that report we concluded by welcoming the establishment of the Internal Audit Service "which should make internal audit more effective" [36].

59.  In his evidence Mr Muis criticises the consistent lack of priority given to internal audit. His written contribution attacks what he considers to be:

  • The "lack of leadership" (p 118) exhibited by DG BUDG;
  • The tendency within the Commission to create new audit bodies rather to focus on the job of prevention errors; and
  • "A pretty dysfunctional Audit Progress Committee….. aimed at keeping internal auditors in check; never querying the accounts, or Accountant, or DG BUDG[37] on its work…and waiving responsibility for vetting Commission accounts" (p 118).

60.  While we share the Court's general analysis and welcome the Commission's Roadmap proposals for self-reform, the evidence from Mr Muis makes clear to us that the root of many of the problems in the internal audit and control system is the question of responsibility. When we questioned Mr Muis on this issue he answered "through the silence of others" (Q 421). In his analysis, the accountants had never signed off on the systems; the internal auditors and Directors General had not signed off for the adequacy of the systems as a whole; the Chief Internal Auditor had never signed off the accounts as a whole; and the Audit Progress Committee had "exempted itself from responsibility for the accounts" (Q 421). In his experience, none of the Commission's Chief Accountants "ever signed, or wanted to sign, or was even expected to sign off" (p 116).

61.  In contrast to the progress reported to us in relation to the Commission's internal accounting system we are concerned that the Commission's system of internal audit is inadequate. We urge the Commission to review fully the procedures in place and bring forward proposals to make the system more robust. These proposals should not seek to create new audit bodies. Rather they should focus on requiring Commission officials and existing audit bodies to take responsibility for the systems and the accounts.

Devolved management in the Commission

62.  The system of devolved management introduced by the Prodi-Kinnock reforms has been welcomed by many of our witnesses on the professional and managerial side[38], but it is not without its critics from within and outside the Commission. There are many aspects to this criticism but, for the moment, we will confine our discussion to financial management issues. As we have seen, the European Parliament's 2003 and 2004 discharge resolutions expressed support for improvements to the current system where 36 separate Annual Activity Reports form the basis of the Commission's control guarantee. Ms Andreasen added to this, arguing that if taken in tandem with changes in the Financial Regulation, the reform weakened the control of payments through the abolition of the centralised ex ante approval system[39].

63.  We are not convinced by these arguments for recentralising responsibility for financial transactions. Rather, we consider that the decentralised system introduced by the Prodi-Kinnock reform has allocated financial management responsibility to the appropriate level, so long as effective control systems are in place.

A SYSTEM REQUIRING COMMISSION OFFICIALS TO TAKE RESPONSIBILITY

64.  A further issue, as Ms Andreasen points out, is that the Directors General are operational managers rather than finance professionals, so there may be a conflict of interest in them signing off singly. For Mr Muis there is a simple solution. He advocates creating a reverse cascade of co-signing off of accounts:

Mr Muis also argued that this should be complemented at national level by a national Statement of Assurance with ex ante and ex post assurance elements, in which there would be a similar signing off process by the appropriate national officials.

65.  As we have seen, the Prodi-Kinnock reforms decentralised management responsibility to the Directorates General. This was achieved by requiring the Directors General to produce and sign Annual Activity Reports. Mr Muis referred to these as the "silver bullet" (Q 425) because of their role as assurance statements from the head of the Directorate General that the money has been used for the purposes intended.

66.  The Commission's Roadmap develops this concept by seeking to amend the Financial Regulation to require the Commission's Accounting Officer to sign a certificate of assurance for the accounts. Coupled to this is an enhanced the role for the Commission-wide annual synthesis of the Annual Activity Reports. These suggestions have gained support from the European Parliament in the 2003 and 2004 discharge resolutions. Further support has come from ECOFIN which called for an effective chain of controls operating to common standards[40].

67.  We are strongly in favour of a system of signing off whereby responsibility for accounts is shouldered first by the accountants and auditors in each Directorate General and then at more and more senior levels. This system should culminate in the requirement for the Secretary General of the Commission to sign an assurance that the Commission's annual accounts are true and fair. We will consider whether similar requirements in the Member States would be appropriate later.

Risk assessment

68.  In all the proposals we have reviewed, there are references to the use of risk analysis and risk management including cost-benefit analysis in the control context. This approach enables the targeting of control resources to where the risks to the budget are greatest. Thus, the Commission's Roadmap proposed the introduction of a common methodology for risk assessment and for ensuring control requirements are proportionate to risk. According to Ivan Lewis MP, this position is supported by the UK government which is prepared to accept higher levels of risk in some programme areas, for example humanitarian aid (Q 1).

69.  According to written evidence from Mr Muis, a common methodology for risk assessment would require a common accounting system "held together by one data architecture" (p 119), an outcome which he believes the 2004 accounting reform has not achieved. In the absence of this, risk assessment for programmes should still be fundamental and routine, using qualitative assessments until the quantitative tools are available.

70.  We fully support the proposal in the Roadmap to introduce a common methodology for risk assessment. However we recognise that that the accounting system is not tailored to provide the data to which such a common methodology could be applied. We consider that efforts should be made to develop the accounting system to produce the necessary data. We endorse the use of qualitative methods to assess the risk in the meantime.

Debt recovery

71.  A number of witnesses raised concerns with us over the Commission's attitude to debt and its debt recovery procedures. In her evidence, Ms Andreasen pointed out that when she first joined the Commission, she noticed a discrepancy of €130 million between the closing balance for 2000 and the opening balance for 2001[41]. On investigation, she claimed these proved to be loans which had been written off without any explanation. However, according to Mr Gray, "the loans were not written off". Rather a provision was made in the accounts to reflect doubts regarding their recoverability (p 98). Ashley Mote MEP expressed concern in his written evidence that Article 87 (4) of the 2002 Financial Regulation allows the writing off of debts below €1 million without any attempt at recovery. He claimed that this loophole was being "ruthlessly exploited" (p 57).

72.  The Commission's Accounting Officer, Mr Gray, set out the formal position. He told us that debts are recorded by the authorising departments and it is his responsibility as Accounting Officer to recover them[42]. In the system as currently operated by the Commission waivers are always recorded with those over €100,000 being reported to the European Parliament (15 were reported in 2005). Most of the waivers granted relate to overpaid or ineligible grant monies; very few concern commercial relationships. For debts above €1 million, the College of Commissioners must decide whether to grant the waiver. Below that figure decision rests with the Directors General, in consultation with the Accounting Officer. Indeed, Mr Gray questioned whether the involvement of the College of Commissioners for debts in excess of €1 million increased the level of scrutiny given to waiver process: "I wonder whether going to the College has any added value because the system is the same" (Q 350).

73.  We are generally satisfied with the Commission's procedures and reporting requirements on debt waivers. We see no evidence of the "ruthless exploitation" of these procedures that some have suggested.


28   Q 330. Back

29   Communication from the Commission: Progress Report as at 31 March 2006 on Modernising the European Commission's Accounting System. COM (2006) 358 Final. Back

30   EM 11399/06 para 18. Back

31   QQ 371, 419. Back

32   Op.cit. Back

33   The Internal Audit Service's functions are set out under Articles 85, 86 and 87 of the Financial Regulation. Back

34   European Commission, Annual Report to the Discharge Authority on Internal Audits Carried out in 2005, COM (2006) 279 Final, 7 June 2006. Back

35   European Court of Auditors, Opinion no. 2/2004 on the 'single audit' model (and a proposal for a Community internal control framework), Official Journal of the European Union C 107, 30 April 2004, pp 1-20. Back

36   European Union Committee, 12th Report (2000-01): The European Court of Auditors: The case for reform (HL 63), paragraph 104. Back

37   The Directorate General responsible for Budget, tasked with managing Community expenditure in the medium-term financial perspective and ensuring that the annual budgetary procedure runs smoothly. Back

38   For example Lord Kinnock, Jules Muis and Brian Gray. Back

39   p 103. Back

40   ECOFIN conclusions, 8 November 2005, 13678/05 (Presse 277). Back

41   Q 413. Back

42   p 87. Back


 
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