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Financial report

Financial statements and accounting principles
Income and expenditure account
Balance sheet
Reserve Funds for Pensions and Social Security
 

Financial statements and accounting principles
 
The Organisation’s consolidated income and expenditure account and consolidated balance sheet as at 31 December 2005 were drawn up in accordance with accounting principles based on Chapter V of the EPC in conjunction with the Organisation’s Financial Regulations.
 
The figures and associated notes for 2005 have not yet been checked and certified by the auditors.
 
The financial report covers two types of activity:

  • operations relating to patents and other classes of transactions, which come under the Office’s accounts
  • administration and management of assets set aside for future payment of pension and long-term care benefits, which come under the part devoted to the Reserve Funds for Pensions and Social Security (RFPSS).
     

In legal terms the Organisation constitutes a single entity, while the RFPSS have to be treated as a special class of asset of the Organisation. The financial statements have accordingly been consolidated, eliminating balances and transactions between the Office and the RFPSS. 
 
Separate financial statements for the Office and the RFPSS are accessible on the EPO website (http://www.epo.org/).

Income and expenditure account

The revival of growth in filings that began in 2004 was sustained in 2005. Around 15 000 or 8.4% more applications were filed than in 2004.
 
On the income side, fees from the patent grant procedure rose by 4.58% (EUR 721.9m in 2005 compared with EUR 690.3m in 2004). The increase in 2004 was 13.49%. Renewal fee income increased by 2.49% (EUR 250.6m in 2005 as against EUR 244.5m in 2004). However, these figures do not take into account that some member states are in arrears for a total amount estimated at around EUR 10m. If this sum had been released, the rise would be 6.58% as against 6.03% in 2004. Financial income was down by 15% (EUR 16.6m in 2005 compared with EUR 19.1m in 2004), due largely to a 3.64% reduction in the cash position as at 31 December 2005 and to interest rates hitting a historic low. There was a major (98%) rise in net RFPSS income (EUR 207.8m in 2005 compared with EUR 104.9m in 2004) thanks to the sustained recovery of the financial markets that began in 2004.
 
In the consolidated statements, the results include unrealised losses, but they exclude unrealised gains on RFPSS assets (EUR 237.4m in 2005, EUR 113.6m in 2004) and consolidation adjustments to the Office’s contributions (EUR 77m in 2005, EUR 74.9m in 2004). Without these two factors, the market value of RFPSS assets rose by EUR 522.2m in 2005 as against EUR 293.5m in 2004.
 
On the expenditure side, staff costs increased by 2.28% (EUR 651.2m in 2005 compared with EUR 636.7m in 2004). The corresponding percentage in 2004 was 6.9%. This rise, unusually moderate, is largely due to the greater number of posts occupied at year’s end. The recruitment policy for examiners and formalities officers was applied judiciously with a view to mastering the workload and maintaining efforts to reduce the existing backlog in the grant procedure. Spending on IT (EUR 72.5m in 2005, EUR 66.7m in 2004) was up 8.7% because of the EPO’s strategic objective on the automation front to establish a viable support framework for grant activities and administrative tasks, to enhance quality, to boost performance and to improve customer services.
 
Expenditure on buildings and equipment was 6.78% down (EUR 45.7m in 2005, EUR 48.8m in 2004). Various savings were made on building renovation work.
 
Depreciation rose 6.31% (EUR 38.7m in 2005 as against EUR 36.4m in 2004) due to ongoing investments.
 
The other categories of expenditure – co-operation, meetings, patent information and public relations, general operating expenditure, financial expenditure and spending on projects funded by third parties – remained broadly unchanged.
 
Fig. 1: Income and expenditure account 


 
Balance sheet
 
Non-current assets grew considerably, rising by EUR 71m or 9.89% (EUR 789.3m in 2005 compared with EUR 718.3m in 2004), due primarily to consistent investment in the property market, ie the acquisition of a new site in Munich together with the start of construction work on a new building. The purchase value of all investments was EUR 109.7m, while the corresponding depreciation totalled EUR 38.7m. The investments were financed entirely from the Office’s own funds.
 
Financial assets increased by EUR 287.2m or 14% (EUR 2 337.9m in 2005 compared with EUR 2 050.7m in 2004), largely because RFPSS assets rose by EUR 284.7m. The remaining EUR 2.5m comes from growth in home loans granted to staff by the Office.
 
Current assets on the other hand were EUR 16.2m down, at EUR 504.9m (compared with EUR 521.1m in 2004).
 
On the liabilities side, short-term debt increased by EUR 5.1m or 5.1% (EUR 104.9m in 2005 compared with EUR 99.8m in 2004).
 
Thus net current assets amounted to EUR 400m as against EUR 421.3m in 2004, a fall of EUR 21.3m. This includes cash totalling EUR 417.6m compared with EUR 432.8m in 2004.
 
Equity grew by EUR 336.9m, the sum of increases in the net assets available for pensions and long-term care (EUR 284.8m) and in reserves (EUR 52.1m).
 
Under Article 38(b) EPC, RFPSS resources constitute a special class of asset of the Organisation, designed to support its pension and social security schemes by providing the appropriate reserves.
 
The market value of these assets rose from EUR 2 226.7m to EUR 2 748.9m, a 23.45% increase.
 
Under the Organisation’s accounting policy, various commitments and contingencies are not disclosed in the balance sheet:

  • The EPO’s expenditure is not wholly covered by procedural fees, being partly financed from renewal fees for patents granted and validated in the member states (Article 39 EPC). On 31 December 2005, the present value of future renewal fees was EUR 1 790.6m, as against EUR 1 685.4m in 2004, a 6.24% increase.
  • The 2005 reserves amounted to EUR 1 285.3m, including estimated income of EUR 651.2m booked while procedures were still pending.
  • For staff benefits – primarily pensions, allowances, sickness and long-care insurance and untaken leave – the estimate as at 31 December 2005 was EUR 4 514m compared with EUR 3 893.2m in 2004. The 15.94% rise was mainly the result of reducing the discount rate used to calculate future commitments for staff benefits.
     

Further details are given in the notes on the 2005 financial report published on the Office’s website.

Fig. 2: Balance sheet 


 
Reserve Funds for Pensions and Social Security
 
The year 2005 witnessed a major change in the interest rate cycle, as central banks, prompted by rising inflation (hitting its highest level for more than a decade in both the USA and the United Kingdom), signalled an end to the era of easy money introduced by the US Federal Reserve in spring 2001.
 
Notwithstanding monetary tightening and despite a surge in oil prices (to over US dollar 70 per barrel for the first time in history), global GDP grew by more than 4%. More specifically, the US economy grew by 3.5%, Japan by 2.8% and Western Europe by 1.6%. Emerging markets benefited from strong economic growth and in many cases took advantage of rising prices for natural resources. Although growing at a slower rate than in 2004, most emerging economies still recorded a strong performance. China (+ 9.4%) and India (+ 7.5%) in particular stood out as rising powers, not only among emerging economies.
 
Conditions appeared to be very good for stocks, since low interest rates encouraged European and Japanese companies to restructure and tempted investors to consider riskier assets than fixed-income securities. Furthermore, fears of a possible weakness in US consumer demand, an overheating of the Chinese economy or a disorderly fall of the US dollar did not materialise. 
 
Despite rising inflation, long bond yields barely changed and equity markets recorded a quite remarkable performance, completing a third consecutive year of gains, with Japan up 40% and the eurozone up more than 20%. The laggard was the USA, where the Standard & Poor’s Index rose just 5%. Excluding the USA, the Dow Jones World Stock Index gained 14.4% (in US dollar terms). The US currency enjoyed its best performance in four years, gaining more than 12% against a basket of six major currencies. Especially resilient against the euro and the yen, it strengthened about 15% against both, as higher interest rates and the repatriation of billions of dollars in profits by US multinational companies added support to the currency.
 
Against this background, the RFPSS were able to achieve a performance of 19.7%, well above the long-term objective (which for 2005 was 5.7%) and more than 1% above the benchmark. With this good result, the RFPSS have produced an average return of 3% over the last five years and of 8.9% over the last ten. The corresponding figures for the long-term objective are 5.3% and 5.2% respectively. The five-year period was of course badly affected by the bear markets between 2000  and 2002.
 
In view of the positive scenario for equity investments, the RFPSS were mostly overweight in this asset class, with special emphasis on emerging-market shares. Investments in fixed-income securities were mostly neutral, although management was active in taking advantage of market opportunities with regard to the duration and credit spreads within the portfolio. With regard to real-estate investments, a new asset class for the RFPSS, holdings were mostly kept towards the low end of the assigned tactical range. Towards the end of the year, management started to position the RFPSS closer to the new strategic asset allocation decided by the Supervisory Board, which allows about 5% of the Funds to be invested (indirectly) in commodities.
 
In addition to the regular management and reporting tasks carried out by the RFPSS Administration, at comparatively low cost, it should be mentioned that a new management information system (providing integrated portfolio management, accounting and risk management) was successfully put in place during the year. Also, a number of changes were made to the RFPSS regulatory framework during the year: as well as minor changes to the investment procedure (including increased transparency for investment decisions), the limit on securities lending was increased (from 20% to 30%) and preparations were made to allow investment in commodities in 2006. In addition, the regulations were amended in order to give the Supervisory Board greater involvement in the use of resources.
 
Fig. 3: RFPSS Result
Fig. 4: RFPSS Net assets

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