Its reputation plunging, EU races to accrual standards

by Jeremy Woolfe

Brussels — Upgrading the European Union’s budgetary accounting systems to full accrual standards may not sound exciting — but it involves a race to head off attacks on the continent’s political unification process following a series of financial scandals in the centrally run funding.

The subject of a major upgrade, the budget comprises $120 billion in annual spending administered from Brussels on behalf of the EU member states, which now number 25 after the introduction of 10 new countries in May. The European Parliament and the European Council, a body comprising ministers from the national governments, decide budget breakdowns. The two institutions work towards a common approach with help from the European Commission, the executive and administrative body.

Money passes from the 25 national governments into the European Commission, which then returns 80 percent to the EU member states. However, the background of the set-up is dismal. With the spending taking place in the countries under political influence, anything from downright dishonesty to local political machinations take their toll. Disgraces unchecked by top management are well on the way to undermining the political cohesion that is at the very heart of the move to a more integrated Europe.

For example, ever since 1994, the commission’s Court of Auditors has been unable to give a clean bill of health “approval” to the overall accounts. It complains that there are too many errors in the countries where the money is spent.

Central administration itself is not unscathed. Last year the lid came off a $6 million scandal, under which public money due to the EU’s official statistics office, Eurostat, was being stashed away in undisclosed bank accounts. Reports of mismanagement from at least one whistle-blower were studiously ignored.

Last year, Julius Muis, who made a reputation for clean doings when at the World Bank, decided to abandon his post as head of the commission’s internal audit department. He said that he was being hindered from looking into the Eurostat affair. He left office this spring.

Last summer, the individual commissioner responsible for Eurostat, Pedro Solbes, refused to resign. Solbes recently moved on to become the Spanish finance minister. Pressure from the European Parliament to get someone to take responsibility has failed. Parliamentarians declined what would have been a vote of no confidence, afraid of further negative attention to EU institutions. They are worried about a low poll turnout in the June elections.

The whole sorry saga around the European accounts was not helped when, in 2002, after a few months in office, newly appointed accounting officer Marta Andreasen declared that the accounting system was open to fraud. It was like a bank with the vault door left ajar, she said. The commission quickly took her off the job. Now it is proceeding with a disciplinary case against her, in which “breach of faith” appears to be an issue.

And this spring, a German journalist investigating financial scandals found himself faced with six Belgian policemen on his doorstep one morning. Hans-Martin Tillack was taken away for questioning, and his files, mobile telephones and computer records were removed. Presumably, the European authorities desperately sought to gag the writer. Their actions resulted in extra coverage, including a feature article in The Wall Street Journal, and extra media coverage all across Europe from Finland to Bulgaria, including numerous TV interviews.

Despite drastic hush-up attempts, the perceived foul play and weakness in Brussels is not going unnoticed by the citizenry. The plummeting reputation of the EU institutions could be behind a move, early this year, by six net-budget contributing countries to get the official budget ceiling cut back to from 1.24 percent to 1 percent of GDP.

Furthermore, British Prime Minister Tony Blair, facing a population heavily skeptical of anything “European,” has raised the specter of a referendum  that would quite likely result in blocking implementation of a recently written draft of a European constitution, which its creators had hoped would fuel further continental integration. As a U.K. referendum seems likely to end in a rejection of the draft constitution, it would help to bring further development in the EU more or less to a stop. For instance, it would cripple any chance at all of tax harmonization across the union.

Accrual to the rescue
In fact, the only real shaft of light to emerge is the radical new accounting system. Politics permitting, this will not only bring Brussels back into a semblance of decency, but might ultimately inspire sound standards throughout the EU’s public sector.

The European Union’s accounts are simpler than those of many public authorities, in that it owns no schools, hospitals, motorways or heritage assets. Its budget must be balanced. Unlike national governments, it cannot borrow to cover deficits. Any borrowing is linked to a specific lending activity, most of which is managed by the European Investment Bank or the European Investment Fund. Accountancy for funding has, since 1996, been on an Oracle-based system, “Sincom 2,” and cash-based.

The central budget is currently capped at up to 1.24  percent of the EU’s gross national income, which is roughly the same as that of the United States. This year’s proposed budget represents less than 1 percent of the total gross national incomes of the EU 25, being, in relative terms, the lowest  since 1990. This common pot comprises resources made up of import levies, the first 1 percent of value-added tax, or VAT, and contributions linked to gross national product. Income remains fairly stable over the years.

As for disbursements, around 40 percent of the common resources disappear into agricultural subsidies. The rest goes to such things as infrastructure improvements in poorer regions, efforts to harmonize employment law, improvements to the environment, trans-Europe coordinated R&D, encouragement for better standards of education, overseas aid, and so on.

Europe’s master accountant
Since his appointment as European accounting officer, in January 2003, Brian Gray, an English professional accountant, bears the heavy burden of getting the accrual system working in the commission. He faces a job of catching up for lost time. However, already some dry runs are taking place, and he expects to have the complete show running, on schedule, in January 2005. Starting from a launch in December 2002, that will make the transformation in just over two years, which is fast.

In the public sector, the European Commission is an early convert to accrual, but not the first. Switzerland, like New Zealand, has switched over. The German federal government, like the U.S., has a long tradition to overcome, though a start is being made in one region (Nordrhein-Westfalen). The British government is going along with a bottom-up approach, converting government sectors first, and planning to bring them all together under a central umbrella by 2007.

At the European Commission in Brussels, Gray has 30 officials and 20 consultants working full time to get standard SAP modules (budget execution, project management, financial accounting and treasury) to work with EU administrative systems. He says that a set of 16 accounting standards is being developed.

These standards cover all the European accounting issues (for instance, group accounting, payables, receivables, pre-financing, financial instruments or employee benefits). The commission decided to choose a “dual system,” which distinguishes between the general and the budgetary accounts.

The move to accrual accounting will be based on the International Public Sector Accounting Standards. It should enable sound financial management of the EU’s assets and liabilities, and provide a full picture of the financial position at any time during a financial year.

Gray says that accrual accounts provide a better basis for judging the financial management of a service than do cash accounts. If public borrowing is matched by the acquisition of assets, then the financial management is sounder than when borrowing serves only to finance additional administrative spending. Furthermore, accrual accounts show a truer picture of the financial management in any year. In cash-based accounts, deferring payments to the following year can hide a deficit.

At best, what could happen is that once the commission has its standard system operating, it would be in a position to apply pressure to recipients of EU funds to install compatible versions. Politics willing, this would eventually achieve a real step forward for public sector accountancy — covering over 45 percent of gross national income — right across Europe.