Financial statements and accounting policies
The Organisation’s income statement and balance sheet as at 31 December 2006 were drawn up in accordance with accounting principles based on the Organisation’s Financial Regulations in conjunction with the European Patent Convention (EPC).
For the year ending 31 December 2006 the EPO for the first time prepared its financial statements according to International Financial Reporting Standards (IFRS) as provided by the International Accounting Standards Board (IASB), with the exception of IAS 19.7.The exception is due to the fact that the financial instruments held by the Organisation’s Reserve Funds for Pensions and Social Security (RFPSS) were classified as plan assets although the RFPSS do not constitute a separate legal entity as required by IAS 19.7.
With respect to the information in the income statement and the balance sheet it should be noted that the net present value of expected future renewal fees, which according to IFRS cannot be capitalised as an asset, needs to be taken into account in evaluating the Organisation’s actual financial position.
This specific situation results from the way the Organisation’s operations are financed. As in all patent offices, the costs of current operations are covered to a substantial extent by future renewal fees on patents. Whereas the costs are generated in the period of processing the patent application from filing up to grant, future renewal fees on patents are received thereafter and spread over the years the patent is in maintained force.
Renewal fees are payable in the countries the proprietor wants his patent to cover (designated states), and are paid to national authorities in the contracting states. The structure and level of renewal fees are fixed by the contracting states.
Under Article 39 EPC, each contracting state pays the Organisation a proportion of the renewal fee for each European patent maintained in that state. The proportion is fixed by the Administrative Council and is the same for all contracting states. It may not exceed 75%, and since 1984 it has been fixed at 50%.
Since there is no legal obligation for the patentee to renew and pay the corresponding renewal fee, and since the structure and level of the fees are defined by the contracting states, the net present value of expected future renewal fees on patents granted is not included as an asset in the Organisation’s balance sheet. As it is nevertheless an essential factor for the Organisation’s financial position, the amount of the net present value of future renewal fees is shown in a footnote to the balance sheet and to the statement of changes in equity. Its change in value is shown in a footnote to the income statement and to the cash flow statement.
The assets and liabilities relating to the defined-benefit pension plan and other post-employment benefits of the Organisation are determined using actuarial valuations.
The financial statements for 2006 have not yet been audited. The audited financial statements for the Organisation will be accessible on the EPO website (www.epo.org ) from 30 June 2007 onwards.
Fig. 1 Income statement for the year ended 31 December 2006
Financial performance in 2006
Revenue from patent and procedural fees in 2006 amounted to almost EUR 1 bn, an increase of 5.5% in comparison to 2005.
Revenue from the various services provided during the grant procedure from patent filing up to grant rose by 6% (EUR 701.3 m in 2006 compared to EUR 661.5 m in 2005).
Renewal fees for granted patents increased by 4.4% (EUR 280.7 m in 2006 against EUR 268.9 m in 2005).
Future growth is supported by a sustaining rise in the number of applications filed. In 2006 the number of filings was around 11 000 (5.6%) higher than in 2005.
A EUR 89.0 m increase in operating expenses (EUR 1 149.0 m in 2006 against EUR 1 059.8 m in 2005) was partly offset by a EUR 35.7 m upturn in the financial result (EUR 45.3 m in 2006 against EUR 9.6 m in 2005). The rise in operating expenses also reflects the increase in the number of staff in employee years in 2006 by 3.9% (2006: 6 070; 2005: 5 843). The financial result was mainly influenced by the increase in the expected return on plan assets to EUR 225.7 m in 2006 against EUR 183.5 m in 2005.
Overall, the 2006 result was a 3.7% improvement over 2005, with a loss of EUR 73.0 m in 2006 compared to EUR 75.8 m in 2005. The change in present value of future renewal fees not reflected in the income statement amounted to EUR 373.0 m (2005: EUR 131.0 m).
In comparison to 2005 the Organisation’s total assets grew by EUR 98.7 m (EUR 1 560.6 m in 2006 against EUR 1 461.9 m in 2005) or 6.8%.
The major change in total assets was realised by further investments in non-current marketable securities, resulting in an increase in the balance per end of 2006 of EUR 76.3 m (EUR 298.7 m in 2006 against EUR 222.4 m in 2005).
Furthermore, the Organisation continued with investments in the construction of a new building on the new site in Munich. The related investments in 2006 amounted to EUR 23.5 m (2005: EUR 44.4 m). Construction of the building is expected to be completed in 2008.
The investments were financed entirely from the Organisation’s own funds.
Fig. 2 Balance sheet as at 31 December 2006
Equity and liabilities
The increase in non-current and current liabilities is mainly composed of the effects resulting from the change in net defined-benefit liability and prepaid fees.
The Organisation provides a pension and social security scheme for its employees which is classified as a defined-benefit plan. The Organisation operates four post-employment defined-benefit plans for its employees. These cover benefits for pensions, long-term care insurance, sickness insurance and death and invalidity insurance. For pensions and long-term care insurance, reserves have been built, and the funds are invested by the Reserve Funds for Pensions and Social Security.
The net defined-benefit liabilities increased from EUR 1 737.5 m in 2005 to EUR 1 829.3 m in 2006, a rise of 5.3%.
Prepaid fees include fees already received for services in the patent grant procedure that are to be provided after 31 December 2006. Non-current and current prepaid fees received for EPO services rose from EUR 651.2 m in 2005 to EUR 727.7 m in 2006 (+11.7%).
Total equity decreased from EUR –1 110.4 m in 2005 to EUR –1 186.4 m in 2006, a fall of 6.8%. The net present value of future renewal fees not reflected in the balance sheet rose from EUR 1 931.0 m in 2005 to EUR 2 304.0 m in 2006 (+19.3%).
Fig. 3 Cash flow statement for the year ended 31 Dec 2006
Fig. 4 Statement of changes in equity for the year ended 31 Dec. 2006
Reserve Funds for Pensions and Social Security
Underpinned by a healthy economic background, capital markets mostly delivered positive returns in 2006.
The advanced economies’ GDPs grew by 4.8%, better than in 2005 (4.3%) and completing a four-year period of strong growth. The US economy in particular continued to grow at the same rate as the previous year (3.2%), whilst growth in Japan inched up from 1.9% to 2.2% and the eurozone took most observers by surprise, with growth accelerating from 1.5% in 2005 to 2.7% in the year under consideration, mostly thanks to a good investment climate for industry and positive export results, despite a strong euro. A similar picture could be observed for the UK. Emerging markets continued their breathtaking development of + 7.6% (2005: 7.4%), with China as usual in the spotlight with 10.5% GDP growth, again a double-digit figure after it recorded 10.2% for 2005. It is estimated that about one-third of global economic growth over the last five years was generated by the Asian giant.
Despite a continuation of the tightening policy started by the US Federal Reserve in mid-2004, with the Federal funds increasing from 4.25% at the beginning of the year up to 5.25% in June 2006 and then maintaining that level, and with the European Central Bank continuing its policy of gradual tightening during the whole of 2006, driving the refinancing rate up from 2.25% to 3.50%, bond yields have only slightly increased in the eurozone and in the USA. All in all, bond indexes delivered negative or small positive returns.
Equity markets mostly delivered good results, which was of course good news for the Reserve Funds for Pensions and Social Security (RFPSS), being invested about 60% in share markets: domestic equities returned 21%, foreign equities 17% (in US dollar terms) and emerging markets 32% (in US dollar terms).
Commodities, an asset class in which the RFPSS started to invest in 2006, showed a divergent path: whilst energy prices showed a negative trend, other commodities, and in particular industrial metals, recorded a strong performance. All in all, however, the Goldman Sachs Commodity Index generated a negative performance of 16% in US dollar terms.
Real estate, another asset class in which the RFPSS invest, was supported in Europe by the good economic conditions and by the low level of interest rates and ongoing strong capital inflows from institutional investors. Domestic real-estate investments returned an astonishing 47%.
In the currency markets, the dominant theme was the weakness of the US dollar, which lost about 10% against the euro; but also the Japanese yen, where monetary policy gives more weight to the relationship with the dollar rather than with the common currency, lost about the same (11%).
In the year under consideration the RFPSS achieved a double-digit return of 12.7%, above benchmark (11.8%) and well above the long-term objective for 2006 (5.2%). Over the last ten years, the RFPSS have achieved a return of 8.3%, 3.1% above the long-term objective value for the same period.
In 2006, Fund Administration started to make full use of the new integrated management information system, with remarkable improvements in terms of the quantity and quality of information at the disposal of the management team. Also, starting from 1 January, an updated strategic asset allocation was put in place, creating some room for commodities, which represent an important element of diversification and reduction of the overall volatility and long-term risk for the RFPSS. Finally, an external consultant was contracted to prepare proposals concerning the regulatory framework for the RFPSS, in particular to seek ways to improve it and to align it with “best practice” adopted by other large and well-regarded institutional investors.