Courtesy Translation

of the letter dated 17 January 2018 Mr. Kay Scheller,

President of the German Supreme Audit Institution [Bundesrechnungshof] sent (in German)

to Prof. Dr. Klaus-Peter Naumann, Chief Executive Officer of the IDW [Institut der Wirtschaftsprüfer in Deutschland e. V.]

Special Report pursuant to Article 99 Federal Budget Code on the intended implementation of harmonised European Public Sector Accounting Standards (EPSAS) in the Member States of the European Union

Your letter dated 1 December 2017

Dear Professor Naumann,

It is with great interest that I read your letter dated 1 December 2017 sent on behalf of the Institut der Wirtschaftsprüfer in Deutschland e. V. (IDW) commenting on our report on harmonised European Public Sector Accounting Standards (EPSAS). In this letter, you address various aspects of the EPSAS implementation.

I decided to reply to your letter (letter of IDW) by means of this open letter, as it does not accurately convey some of the contents of our report and draws the wrong conclusions concerning our position. In particular, I wish to draw your kind attention to the following:

Basic features of the implementation of EPSAS

The European Commission (the Commission) is planning to implement EPSAS in the Member States of the European Union. The EPSAS are to be based on accrual accounting and are to be binding for all levels of government. These standards are intended to provide more reliable data of the EU Member States and to improve their fiscal monitoring, thus helping to avoid future sovereign debt crises. According to rough estimates made by the Commission, the costs of implementing EPSAS are to amount to €3.1 billion in Germany alone.

We speak out against the implementation of EPSAS

In contrast to the statements in your letter, our report does not assess the pros and cons of accrual accounting versus cash-based accounting. Neither does it advocate for or against implementing accrual accounting at the federal government level. Furthermore, you may be aware that the Budgetary Principles Act permits the Federal Government and the Federal States to use either cash- based or accrual-based accounting.

A sustainable budgetary and fiscal policy is possible both in a cash-based and an accrual-based system. In our annual report, we have listed the steps to be taken by the Federal Government to achieve fiscal sustainability. Based on our experience, accrual accounting does not ensure sound public finances.

Our report explicitly opposes the compulsory implementation of EPSAS since with this project, the Commission is applying the wrong cure and does not address the genuine problem. The Commission already has access to the financial data necessary for fiscal oversight, that is, even without EPSAS.

In our opinion, the European Union does not face a lack of information. The experience has shown that, in spite of blatant infringements of the European fiscal rules, no financial sanctions have been imposed against the EU Member States. There is not a lack of high-quality financial data but of a sound budgetary and fiscal policy and of consistent enforcement of the European fiscal rules.

Implementing EPSAS would not solve this problem. The current figures on the deficit and public debt ratios in the EU area furnished by the Federal Statistical Office (DESTATIS) on 11 January 2018 again provide ample evidence that in a number of EU Member States fiscal sustainability has been at risk for years.

Cost and benefit of implementing EPSAS

Your letter notes that our report does not distinguish between costs directly associated with implementing accrual accounting and additional costs for long overdue IT maintenance and administrative improvement. Your letter also points to the merits of accrual accounting in comparison to cash accounting and advocates in favour of implementing EPSAS.

On this, first of all I wish to note that – as highlighted and described in detail in our report – the Commission has so far neither submitted an overall strategy nor a cost-benefit analysis for the implementation of EPSAS. Thus, a key requirement for the proper and efficient use of public funds has not been met. This approach does not comply with the value for money principle laid down in the German Constitution and is unacceptable given that the costs are likely to amount to billions of euros and that considerable difficulties in budgetary practice are likely to emerge when implementing EPSAS.

We also believe that it is not enough to merely list potential benefits of accrual accounting over cash-based accounting without assessing the specific monetary benefit of accrual accounting for a public budget against the cost of EPSAS implementation. This does not allow a well informed decision. Especially for the federal budget as a transfer budget, evidence would be needed that the effort associated with the transition is justified. If the IDW holds sound data on which it bases its decision in favour of the EPSAS, I suggest that these be made available for the public discussion.

Our report refers to the statements made by the Commission and the audit firm PricewaterhouseCoopers (PwC) on the expected costs of implementing EPSAS. Our report provides explanations on why these cost estimates are not robust. In contrast to your letter, the Commission and PwC point out that the estimates have attempted to include only those costs that are solely attributable to the implementation of EPSAS. In this context, PwC speaks of unavoidable costs.

These include the costs for implementing the standards and the central IT systems associated. Costs not included are e.g. the costs of a comprehensive reform of the financial reporting system.

Suboptimal management caused by cash-based accounting

Your letter states that especially cash-based accounting has resulted in suboptimal financial management, arguing that it only focuses on inflow and outflow of cash and therefore has not deterred the deferral of urgently needed measures to maintain the national infrastructure. Your letter states that the dilapidation of e.g. motorways, bridges, local schools and kindergartens has occurred only because cash-based accounting does not sanction such deferrals.

Your letter thus suggests that the poor condition of public infrastructure in Germany is primarily attributable to cash-based accounting and its inherent risk of poor management. We doubt that this positive correlation can be substantiated. At any rate, a look at the situation in those EU Member States that have for many years relied on accrual-based accounting and reporting systems does not confirm this assumption. Despite accrual-based accounting, large public deficits and debt ratios as well as dilapidated infrastructure can be found in those countries.

In this context your letter seems to ignore Parliament’s right to control the budget. This right enshrined in the Constitution is one of the oldest and most important privileges of Parliament, enabling it to exert decisive influence on the way in which government operates and sets its priorities. Neither cash-based accounting nor accrual-based accounting can or should sanction the budget legislator or limit its scope for fiscal policy decisions. The applicable constitutional debt rule stipulates that the budget legislator is free to decide how it intends to ensure a balanced budget in compliance with the debt rule. Restricting this right would mean a substantial encroachment on Parliament’s constitutional right to control the budget.

Furthermore, your letter seems to disregard the fact that mismanagement is not necessarily the only cause for the poor condition of public infrastructure. Rather than that, various other factors can account for the fact that necessary maintenance work is not carried out. The reason may be e.g. that budget funds or planning or building capacities are allocated to programmes considered to be more urgent from a policy point of view. I wish to refer to the special situation after the German unification when the increased demand for investments in the public infrastructure of Germany’s eastern states was given due priority.

On top of this, the depreciations assessed and recognized under accrual accounting do not reliably reflect the loss of value of physical assets and the age- related loss of productivity and efficiency of assets. In road construction, for example, the maintenance needs are already assessed much more accurately by means of methodologies that permit sound projections of the changes in the condition of the pavements over time. In addition, maintenance and funding programmes for civil engineering structures (including bridges) throughout Germany may be steered by means of the building structures management system.

Completeness of the statement of assets and liabilities

Your letter correctly points out that the Federal Government’s statement of assets and liabilities is not complete. Several material items are not disclosed in it.

In our annual report on federal financial management, we also regularly alert to the fact that the statement of assets and liabilities does not fully disclose the assets and liabilities of the Federal Government. We did so recently in December 2017. However, we acknowledge that the Federal Ministry of Finance has made considerable efforts over the past few years to complement the statement of assets and liabilities and to enhance its transparency.

Differing from the statements made in your letter, our position in this matter has remained the same. We hold that further efforts are needed, also in view of the legal requirement imposed by Article 73 Federal Budget Code and therefore support the Ministry of Finance in its efforts to complement and enhance the statement of assets and liabilities.

Involvement of private-sector audit firms in the decision-making processes

Your letter states that it is common practice and essential to draw on external knowledge and expertise when drafting laws and regulations. Your letter states that for this reason, our demand not to rely on the expertise and experience of the audit profession in connection with the implementation of EPSAS is therefore difficult to comprehend.

In contrast to what your letter states, our report does not make this demand. We have merely pointed out that from the outset, the Commission largely relied on private-sector audit firms in the project. These are key players with vested interests and can therefore exert considerable influence on the development of EPSAS. We still consider this a matter of concern because, in case of a compulsory implementation of EPSAS, the demand for support and consultancy services in the public sector of the respective EU Member States will create a market worth billions of euros for exactly these audit firms. This conflict of interest is apparent and unacceptable.

We stand by our opinion that governments’ leeway is eroded if private sector firms gain significant influence on potential European Union legislation and can thereby create new markets and sources of revenue in their favour.

I hope I have been able to clarify our position on the intended implementation of EPSAS and remove any potential misunderstandings.

Yours sincerely, 

Kay Scheller