EU Accounting Rule 3: Expenses and Payables PDF

EUROPEAN COMMISSION Budget Budget execution Accounting EUROPEAN UNION ACCOUNTING RULE 3 EXPENSES AND PAYBLES  EUROPEAN COMMISSION Budget Budget execution Accounting...

EUROPEAN COMMISSION Budget Budget execution Accounting EUROPEAN UNION ACCOUNTING RULE 3 EXPENSES AND PAYBLES  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 2 of 29 INDEX 1. Objective....................................................................................................................................... 3 2. Scope............................................................................................................................................. 3 3. Definitions..................................................................................................................................... 4 4. Recognition and Measurement..................................................................................................... 8 4.1 Recognition.......................................................................................................................... 8 4.2 Initial measurement.............................................................................................................. 9 4.3 Cut-off.................................................................................................................................. 9 4.4 Non-exchange expenses..................................................................................................... 11 4.5 Detailed list of payable types............................................................................................. 14 5. Subsequent Measurement........................................................................................................... 26 5.1 Subsequent measurement................................................................................................... 26 5.2 Changes in estimates.......................................................................................................... 27 5.3 Criteria for cancellation of an asset.................................................................................... 28 5.4 Termination of contracts.................................................................................................... 28 5.5 Correction of eligible expenditure..................................................................................... 28 6. Impairment.................................................................................................................................. 28 7. Derecognition.............................................................................................................................. 28 8. Disclosures.................................................................................................................................. 29 9. Effective date.............................................................................................................................. 29 10. Reference to other rules.............................................................................................................. 29  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 3 of 29 1. Objective The objective of this EU accounting rule is to prescribe the accounting treatment for expenses and payables. 2. Scope The types of expenses or expenditure that the European Union may report include, but are not limited to, the following:  short-term employee benefits;  transfers (grants, structural funds, EAGF expenses, etc.);  cost of goods (e.g. furniture);  costs of services;  interest expenses;  staff expenditure;  travel expenses. Nearly all these items may be similar to expenses recognised by corporate enterprises, such as payroll expenses, the cost of goods (i.e. supplies), and the cost of services, as they are exchange expenses. Exchange expenses are expenses where the European Union receives goods or services in return. This category of expenses is similar to those identified in the private sector and should not raise specific accounting or reporting issues for the European Union. Besides exchange expenses, the European Union also have non-exchange expenses. These are transfers of money from the European Union to beneficiaries for which the European Union does not:  receive any goods or services directly in return, as would be the case with a purchase/sale transaction;  expect to be repaid in the future, as would be the case with a loan; or  expect a financial return, as would be the case with an investment. Transfers can be considered as non-exchange transactions, because the European Union gives value to another entity without receiving anything in exchange. Expenses such as these, which are unique to governments or organisations like the European Union, require distinctive accounting criteria. Those criteria can be summarised as follows:  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 4 of 29  Has the transfer been authorised? Transfers should fall under a policy area of the EU. Even if the other criteria have been met, the transfer cannot be recognised under the governing legislation unless the proper authorisation has been given.  Has the recipient met the eligibility criteria?  Can the amount be reasonably estimated? In many cases, this seems to be a serious impediment to recognising a transfer. Professional judgment is required in such cases. If all the criteria are met, the expenditure or costs are declared eligible and recognised as an expense in the economic outturn account. 3. Definitions Below are definitions of the key concepts used in the text: 1) Expenses are decreases in economic benefits or service potential during the reporting period in the form of outflows or consumption of assets or incurrence of liabilities that result in decreases in net assets/equity. Distributions of the result of the year or reserves to Member States are not considered as expenses. 2) Liabilities are present obligations of the European Union arising from past events, the settlement of which is expected to result in an outflow from the European Union of resources embodying economic benefits or service potential. 3) An exchange transaction is one in which the entity receives assets or services, or has liabilities extinguished, and directly gives approximately equal value to the other party in exchange. Exchange transactions can be divided into three categories: the receipt of services, the purchase of goods and the use by the European Union of others’ assets yielding interest, royalties and dividends. 4) Non-exchange transactions (or non-reciprocal transfers) are transfers in which the entity receives assets or services or has liabilities extinguished without directly giving approximately equal value in exchange to the other party or parties to the transfer (there is no transfer of ownership to the European Union). 5) The receipt of services and the performance of work involve the performance of an agreed task over an agreed period of time. The services may be received within a single period or over more than one period. 6) The purchase of goods includes goods purchased by the entity for its internal use, for the production of inventories (e.g. publications) and goods purchased for resale. 7) The use by the European Union of others’ assets yielding interest, royalties and dividends includes:  interest: charges for the use of cash or cash equivalents or amounts due to the entity;  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 5 of 29  royalties: charges for the use of long-term assets of the entity, for example, patents, trademarks, copyrights and computer software; and  dividends or equivalents that are distributions of surpluses to holders of equity investments in proportion to their holdings of a particular class of capital. 8) Transfers are amounts of money paid or to be paid by the European Union to beneficiaries for which the European Union do not:  receive any goods or services directly in return, as in the case of a purchase/sale transaction;  expect to be repaid in the future, as in the case of a loan; or  expect a financial return, as in the case of an investment. (a) Entitlements are transfers that the European Union must make if the beneficiary meets specified eligibility criteria. Under this category, the European Union is automatically obliged to provide benefits to beneficiaries who meet the requirements laid down by regulation (Financial Regulation, Staff Regulations and other specific regulations). Examples of entitlements are unemployment benefits, family allowances, etc. (b) Transfers under agreements (including grants under agreements). These transfers are similar to entitlements in that the beneficiary has the right to a transfer if he meets the eligibility requirements. They are different, however, because the beneficiary must spend money to be entitled to any reimbursement. But the major difference is that the terms of agreement are negotiated and agreed upon in a signed contract. (c) Discretionary grants, contributions and donations. The European Union can decide whether or not to make a transfer, what conditions must be fulfilled (if any), what amount is to be transferred and who the beneficiaries will be. In most cases, beneficiaries have to apply for the money or meet some eligibility criteria. However, applying or meeting eligibility criteria does not guarantee that the beneficiary will receive the money. The European Union still has discretion and power to decide whether or not to make the transfer. (d) Grants are a specific category of transfers. Grants are assistance by the European Union in the form of transfers of resources to a beneficiary in return for past or future compliance with certain conditions relating to the beneficiary’s operating activities, which are pursuant to a European Union policy. Grants are direct financial contributions charged to the budget which are given by way of a donation to finance either an action that forms part of an EU policy (action grant) or the functioning of a body pursuing an aim of general European interest under direct or indirect centralised management (operating grant).  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 6 of 29 There is no consideration in the sense that the European Union does not receive goods or services in exchange. 9) Short-term employee benefits are employee benefits, other than termination benefits and equity compensation benefits, which fall due entirely within twelve months after the end of the period in which the employees render the related service. They include items such as:  wages and salaries;  short-term compensated absences such as paid annual leave and paid sick leave, where the absences are expected to occur within twelve months after the end of the period in which the employees render the related employee service; and  non-monetary benefits such as medical care, housing, cars and free or subsidised goods or services for current employees. Accounting for short-term employee benefits is generally straightforward because no actuarial assumptions are required to measure the obligation or the cost and they do not entail any actuarial gain or loss. Unlike pensions, which are a long-term liability, short-term benefits granted to staff are entitlements that are due to staff in the short term. Besides wages and salaries, the European Union must also account, for example, for paid leave acquired by staff in connection with the services they have performed for the entities of the European Union. 10) Percentage-of-completion is a method that measures the work performed in connection with construction contracts, revenues, grants or service contracts. The percentage-of-completion of a transaction may be determined by a variety of methods. The European Union uses the method that measures reliably the services performed. Depending on the nature of the transaction, the methods may include:  short-term compensated absences such as paid annual leave and paid sick leave, where surveys of services or work performed;  services or work performed to date as a percentage of the total services to be performed; or  the costs incurred to date as a proportion of the estimated total costs of the transaction. Only costs that reflect services or work performed to date are included in the costs incurred to date. Only costs that reflect services or work performed and to be performed are included in the estimated total costs of the transaction. 11) Payables are usually amounts due to a creditor, including transactions arising from the purchase of goods and services. At the end of the reporting period an invoice for these items would generally have been received. Payables also include transfers to beneficiaries. Payables differ from accrued liabilities in that the invoices have been received by the reporting date. In  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 7 of 29 contrast, an accrued liability represents an estimate of a liability that is not supported by an invoice or a cost claim or an expense summary at the end of the reporting period. The accrued liability relates to an expense that has been incurred by the end of the reporting period. 12) Deferred expenses are expenses that are recorded during the reporting year in the financial statements even though they should not be accounted for because they relate to the following reporting period. At year-end, these expenses recorded in the economic outturn account are cancelled and appear on the assets side of the balance sheet. 13) A contingent liability is: (a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the European Union; or (b) a present obligation that arises from past events but is not recognised because: (i) it is not probable that an outflow of resources embodying economic benefits or service potential will be required to settle the obligation; or (ii) the amount of the obligation cannot be measured with sufficient reliability. 14) Loans are financial assets that are generated by the European Union by providing money, goods, or services directly to a beneficiary. Loans are not considered as transfers because they have to be repaid by the beneficiary. 15) Differentiated appropriations are appropriations where a distinction is made between commitment appropriations and payment appropriations; this makes it possible to comply with the budget principle of annuality, while allowing the management of operations extending over several financial years. (a) Commitment appropriations are intended to cover the total cost of legal commitments entered into in principle during the current financial year. (Exception: financing agreements and individual legal commitments implementing global commitments.) (b) Payment appropriations cover expenditure arising through the execution of commitments contracted during the current and/or previous financial years. So in the case of differentiated appropriations, the amount of commitment appropriations is often different from the amount of payment appropriations. 16) Non-differentiated appropriations consist of equal amounts of commitment appropriations and payment appropriations entered for the same financial year. The appropriations committed during the financial year also constitute the payment appropriations that can be used during that year and the next (automatic carryover). They cover budget expenditure of an administrative nature, EAGF expenditure, repayments to Member States and loan guarantees. 17) Materiality: Information is material if its omission or misstatement could influence the decisions or assessments made by the users of the financial statements.  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 8 of 29 18) Distinction between dates: Different dates are used in the accounting process relating to expenses: (a) Reception date is the date when an invoice for the purchase of goods or services or a request for repayment is received; (b) Recognition date is the date when the invoice or repayment request is declared eligible by the authorising officer and an expense is booked in the economic outturn account; (c) Delivery date is the date of delivery of the goods or services which constitutes the generating event for recognition of an expense in the general accounts; (d) Reporting or cut-off date is the last day of the accounting year, i.e. 31/12/N. 19) Eligible costs: The notion of "eligible costs" in the general accounts must be distinguished from the notion of eligible costs used in the context of standard grant agreements (as per Article 108(1) of Regulation No 2342/2002) laying down detailed rules for the implementation of the Financial Regulation). In the general accounts, eligible costs are the costs accepted by the European Union following analysis of cost claims. This rule does not refer to the total costs initially planned in the project. 4. Recognition and Measurement 4.1 Recognition Expenses are recognised in the economic outturn account when a decrease in future economic benefits or service potential related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably. This means, in effect, that recognition of expenses occurs simultaneously with the recognition of an increase in liabilities or a decrease in assets. Generally, expenses are recognised in the economic outturn account on the basis of a direct association between costs incurred and the earning of specific items of revenue. But the European Union main revenues include both taxes and contributions from Member States. Moreover, the payment of taxes or contributions does not entitle a taxpayer to an equivalent value of services or benefits, as there is no direct exchange relationship between paying the tax or the contribution and receiving European Union services or transfers. Consequently, matching revenues and expenses is not a concept that is readily applicable to the European Union, except when the European Union has trading activities or receives transfers dedicated to a specific purpose. Under the accrual basis of accounting, the European Union should apply a basis of accounting under which transactions and other events are recognised when they occur and not only when cash or its equivalent is received or paid or when the invoice is received. Generally, under accrual accounting, the generating event is the service performed (delivery acceptance) or the supplies delivered (delivery note).  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 9 of 29 During the year, payables must be recorded when invoices are received and not at their moment of payment. So in most cases an expense is recorded in the general accounts (economic outturn account) well before the payment. 4.2 Initial measurement Expenses and corresponding payables should be measured at their fair value, which in general corresponds to the amount of the original invoice. 4.3 Cut-off Transactions and events are recorded in the accounting records and recognised in the financial statements of the periods to which they relate. The generating event is delivery of the goods or services. Analysis of the generating event for each transaction makes it possible to book the expense to the correct year. The principle of separation between years is thus respected. At year-end, if no invoice has been received but the service has been performed or the supplies de- livered, the amount to be recognised is estimated reliably by the management. This estimate is based on different information including the initial budget dedicated to the project, the purchase or- der, and the stage of completion of the service. Similarly, if at the end of the year the invoice has been recorded in the economic outturn account but the service has not been performed or the supplies have not been delivered, a deferred expense should be recognised. Examples 1. Purchase of goods A (not fixed assets or stock) to be delivered: Generating event: delivery of the goods At 31/12/N the goods have been delivered but no invoice has yet been received. The ex- pense must be entered in the economic outturn account for year N, with the double entry in an “Invoice not received” account on the liabilities side of the balance sheet.  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 10 of 29  On 01/01/N+1 the previous entry is reversed (in the economic outturn account for N+1). After receipt of the invoice (for example on 11/01/N+1), an expense equal to the amount of the invoice is recorded in the economic outturn account for N+1, with the double entry in a vendor account on the liabilities side of the balance sheet. So in year N+1 an expense and a negative expense (via the reversing entry) will have been recorded and thus there will be no impact on the outturn for year N+1. 2. Purchase of goods B (not fixed assets or stock) to be delivered: Generating event: delivery of the goods On 24/12/N, the invoice is received by the European Union. An expense is recorded in the economic outturn account with the double entry in vendor account in the balance sheet.  On 31/12/N the goods have not yet been delivered and the expense has to be allocated to the right accounting year. So a prepaid expense, in other words a credit, has to be entered in the economic outturn account for year N (reduction of an expense) and a debit made to the assets on the balance sheet for year N in the “Prepaid expenses” account. In this way no expense is booked to year N.  On 3/01/N+1 the goods are delivered; the expense is booked to the economic outturn ac- count for year N+1, with the double entry in the “Prepaid expenses” account on the assets side of the balance sheet for year N+1. This kind of case is very rare in practice, since it assumes that the eligibility check accepted the invoice even though the goods had not been delivered. However, the example is given in order to illustrate the relationship between prepaid expenses and deferred expenses. 3. Entry in the accounts of rent for a previous year. The accounting officer must book the expense ensuring correct allocation between financial years. Generating event: provision of service Case 1: The rent invoice for December N is not received until January N+1. So the rent for December N must be entered as an expense for year N, with the double entry in the account “Invoices not received” on the liabilities side of the balance sheet. On 01/01/N+1 the previ- ous entry will be reversed in the financial statements for year N+1. Once the invoice is re- ceived, it will be entered as an expense in the economic outturn account for N +1, matching the entry in a liability account in the balance sheet for N+1. In year N+1 an expense and a negative expense (via the reversal) were recorded and so there is no impact on the outturn for year N+1.  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 11 of 29 Case 2: In October N the accounting officer receives an invoice for rent for the following three months. The invoice must be booked as expenses, matching the entry in the vendor ac- count on the liabilities side of the balance sheet. Rules for allocation between years: Case 1: Although the invoice is received in N+1, the European Commission benefited from a service provided in December: use of the premises. As the generating event is the provi- sion of the service, the Commission must recognise the December rent expense in year N via a closing entry. Case 2: The accounting officer books the invoice as soon as it is received. However, he has to apply the rule on allocation between years. By 31 December N the European Commission has obviously benefited from only two months’ rent in year N. So only the rent for November and December should be booked to year N. The rent for January N+1 will be entered as an asset in the balance sheet for year N, under prepaid expenses, matching a credit entry under rent expenses (economic outturn account for year N). On 1 January N+1 the assets will be credited with the double entry under expenses in the economic outturn account. 4.4 Non-exchange expenses This section outlines the accounting treatment of non-exchange expenses, which are specific to the European Union. Exchange expenses, on the other hand, have to be analysed in line with the principles governing the recognition and measurement of expenses set out above. For the European Union, non-exchange expenses are transfers to beneficiaries. We can define three major types of transfers:  Entitlements. They are defined as transfers that the European Union must make if the beneficiary meets specified eligibility criteria. Under this category, the European Union are automatically obliged to provide benefits to beneficiaries who meet the requirements laid down by the regulations (Financial Regulation, Staff Regulations and other specific regulations). For example, many EAGF measures are included in this definition from a beneficiary point of view. – Transfers under agreements (including grants under agreements). These transfers are similar to entitlements in that the beneficiary has the right to a transfer if he meets the el- igibility requirements. They are different, however, in that the beneficiary must spend money to be entitled to any reimbursement. But the main difference is that the terms of agreement are negotiated and agreed upon in a signed contract.  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 12 of 29 – Discretionary grants, contributions and donations. The European Union can decide whether or not to make a transfer, what conditions must be fulfilled, if any, what amount will be transferred and who the beneficiaries are to be. In most cases, beneficiaries have to apply for the money or meet some eligibility criteria. However, applying or meeting the eligibility criteria does not guarantee that the beneficiary will receive the money. The EU still have the discretion and power to decide whether or not to make the transfer. (a) Entitlements Initial recognition Transfers should be recognised in the European Union's financial statements as expenses in the pe- riod during which the events giving rise to the transfer occurred, as long as:  the nature of the transfer is allowed by regulation (Financial Regulation, Staff Regula- tions, or other specific regulation);  any eligibility criteria have been met by the beneficiary; and  a reasonable estimate of the amount can be made. Measurement During the year, transfers should be pre-recorded when the request for payment is received and not at the time of payment. Transfers are recorded at original payment request amounts. If the request for payment meets the recognition criteria, it is recognised as an expense for the eligi- ble amount. Cut-off The European Union may have current liabilities for amounts already due to eligible individuals or institutions but not yet recognised at the reporting date. Under the recognition criteria the amount of the expense to be recognised by the European Union is the estimated amount of the transfer obliga- tion due for the period. Where an amount cannot be recognised within the time frame necessary for the preparation of the financial statements, any amount that is known with reasonable certainty before the financial state- ments are completed should be recognised as an accrued expense if the outflow of resources is cer- tain. If a material amount cannot be determined with reasonable certainty, it should be disclosed in the notes to the financial statements. (b) Transfers under agreements Transfers under agreements are different from other entitlements in that an expense incurred or a task performed is a prerequisite in order to be eligible for reimbursement. The European Union, when making a transfer, may pay for all eligible expenditure or for only a portion thereof depending on the type of management.  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 13 of 29 Initial recognition Transfers should be recognised in the European Union’ financial statements as expenses in the peri- od when the events giving rise to the transfer occurred, provided that:  a contract has been signed authorising the transfer (by a government body);  any eligibility criteria have been met by the beneficiary; and  a reasonable estimate of the amount can be made. For example, through invoices sent by the beneficiary or where proof of a project's state of progress can be established. Measurement During the year, transfers under agreements must be pre-recorded when cost claims or expense summaries are received and not at the time of their payment. Transfers are carried at the original value shown on the related cost claim or expense summary. The counterpart is recorded in a sus- pense account in the balance sheet. A correction can be recorded if there is objective evidence that some amounts are not due from the European Union under the contractual eligibility criteria. The amount of the correction is the differ- ence between the carrying amount and the eligible amount. The eligible amount is the amount that should be recognised as an expense in the economic outturn account. The difference between the carrying amount and the eligible amount must always be notified to the beneficiary. However, if the beneficiary contests the correction, the corresponding risk has to be assessed. In addition, a supplementary expense may have to be recognised in the economic outturn account, de- pending upon the outcome of the risk assessment. Cut-off The European Union may have current liabilities for amounts already due to beneficiaries but not yet recognised at the reporting date. Under the recognition criteria the amount of the expense to be recognised by the European Union is the estimated transfer obligation due for the period, that is to say the portion of the incurred eligible expenses due to the beneficiaries. Where an amount cannot be recognised within the time frame necessary for the preparation of the financial statements, a reasonable estimate of any material amount should be made and it should be recognised as an accrued expense if the outflow of resources is certain. If a material amount cannot be determined with reasonable certainty, it should be disclosed in the notes to the financial state- ments. (c) Discretionary grants, contributions and donations Initial recognition Transfers should be recognised in the European Union’ financial statements as expenses for the pe- riod during which the events giving rise to the transfer occur, provided that:  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 14 of 29  the transfer has been authorised (by a government body);  any eligibility criteria have been met by the beneficiary; and  a reasonable estimate of the amount can be made. Measurement As long as the grant, contribution or donation is discretionary, the European Union has no obliga- tion to pay it. Therefore no expense is recognised in the financial statements at the time the applica- tion is made. During the year, discretionary grants, contributions or donations must be recorded when the payment is authorised by the authorising officer of the European Union. They are carried at the amount originally authorised. Cut-off Authorised discretionary grants, contributions or donations are recognised in the financial state- ments for the period during which the authorising officer accepts the claim. (d) Off-balance sheet Commitments for future payments should not be recognised as liabilities and, subsequently, as ex- penses. Nevertheless, any contingent liability should be disclosed in the notes to the financial state- ments. If the European Union decides to award a transfer on the basis of a contract, the existence of an off-balance sheet commitment for the amount specified in the contract must be recog- nised in the financial statements. On the other hand, the amount specified in the contract need not be recognised immediately as an expense, since the generating event for the expense will be the eligibility of the ex- penditure effected by the beneficiary. This criterion applies to entitlements and transfers under agreements. As the award of transfers of the type “discretionary grants, contributions and donations” is by nature dis- cretionary, they should not be considered as commitments. However, if the amounts are ma- terial, this information may be mentioned in the notes. 4.5 Detailed list of payable types The accounting treatment for each of the aforementioned categories of transactions is summarised in the table below. Pre-financing or guarantees related to these transactions may have occurred be- fore their booking as expenses. The related accounting treatment is disclosed respectively in Ac- counting Rules 5 “Pre-financing” and 10 “Provisions, contingent assets and liabilities”.  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 15 of 29 Event or trans- Generating Recording during Reporting date/ action event the year Cut-off Exchange transactions Procurement (goods) Goods delivered Original invoice amount Delivery note Percentage-of- Procurement (services) Services delivered Original invoice amount completion method Transactions Incurred charges under Evaluation of incurred Interest and royalties Cash paid contract charges Short-term employee Based on relevant vouch- Estimate of the follow- Service rendered benefits ers (pay slip…) ing service rendered Non-exchange transactions Estimate of eligible Expenses incurred in a Payment of the advance to EAGGF guarantee expenses incurred but Member State (MS) the MS not paid Entitlements Acceptance of an appli- Estimate of entitle- Other entitlements Request for payment ments due at the end of cation the period Estimate of portion of Incurred eligible ex- Eligible cost claim / ex- incurred eligible ex- Grants under agreement penses pense summary (1) penses due to benefi- Transfers un- ciaries der agree- Estimate of portion of Incurred eligible ex- Eligible expense summary incurred eligible ex- ments Structural funds penses (1) penses due to benefi- ciaries Reimbursable advances Eligibility criteria met Eligibility criteria met Eligibility criteria met Discretionary grants Acceptance Acceptance Acceptance Discretionary grants, con- Contributions Acceptance Acceptance Acceptance tributions, donations Donations Acceptance Acceptance Acceptance Outstanding commit- ments (Reste à liquider Not an expense Not an expense Not an expense - RAL) Other Payment appropriations Not an expense Not an expense Not an expense carried over  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 16 of 29 (1) During the year, the carrying amount of the cost claim / expense summary must be pre-recorded when it is received. The eligible amount is the amount that should be recognised as an expense in the economic outturn account. (a) Procurement (goods) Expenses arising from the purchase of goods should be recognised when the significant risks and rewards of ownership of the goods are transferred to the European Union, provided that the amount of the expense can be measured reliably. Consequently, the event is recognised when the supplies are delivered (delivery note) and accepted by the European Union. (b) Procurement (services) A transaction involving the provision of services should be recognised by reference to the stage of completion of the transaction at the balance sheet date. In actual fact, instalment payments and pre- financing paid to beneficiaries often do not reflect the periodicity or rate of performance of the con- tracted services. The stage of completion of a transaction can be determined by a variety of methods. The European Union use the method that most reliably measures the services performed. Depending on the nature of the transaction, the methods may include:  surveys of work or services performed, including budget information related to the pro- ject; or  contract costs incurred as a percentage of total contract costs, provided they reflect the work or services performed to date; or  completion of a physical proportion of the contract work/services. For practical purposes, when services are performed by an undefined number of acts over a speci- fied period of time, the expense is recognised on a straight-line basis over the specified period un- less there is evidence that some other method better represents the stage of completion. When one particular act is much more significant than any other, it is considered as principal to the others. The expense is not recognised until that significant act is completed. (c) Interest / Royalties Expenses should be recognised using the following accounting treatments: a) Interest is recognised as due in accordance with the substance of the relevant agreement. At the reporting date, unpaid interest is accrued and recognised on a time-proportion basis tak-  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 17 of 29 ing into account the effective yield on the asset (see Accounting Rule 12 "Financial assets, financial liabilities"). b) Royalties are recognised as they are due in accordance with the substance of the relevant agreement. At the reporting date, royalties related to the period and not yet recorded are ac- crued. The corresponding accrued expense should be based on a reliable estimate. The effective yield on an asset is the rate of interest required to discount the stream of future cash receipts expected over the life of the asset to equate them to the initial carrying amount of the asset. (d) Short-term employee benefits Definition When an employee has provided service to the European Union during a reporting period, the Eu- ropean Union should recognise the amount of short-term employee benefits expected to be paid in exchange for that service as a liability (accrued expense), after deducting any amount already paid. The counterpart is an expense recognised in the economic outturn account. If the amount already paid (and recorded) exceeds the non-discounted amount of the benefits, the European Union should recognise that excess as an asset (prepaid expense) to the extent that the prepayment will lead, for example, to a reduction in future payments or a cash refund. The counter- part is a decrease in expenses in the economic outturn account. This category of employee benefits is expected to occur within twelve months after the end of the period in which the employee performs the related service. The generating event is performance of the service. So an employee who has to move house by reason of his duties, for example, is entitled to reimbursement of his moving expenses. The employee moves house in December of year N but is not reimbursed until 5 January N+1, for the sum of €3 000. The European Union must book an expense of €3 000 to year N, in accordance with the principle of allocating expenditure to the correct accounting year. In this case, the allocation is made by reference to the concept of the service performed. The European Union should recognise the expected cost of short-term employee benefits, including compensated absences, non-monetary benefits or other benefits. The cost of compensating employees when they will be absent should be recognised. Reasons for future absence include, for example, vacation, maternity or paternity leave, jury duty and military  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 18 of 29 service. The European Union should measure the expected cost of accumulated compensated ab- sences as the additional amount that the European Union expect to pay as a result of the unused en- titlement that has accumulated at the balance sheet date. Those amounts should be recognised as expenses in the period to which they relate. Example: The staff of the European Union is entitled to paid leave. This entitlement arises as they provide service to the European Union. Thus the expense, if significant, must be recognised in the year in which it arose; it is linked to the service provided. The provision for paid leave recorded at the end of the year in the balance sheet should equal:  opening entitlements established;  plus new entitlements acquired for that year;  minus entitlements used up during the year. The resulting difference is an expense recorded in the economic outturn account. Lastly, evaluation of the provision is made for each staff member on the basis of his/her remunera- tion for the year. This accrued expense will be entered in the accounts if it is material. Unlike accumulated compensated absences, non-accumulating absences are not carried forward. However, they lapse if the entitlement for the current period is not used in full. They do not entitle employees to a cash payment for unused entitlements when leaving the European Union. These ac- cruals are therefore recognised only when they occur, since the amount of the benefit does not in- crease with the length of employee's service. The following list shows the main short-term employee benefits granted by the European Union. A full description of all the benefits listed below can be found in the Staff Regulations.  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 19 of 29 Wages, salaries, social security contributions, non-monetary ben- Accounting treatment efits Wages These benefits are calculated and allocated each month. So the ex- National social security contribution pense is recorded at the end of the month and covers the benefits for auxiliary and temporary staff earned by all staff in service for the past working month. In some Allowances for handicapped children cases the salary paid also covers services performed by staff in past Household allowance years or months. The expense is recorded in the current year even if it is in respect of services performed in previous years as the amount Dependent child allowance is not material. On the other hand, this information will be given in the Education allowance notes. Expatriation allowance With regard to retroactive salary payments, the impact will be differ- Secretarial/accounting allowance ent according to whether retroactive application concerns the current year or previous years — see (a) below. Overtime flat rate Expenses relating to non-monetary benefits must be booked when Non-monetary benefits the service is performed (see IV.1.1). Short-term compensated absence Normal leave (accumulated) At the end of the year, if staff has not used up all of their leave enti- Paid leave tlement, an additional expense must be recorded to reflect paid leave not taken but owed by the European Union for the year. The maxi- mum number of days’ leave that can be carried over to the following year is 12. Special leave (non-accumulated) “Sick pay” (right to 12 days per year with periods of 3 days maximum) The expense is recorded when staff are absent. In practice, the ex- “Maternity/paternity” leave pense is recorded each month together with the salary booking. The Travel allowance (2 days/year + amount of salary paid remains unchanged even though the absentee travel allowance) has not worked and has not produced a “gain” for the European Un- Training, election, adoption, nursing ion via his work. mothers, trade unions, jury service Other special leave Other A provision must be entered when the generating event occurs, i.e. when the staff member submits his application for unemployment benefit. The benefit has to be analysed from the point of view of ma- Unemployment benefit teriality. If the benefit is not material with regard to the Union‘ finan- cial statements, then the provision need not necessarily be recog- nised. Advances do not constitute expenses. They give rise to balance sheet entries. Mission expenses must be booked as an expense when the services (hotel, transport) are provided. Advances on mission expenses In practice, the expense is booked when the statement of mission expenses is received. At the reporting date, an estimate will have to be made of the amount of expenses for which no statement has yet been received and the amount entered as accrued expenses.  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 20 of 29 Advances do not constitute expenses. They give rise to balance Advances on salary sheet entries. This type of leave has no impact on expenses as it is self-financed Leave on personal grounds by the employees themselves. (a) If, at the reporting date, the impact relates to the current year, the extra expense of salaries due will be booked to the correct year. On the other hand, if the impact relates to previous years, the ex- pense will still have to be booked to the current year, but this information will have to be disclosed in the notes if the amounts are material. (e) Grants under agreements Grants under agreements are direct contractual financial contributions, by way of donations, from the budget, in order to finance:  either an action intended to help achieve an objective pursuant to a European Union pol- icy (action grants); or  the functioning of a body which pursues an aim of general European interest or has an objective pursuant to a European Union policy (operating grants). The same accounting process, as set out below, applies to both operating and action grants. Reception of the cost claim: eligibility check When the cost claim or expense summary is received, it must be pre-recorded in a balance-sheet account to ensure the carrying amount is recorded. The amount is not recognised as an expense be- cause the European Union are committed to paying only in respect of eligible expenditure. The amount is carried as a debit in a suspense account. Cost claim approved: expense recognised The European Union check eligibility by reference to the contractual agreement. Once the eligible expenses have been determined and approved, they are recognised as such in the economic outturn account. The suspense account is then credited for the eligible amount. The difference between the carrying amount and the eligible amount of the cost claim or expense summary should always be notified to the beneficiary. The European Union then sends a technical credit note to the beneficiary. This note is recorded against the liability and the suspense account. Thus only the eligible amount is recognised as an expense in the economic outturn account. The technical credit note or the correction made to the cost claim or expense summary may be contested by the beneficiary. In this case, the European Union' management should consider whether a provi- sion for risk needs to be made.  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 21 of 29 The standard contract specifies that the amount of the grant paid is conditional on the Eu- ropean Union receiving a report on the costs, generally known as a “cost claim” or “ex- pense summary”. The European Union perform checks on these reports, verifying in particular whether the costs are eligible. Practical experience has shown that some costs may be excluded, reduc- ing the amount payable by the European Union accordingly. The accounts must reflect these changes while ensuring that the European Union’ liability to the beneficiary remains traceable and is conserved. The approach followed makes it pos- sible:  to keep a trace of the amount of the cost claim or expense summary received by the Euro- pean Union. This allows management to monitor the difference between cost claims re- ceived and eligible costs;  to determine the actual expense which the European Union consider they owe under con- tract; and  to establish the debt outstanding. However, these changes must be notified to the beneficiary in advance. Notifying the third party makes it possible to ensure that potential litigation is properly taken into account. Reporting date: accrued expense Action grants should be recognised when the beneficiary incurs eligible expenditure. At the report- ing date, the European Union should recognise the liability and the corresponding expense for the estimated portion of incurred eligible expenses due to beneficiaries. This estimate is determined as follows:  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 22 of 29 Cost claim or expense summary received after the reporting date and during the closing period? Eligible expenses are YES NO Work-in-progress information known? available? (1) YES NO YES NO Separation be- Separation be- Record an accrued The European Union fore/after the fore/after the expense based on the have to update their reporting date reporting date progress information procedures in order to available? available? available. obtain reliable infor- mation for material The information must items. be reliable. YES NO YES NO Recognise Apply a pro Recognise an Apply a pro (1) Work-in-progress information an expense rata tempo- expense for rata tempo- for each ris method each relevant ris method Can be based on beneficiary reporting, budget infor- relevant on eligible period based on estimat- mation, past experience, etc. This information should period expenses. on an estimate ed eligible be a reliable “best estimate”. The materiality concept based on of eligible expenses. also applies in the research for information. eligible expenses. expenses.  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 23 of 29 (f) EAGGF EAGGF transactions are covered by very specific rules. The Financial Regulation stipulates that the European Union must “reimburse the expenditure incurred by the Member States” (Article 150). Thus Article 150 and, more generally, the specific EAGGF Regulation stipulate that the European Union has a commitment towards Member States and not directly towards all the beneficiaries of the European Union' EAGGF funds. The Member State has the obligation to manage and allocate the funds itself. It then sends in a statement of expenses, which can be audited and contested by the European Union. In this way, the European Union do not have to collect the information from all the individual beneficiaries. Only the commitment to reimburse all the relevant eligible expenses incurred by Member States should be translated in the financial statements. When the European Commission pays the “advance”, this amount should be recognised as an expense in the economic outturn account. At the reporting date, expenses incurred by Member States should be recognised using the following method: Statement of Member States’ eligible expenses received at the reporting date? YES NO Eligible expenses should be estimated by the European Regarding the EAGGF process, November and December Union. This estimate is based on reliable information and eligible expenses are accepted in January and February. should be a best estimate. Those amounts are known before the financial statements are issued. Consequently, it is necessary to record an ac- This estimate is recognised as an expense for the period. crued expense. The counterpart is an "accrued charge" account in the lia- bility on the balance sheet. (g) Structural Funds The treatment of these transactions is much the same as for action grants and therefore a similar process is required. The main difference concerns the generating event: the generating event for the “off-balance sheet” record is not the commitment but the formal decision to participate in the ac- tion.  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 24 of 29 The contingent liability for the Structural Funds should always be recognised for the total amount at the moment of the decision to participate. This liability should be disclosed in the notes to the fi- nancial statements. Additionally, regarding the shared management process, the European Union do not have to recognise their obligation towards all the individual beneficiaries but only towards the contractors, such as Member States, paying authorities, etc. When the expense summary is received, it must be pre-recorded in a balance sheet account to en- sure its traceability. The liability is recognised against a suspense account on the assets side of the balance sheet. By referencing the contractual agreement, the European Union should recognise only eligible ex- penses as expenses in the economic outturn account. When the expenses are declared eligible by the European Union, they are booked against suspense accounts. The difference between the carrying amount and the eligible amount of the expense summary should always be notified to the beneficiary. If the European Union make a correction to the cost claim or expense summary and the beneficiary contests it, the management of the European Union should consider making a provision. At year-end, a best estimate should be recorded for eligible expenses related to the reporting period but not yet declared. (h) Loans on special conditions In certain circumstances, the European Union can provide loans for feasibility studies and other ac- tions by operators intending, for instance, to set up a joint venture or to invest or develop a type of media or specific project. These loans are normally repaid by the beneficiary three years after completion of the action. How- ever, the contracts stipulate that the loans are not repayable if the revenues generated by these ac- tions have not covered their costs. The decision to change a loan into a grant is taken by the author- ising officer on the basis of a review of the success of the action. The cost claims and the cleared pre-financing are charged to 'Loans on special conditions', a sub- category of 'Long-term pre-financing'. The following treatment should be followed:  If the action is deemed unsuccessful, the loan should be written-off and recognised as an expense;  If the project is successful, the authorising officer can recover the amount due under the contract. The amount of the loan is transferred to a debtor account, which is cancelled when cash is received; and  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 25 of 29  If the project has not been closed or where its status is not known, the outstanding amount should be kept in the balance sheet as a loan, with an appropriate estimate of its impairment. (i) Outstanding commitments (Reste à liquider - RAL) and payment appropriations carried over Definition of outstanding commitments (RAL) The Union budget has to reconcile the need to observe the principle of annuality and the need to manage multi-annual actions. In this context, outstanding commitments (RAL) represent the time lag between when budget commitments are entered into and when payments are actually made. Outstanding commitments (RAL) are of two kinds: “abnormal” cases, where there are difficulties in executing certain multi-annual actions, and “normal” cases arising through the system of differenti- ated appropriations (the commitment is made in the first year, while the payment appropriations are spread over several years). In the accounts published before introduction of the IPSAS standards, the entire RAL was considered as a potential liability. Definition of payment appropriations carried over Part of the RAL consists of payment appropriations carried over. These are budget commitments for which the payment(s) will be made in the following year(s). In the accounts published before introduction of the IPSAS standards, payment appropriations car- ried over were entered as expenses for the year with a matching entry in an account on the liabilities side of the balance sheet. Accounting method As the changeover to accrual accounting requires expenses to be booked to the correct financial year, payment appropriations carried over no longer need to be entered in the accounts. Doing so would duplicate the deferred expenses entries. Mention can be made of outstanding commitments in the notes to the financial statements as con- tingent liabilities. However, the total amount will have to be corrected for deferred expenses and prepaid expenses. These will already have been entered in the general accounts. In addition, legal commitments for which there has not yet been a budget commitment (Structural Funds, fisheries agreements, Cohesion Fund, etc.) will have to be added. Similarly, outstanding commitments may provide relevant information when estimating closing en- tries (for example, for grants, the Structural Funds, etc.).  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 26 of 29 Example System in place before implementing accrual accounting Under the budget adopted, €60 million is available for an action under the heading of ex- ternal policy. The project is planned to run for three years with payments of €20 million a year. N N+1 N+2 Commitment 60 Delivered but not paid 12 Payment 20 8 32 Outstanding commitments 40 32 0 Payment appropriations carried over 0 12 0 In year N+1 the RAL amounts to €32 million, which breaks down as follows: €20 million for year 3 and €12 million to be entered against year N which have not yet been paid to the beneficiary (they are then known as ‘appropriations carried over’). The €12 million in appropriations carried over in our example used to be entered as a lia- bility on the balance sheet. With the changeover to accrual accounting, deferred expenses have to be valued at the reporting date. Thus the sum of €12 million will normally be in- cluded in the amount of deferred expenses entered when closing the accounts. Thus the entry of appropriations carried over will disappear because it would duplicate the closing entries (deferred expenses in the present case). 5. Subsequent Measurement 5.1 Subsequent measurement Event or transac- Recording during Generating event Reporting date tion the year Change in esti- Correction of esti- Period of the Latest information mates mates change Adjustments of expenses Cancellation of an Cancellation Cancellation voucher N/A asset voucher issued issued  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 27 of 29 Termination of Associated indemni- Procedure initiated N/A contract ties Result of the audit Correction of eligi- Latest information known and approved N/A ble expenses (result of audit) by the European Un- ion 5.2 Changes in estimates Because of the uncertainties inherent in accrued expense estimates (for instance, for grants or EAGF), some financial statement items cannot be measured with precision but can only be estimat- ed. The estimation process involves judgment based on the latest information available. The use of reasonable estimates is an essential part of the preparation of financial statements and does not un- dermine their reliability. Consequently, those estimates may have to be revised when changes occur regarding the final data issued by beneficiaries or third parties. By its nature, the revision of the estimate does not bring the adjustment within the scope of the definition of an extraordinary item or a fundamental error. The effect of a change in an accounting estimate should be included when determining the net ac- counting surplus or deficit for the period of the change. The effect of a change in an accounting es- timate should be included in the same economic outturn account classification as was used previ- ously for the estimate. Consequently, any changes in estimates must be recorded as a decrease or increase of the corre- sponding initial expense when the cost statement is received by the European Union. The nature and amount of a change in an accounting estimate should be disclosed in the notes to the financial statements (if material). Example: Using the percentage-of-completion method, the estimates often need to be revised as events occur and uncertainties diminish. Indeed, the contractual amount may increase or decrease from one period to the next. For example: - A contractor and the European Union may agree to variations or claims that in- crease or decrease contract amounts in a period subsequent to that in which the con- tract was initially agreed. - The amount may decrease as a result of penalties arising from delays in completing the contract that are attributable to the contractor.  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 28 of 29 5.3 Criteria for cancellation of an asset Where the European Union write off receivables, the European Union should recognise the decrease in the carrying amount of assets as an expense for the period in which the decrease is recognised. In order to recognise this expense, the European Union should establish a formal document that confirms the write-off. 5.4 Termination of contracts When the termination procedure is initiated, all indemnities associated with the procedure should be recognised as expenses. 5.5 Correction of eligible expenditure When a cost claim is received by the European Union, the eligibility of the expenses reported by the beneficiary is analysed. A modified cost claim is not recognised in the economic outturn account (either as a decrease of expenses or as revenue) until the European Union authorise the eligible expenses. As explained before, the expense should be recognised when the eligibility criteria are met. Sometimes the eligible expenses may be modified after acceptance of the cost claim, for example, as a result the findings of an audit. If the modification or reimbursement occurs within the same financial year, the decrease in eligible expenses should be recognised as a decrease in expenses. If the modification or reimbursement does not occur within the same financial year, the decrease in eligible expenses should be recognised as revenue. 6. Impairment Not applicable 7. Derecognition In this rule, the scope of cancellation of a liability should be considered only under limited circum- stances, for example, the cancellation of a loan received or of a debt when goods are received or a service is rendered; a credit note received from a supplier should be considered as a decrease in ex- penses. Event occurs in the same year Event occurs in a year after Same reporting date as the first booking the first booking  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 3: EXPENSES AND PAYABLES Date: October 2006 Page 29 of 29 Cancellation of liability: borrowing Revenue Revenue Credit note received from a supplier (procurement) Negative expense Negative expense Commercial decrease (procurement) Negative expense Negative expense Where a creditor cancels liabilities or another entity assumes liabilities, the European Union should recognise the decrease in the carrying amount of liabilities as revenue for the period in which the decrease is recognised. In order to recognise this revenue, the European Union should obtain a for- mal document that confirms the cancellation or transfer. The creditor or the European Union them- selves must issue this voucher. If the European Union issue the voucher, the creditor has to provide proof of agreement or must be allowed sufficient time to contest the European Union' decision. 8. Disclosures The European Union should disclose in the notes to the financial statements:  the accounting policies adopted for the recognition of expenses, including the methods used to determine the stage of completion of transactions involving the provision of ser- vices, grants or structural funds.  the amount of each significant category of expenses recognised during the period. All relevant information should be disclosed in the notes to the financial statements. 9. Effective date This rule shall be effective for annual financial statements covering periods beginning on or after 1 January 2007. 10. Reference to other rules This accounting rule is based on the following standards: IPSAS 1 "Presentation of Financial Statements" IPSAS 4 "The Effects of Changes in Foreign Exchange Rates" EU Accounting Rule 13 "Foreign currency translation.