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Report of the Treasurer for the Year Ended December 31, 2008 (2009)

Chapter: III. Financial Condition

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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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Suggested Citation:"III. Financial Condition." National Academy of Sciences. 2009. Report of the Treasurer for the Year Ended December 31, 2008. Washington, DC: The National Academies Press. doi: 10.17226/12686.
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III. Financial Condition 39

Report of the Auditing Committee of the National Academy of Sciences June 9, 2009 Dr. Ralph J. Cicerone, President National Academy of Sciences Dear Dr. Cicerone: In accordance with paragraph 11 of section II of the Bylaws of the National Academy of Sciences, the firm of KPMG LLP was retained by the Auditing Committee on behalf of the Council to conduct an audit of the accounts of the Treasurer for the year ended December 31, 2008, and to report to the Auditing Committee. The independent accountants have completed their audit and submitted their report. In accordance with paragraph 13 of section II of the Bylaws, the Auditing Committee has reviewed the report and recommends to the Council that it be accepted and that the opinion of the independent accountants be published with the report of the Treasurer. Respectfully submitted, PURNELL W. CHOPPIN, Chair SUSAN GOTTESMAN RONALD L. GRAHAM GERALD M. RUBIN SEAN C. SOLOMON Auditing Committee 2101 Constitution Avenue, NW Washington, DC 20418 40

KPMG LLP 2001 M Street, NW Washington, DC 20036 Independent Auditors’ Report The Auditing Committee National Academy of Sciences: We have audited the accompanying statements of financial position of the National Academy of Sciences (NAS) as of December 31, 2008 and 2007, and the related statements of activities and cash flows for the years then ended. These financial statements are the responsibility of NAS’ management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of NAS’ internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of NAS as of December 31, 2008 and 2007, and its changes in net assets and its cash flows for the years then ended in conformity with U.S. generally accepted accounting principles. As discussed in note 2(j) to the financial statements, NAS adopted the provisions of Statement of Financial Accounting Standards No. 157, Fair Value Measurements, as of January 1, 2008, for fair value measurements of all financial assets and financial liabilities. As discussed in notes 2(k) and 9 to the financial statements, NAS adopted the provisions of FASB Staff Position 117-1, Endowments of Not-for-Profit Organizations: Net Asset Classification of Funds Subject to an Enacted Version of the Uniform Prudent Management of Institutional Funds Act and Enhanced Disclosures for All Endowment Funds, as of January 1, 2008. May 28, 2009 41 KPMG LLP, a U.S. limited liability partnership, is the U.S. member firm of KPMG International, a Swiss cooperative.

NATIONAL ACADEMY OF SCIENCES Statements of Financial Position December 31, 2008 and 2007 (Dollars in thousands) Assets 2008 2007 Current assets: Cash and cash equivalents $ 4,110 $ 3,203 Short-term investments (note 3) 43,456 46,941 Contracts receivable – U.S. government (note 11) 55,786 45,566 Contributions and other receivables, net (note 5) 15,212 16,377 Other current assets 4,156 3,813 Total current assets 122,720 115,900 Other assets (notes 2, 12, 14, and 16) 8,508 12,266 Long-term investments (note 3) 309,740 464,908 Contributions receivable, net (note 5) 31,480 37,312 Property and equipment, net (notes 4 and 15) 128,349 129,671 Einstein Memorial 1,723 1,723 $ 602,520 $ 761,780 Liabilities and Net Assets Liabilities: Current liabilities: Accounts payable and accrued expenses $ 38,598 $ 30,770 Deferred revenue (note 6) 35,471 31,414 Line of credit (note 7) 686 3,345 Other current liabilities (note 12) 4,818 5,533 Total current liabilities 79,573 71,062 Bonds payable (note 12) 120,681 121,067 Funds held on behalf of others (note 3) 7,186 11,804 Note payable (note 13) 1,513 2,270 Accrued employee benefits (note 14) 8,597 5,879 Other long-term liabilities (notes 2, 12, and 15) 17,698 9,409 Total liabilities 235,248 221,491 Net assets: Unrestricted 51,731 191,130 Temporarily restricted (note 8) 200,791 238,325 Permanently restricted (note 9) 114,750 110,834 Total net assets 367,272 540,289 Commitments and contingencies (notes 3, 11, 12, 14, 17, and 18) Total liabilities and net assets $ 602,520 $ 761,780 See accompanying notes to financial statements. 42

NATIONAL ACADEMY OF SCIENCES Statements of Activities Years ended December 31, 2008 and 2007 (Dollars in thousands) 2008 2007 Temporarily Permanently Temporarily Permanently Unrestricted restricted restricted Totals Unrestricted restricted restricted Totals Revenues, gains, and other support: Government contracts and grants (note 11) $ 202,810 - - 202,810 $ 178,021 - - 178,021 Private contracts and grants 23,836 21,423 - 45,259 20,071 28,763 - 48,834 Other contributions 3,195 1,064 3,916 8,175 4,511 12,825 1,544 18,880 Fees and publications 18,757 - - 18,757 19,909 - - 19,909 Investment income (loss) (note 3) (25,108) (120,758) - (145,866) 23,636 24,290 - 47,926 Other income (note 12) 1,945 - - 1,945 6,944 - - 6,944 Net assets released from restriction (note 8) 42,077 (42,077) - - 33,991 (33,991) - - Total revenues, gains, and other support 267,512 (140,348) 3,916 131,080 287,083 31,887 1,544 320,514 Expenses (notes 12, 14, and 15): Programs (note 10) 247,426 - - 247,426 225,164 - - 225,164 Management and general 47,823 - - 47,823 48,452 - - 48,452 Fundraising 2,511 - - 2,511 2,302 - - 2,302 Total expenses 297,760 - - 297,760 275,918 - - 275,918 Post-retirement changes other than net periodic benefit cost (note 14) 6,337 - - 6,337 - - - - Change in net assets, before adoption of SFAS No. 158 and reclass- ification of net assets under FSP 117-1 (36,585) (140,348) 3,916 (173,017) 11,165 31,887 1,544 44,596 Effect of adoption of SFAS No. 158 (note 14) - - - - (604) - - (604) Reclassification of net assets under FSP 117-1 (note 9) (102,814) 102,814 - - - - - - Change in net assets (139,399) (37,534) 3,916 (173,017) 10,561 31,887 1,544 43,992 Net assets at beginning of the year 191,130 238,325 110,834 540,289 180,569 206,438 109,290 496,297 Net assets at end of the year $ 51,731 200,791 114,750 367,272 $ 191,130 238,325 110,834 540,289 See accompanying notes to financial statements. 43

NATIONAL ACADEMY OF SCIENCES Statements of Cash Flows Years ended December 31, 2008 and 2007 (Dollars in thousands) 2008 2007 Cash flows from operating activities: Change in net assets $ (173,017) $ 43,992 Adjustments to reconcile change in net assets to net cash provided by operating activities: Depreciation and amortization 7,162 7,571 Loss on disposal of property and equipment 84 50 Bad debt expense 533 322 Net loss (gain) on investments 165,904 (20,098) Net loss (gain) on investments held on behalf of others 3,765 (562) Amounts collected on behalf of others (2,723) (5,630) Amounts remitted on behalf of others 3,664 17,402 Amortization of deferred gain - (430) Change in value of interest rate swap 9,057 2,325 Change in value of split-interest agreements 343 (121) Effect of adoption of SFAS No. 158 - 604 Contributions restricted for construction or endowment (6,645) (3,997) (Increase) decrease in assets: Other receivables 6,465 181 Contracts receivable — U.S. government (10,220) (4,262) Other current assets (343) 401 Other assets 2,612 (183) Increase (decrease) in liabilities: Accounts payable and accrued expenses 7,828 (1,492) Deferred revenue 4,057 3,768 Other current liabilities (885) (1,702) Funds held on behalf of others (4,618) (11,210) Other long-term liabilities 35 3,692 Accrued employee benefits 2,718 (2,046) Net cash provided by operating activities 15,776 28,575 Cash flows from investing activities: Additions to property and equipment (5,910) (1,874) Sales or maturities of investments 231,756 294,044 Purchases of investments (243,624) (321,899) Net cash used in investing activities (17,778) (29,729) Cash flows from financing activities: Contributions restricted for construction or endowment 6,645 3,997 Proceeds from line of credit 123,426 108,029 Payments on line of credit (126,085) (108,449) Payments on bank note (757) (757) Proceeds from interest rate swaption - 2,150 Proceeds from bond issue 66,325 - Payments on bond principal (66,645) (1,565) Payments on capital lease liability - (2,830) Net cash provided by (used in) financing activities 2,909 575 Net increase (decrease) in cash and cash equivalents 907 (579) Cash and cash equivalents, beginning of year 3,203 3,782 Cash and cash equivalents, end of year $ 4,110 $ 3,203 Supplemental disclosure of cash flow information: Interest paid $ 5,189 $ 6,324 See accompanying notes to financial statements. 44

NATIONAL ACADEMY OF SCIENCES individuals to serve on study groups in other organiza- tional units, and disseminates information to the public Notes to and the relevant professions. IOM was established as a separate membership organization within NAS. The Financial Statements financial activities and results of IOM are included in the NAS financial statements. December 31, 2008 and 2007 (d) National Academy of Engineering The National Academy of Engineering (NAE) was (1) ORGANIZATION AND RELATED established in 1964 under the charter of NAS as a related ENTITIES parallel organization, autonomous in its governance, administration, and the selection of its members. NAE (a) National Academy of Sciences shares with NAS the responsibility for advising the federal government on scientific issues. The NAE The National Academy of Sciences (NAS) was formed conducts independent program activities and activities under a charter that was passed as an Act of Incorporation through the NRC. The results of both of these activities by the United States Congress and signed into law on are included in the NAS financial statements. March 3, 1863. NAS operates as a private cooperative society of distinguished scholars engaged in scientific or (e) National Academy of Engineering Fund engineering research, dedicated to the furtherance of science and its use for the general welfare. NAS is exempt The National Academy of Engineering Fund (NAEF) is a from federal income taxes under Section 501(c)(3) of the separately incorporated not-for-profit organization Internal Revenue Code, except for unrelated business established and controlled by NAE to raise funds to income. support its goals. The financial activities and results of NAEF are not included in the NAS financial statements. (b) National Research Council (f) The National Academies’ Corporation Most of the activities undertaken by NAS are carried out through the divisions and boards of the National Research The National Academies’ Corporation (TNAC) was Council (NRC). The NRC draws on a wide cross separately incorporated in 1986 as a not-for-profit section of the nation’s leading scientists and engineers for corporation for the purpose of constructing and maintain- advisory services to government agencies and Congress. ing a study and conference facility. This facility, the To respond effectively to both the disciplinary concerns Arnold and Mabel Beckman Center, located in Irvine, of the research community and the complex interdiscipli- California, operates to expand and support the general nary problems facing American society, NRC is organ- activities of NAS, NRC, IOM, and NAE. TNAC is ized into the following five major divisions responsible controlled by NAS and NAEF. The financial position and for most study activities: results of TNAC are not consolidated in the NAS financial statements. ! Behavioral and Social Sciences and Education In May 2007, NAS began managing the operations of the ! Earth and Life Studies Beckman Center. TNAC contributed $510,000 and ! Engineering and Physical Sciences $851,000 to the NRC for the years ended December 31, ! Policy and Global Affairs 2008 and 2007, respectively, towards the operation of the ! Transportation Research Board Beckman Center. In addition, TNAC contributed $277,000 and $11.7 million to the NRC for the years NRC activities are under the control of the NAS govern- ending December 31, 2008 and 2007, respectively, to be ance structure, and therefore are included in the NAS spent on programs conducted in whole or in part at the financial statements. Beckman Center. (c) Institute of Medicine The Institute of Medicine (IOM), established in 1970, conducts studies of policy issues related to health and medicine. IOM issues position statements on these policies, cooperates with the major scientific and professional societies in the field, identifies qualified 45

(2) SUMMARY OF SIGNIFICANT long-lived assets are released in the period in which the ACCOUNTING POLICIES assets are acquired or placed in service. (a) Basis of Accounting Allowances are recorded for estimated uncollectible contributions based upon management’s judgment and Net assets, revenues, gains, and losses are classified based analysis of the credit worthiness of the donor, past on the existence or absence of donor-imposed restrictions. collection experience, and other relevant factors. Contri- Accordingly, net assets of NAS are classified and butions to be received after one year are discounted at an reported as follows: appropriate rate commensurate with risks involved. Amortization of the discount is recorded as additional Permanently restricted – Net assets subject to do- revenue and is used in accordance with donor imposed nor-imposed stipulations that they be maintained in restrictions, if any, on the contributions. perpetuity by NAS. Generally, the donors of these assets permit NAS to use all or part of the income earned on NAS performs certain fundraising activities on behalf of related investments for general or specific purposes. NAEF. NAS collected a total of $2.5 million and $4.9 million in 2008 and 2007, respectively, on behalf of Temporarily restricted – Net assets subject to do- NAEF. NAS disbursed $2.6 million and $4.9 million to nor-imposed stipulations that may or will be met either by NAEF from these collected amounts in 2008 and 2007, actions of NAS and/or the passage of time. When a donor respectively. Amounts collected but not yet remitted to restriction expires, temporarily restricted net assets are NAEF are reported as assets and liabilities in the NAS reclassified to unrestricted net assets. financial statements Unrestricted – Net assets arising from exchange transac- (e) Contracts and Grants tions and contributions not subject to donor-imposed stipulations. The majority of NAS activities are performed under cost-reimbursable contracts with the U.S. government. (b) Cash Equivalents For the years ended December 31, 2008 and 2007, the Department of Transportation provided 43% and 35%, NAS reports liquid, temporary investments purchased respectively, of NAS government grant and contract with original maturities of three months or less as cash revenue. equivalents. NAS records federal contracts as exchange transactions, (c) Investments recognizing revenue as recoverable costs are incurred. Investments are stated at fair value. Changes in the fair Revenues from nonfederal grants qualifying as contribu- value of investments are reported within investment tions are recorded by NAS upon notification of the grant income in the statements of activities. award. Such grants are classified as temporarily restricted net assets when use of the grant funds is limited to Certain investments are pooled for long-term investment specific areas of study or is designated for use in future purposes. Investments in the pool are administered as an periods. open-end investment trust, with shares of the pool funds expressed in terms of participating capital units (PCUs). (f) Deferred Revenue PCU values are used to determine equity in the allocation of investment income among funds in the pool whenever For both federal and nonfederal grants and contracts that additional funds are contributed or withdrawn. are determined to be exchange transactions, revenue is recognized as the related costs are incurred. Funds (d) Contributions received in advance of being earned for these grants are recorded as deferred revenue in the statements of financial Contributions, including unconditional promises to give, position. are recognized as revenues in the period received. Conditional promises to give are not recognized until all (g) Inventories conditions on which receipt depends are substantially met. Inventories are stated at the lower of cost or net realizable Gifts of land, buildings, or equipment are reported as value and include both work in-process and finished unrestricted net assets unless explicit donor stipulations goods related to publication activities. The majority of specify how the donated assets must be used. Temporary NAS publication inventories and supplies reside with an restrictions on gifts that must be used to acquire NAS unit, the National Academy Press (NAP). NAP uses 46

the full absorption costing methodology in pricing In October 2008, the FASB issued FASB Staff Position finished products. This methodology includes direct FAS 157-3, “Determining the Fair Value of a Financial printing and related indirect costs. Inventories are Asset When the Market for That Asset is Not Active (FSP included in other current assets in the statements of 157-3),” which was effective immediately. FSP 157-3 financial position. clarifies the application of SFAS No. 157 in cases where the market for a financial instrument is not active and (h) Property and Equipment provides an example to illustrate key considerations in determining fair value in those circumstances. NAS has Depreciation of NAS buildings and equipment is considered the guidance provided by FSP 157-3 in its computed on a straight-line basis using the following determination of estimated fair values during 2008. lives: Fair value is defined as the exchange price that would be ! Buildings – 40 years received for an asset or paid to transfer a liability (an exit ! Building and leasehold improvements – lesser of the price) in the principal or most advantageous market for remaining life of the building or improvement the asset or liability in an orderly transaction between ! Furniture and equipment – 4 to 10 years market participants on the measurement date. SFAS No. 157 also establishes a fair value hierarchy, which The Einstein Memorial sculpture is valued at cost and is requires an entity to maximize the use of observable not depreciated. Construction-in-progress is not depreci- inputs and minimize the use of unobservable inputs when ated until the related assets are placed in service. measuring fair value. The standard describes three levels of inputs that may be used to measure fair value: (i) Split-Interest Agreements Level 1: Quoted prices in active markets for identical Charitable gift annuity agreements are classified as other assets or liabilities. assets in the statements of financial position. Periodically, NAS pays a fixed amount of the assets to the beneficiary Level 2: Observable inputs other than Level 1 prices such designated by the donor. Upon termination of an annuity, as quoted prices for similar assets or liabilities; quoted the remainder interest in the assets is available for use by prices in markets that are not active; or other inputs that NAS as restricted or unrestricted assets in accordance are observable or can be corroborated by observable with the donor’s designation. At December 31, 2008 and market data for substantially the full term of the assets or 2007, NAS had charitable gift annuity assets of liabilities. $2.1 million and $3.0 million, respectively. NAS has recorded a liability of $1.5 million and $1.4 million at Level 3: Unobservable inputs that are supported by little December 31, 2008 and 2007, respectively, representing or no market activity and that are significant to the fair the present value of estimated future cash payments to value of the asset or liabilities. annuitants based on the annuitant’s life expectancy. The following discussion describes the valuation method- (j) New Accounting Standards: Fair Value Measure- ologies used for financial assets measured at fair value. ments and Fair Value Option The techniques utilized in estimating the fair values are affected by the assumptions used, including discount rates Effective January 1, 2008, NAS adopted Statement of and estimates of the amount and timing of future cash Financial Accounting Standards (SFAS) No. 157, Fair flows. Care should be exercised in deriving conclusions Value Measurements, which defines fair value, establishes about NAS’ business, its value or financial position based a framework for measuring fair value in accordance with on the fair value information of financial assets presented GAAP and expands disclosures about fair value meas- below. urements. This pronouncement did not require any new fair value measurements and its adoption did not affect Fair value estimates are made at a specific point in time, the results of operations or financial position of NAS. based on available market information and judgments about the financial asset, including estimates of timing, On January 1, 2009, NAS will be required to apply the amount of expected future cash flows and the credit provisions of SFAS No. 157 to fair value measurements standing of the issuer. In some cases, the fair value of nonfinancial assets and nonfinancial liabilities that are estimates cannot be substantiated by comparison to recognized or disclosed at fair value in the financial independent markets. In addition, the disclosed fair value statements on a nonrecurring basis. NAS is in the process may not be realized in the immediate settlement of the of evaluating the impact, if any, of applying these financial asset. Furthermore, the disclosed fair values do provisions on its financial position and results of opera- not reflect any premium or discount that could result from tions. offering for sale at one time an entire holding of a 47

particular financial asset. Potential taxes and other Fair value of alternative investments including private expenses that would be incurred in an actual sale or placement equity securities and hedge funds is based on settlement are not reflected in amounts disclosed. the alternative investment fund managers’ net asset value (NAV). Valuations provided by alternative investment The following methods and assumptions were used to fund managers include estimates, appraisals, assumptions estimate the fair value of each class of financial instru- and methods that are reviewed by management. When ments: necessary, NAS adjusts NAV for contributions, distribu- tions, or general market conditions subsequent to the The carrying value of cash equivalents such as money latest NAV valuation date when calculating fair value. market funds approximates the fair value because of the Since the most significant valuation inputs are not short maturity of these investments. These amounts are observable in the marketplace, the alternative investment disclosed in Level 1. valuations are disclosed in Level 3. NAS’ fixed maturity investments (bonds and notes), other Charitable gift annuity investments and deferred compen- than U.S. Treasury securities, generally do not trade on a sation investments are held in institutional debt and equity daily basis. The fair value estimates of such debt securi- mutual funds along with some U.S. Treasury securities. ties are based on prices provided by NAS’ investment The U.S. Treasury securities are included in Level 1, and managers and custodian bank. Both the investment the mutual funds are included in Level 2. The deferred managers and the custodian bank use a variety of pricing compensation obligation to employees is equal to the fair sources to determine market valuations. Each designate value of the investments held and is disclosed in the same specific pricing services or indexes for each sector of the levels as the investment assets. market based upon the provider’s expertise. NAS’ debt securities portfolio is highly liquid, which allows for a NAS has an interest rate swap agreement covering the high percentage of the portfolio to be priced through fixed-rate bonds payable. NAS also entered into a pricing services. Accordingly, the estimates of fair value swaption agreement which gives the counterparty the for such debt securities are included in Level 2 inputs. option to require NAS to enter into an additional swap The estimated values of U.S. Treasury securities are based agreement related to the fixed-rate bonds payable. The on actively-traded market prices and are accordingly fair value of the swap and swaption are determined using included in the bonds and notes amount in Level 1. pricing models based on observable market data such as prices of instruments with similar maturities and charac- Fair values of exchange-traded equity securities have teristics, interest rate yield curves, and measures of been determined by NAS from observable market interest rate volatility. The value was determined after quotations on major trade exchanges. Accordingly, such considering the potential impact of collateralization and equity securities are disclosed in Level 1. NAS also netting agreement, adjusted to reflect nonperformance invests in institutional debt and equity mutual funds. risk of both the counterparty and NAS. Accordingly, the These mutual funds are not available to retail investors swap and swaption are included in derivative assets and and are not traded on national exchanges. The fair values liabilities as Level 2. of such institutional mutual funds are based on observable market information rather than quoted exchange market The funds held on behalf of others liability approximates prices. Accordingly, the estimates of fair value for such the investments held in NAS’ long-term investment pool mutual funds are included in Level 2. on behalf of TNAC. Therefore, the liability is disclosed in the same levels as the investment assets. 48

The following table presents NAS’ fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis at December 31, 2008 (dollars in thousands): Fair value measurements at December 31 using: Fair Value Level 1 Level 2 Level 3 Financial Assets: Short-term and Long-term Investments: Cash Equivalents $ 19,928 $ 19,928 $ - $ - Bonds and notes 83,820 21,790 62,030 - Equity securities 172,481 71,353 101,128 - Hedge funds 65,283 - - 65,283 Private placements 11,684 - - 11,684 Total Investments 353,196 113,071 163,158 76,967 Charitable gift annuity assets: Cash equivalents 30 30 - - Bonds and notes 644 59 585 - Equity securities 1,439 - 1,439 - Total charitable gift annuity assets 2,113 89 2,024 - Deferred compensation assets: Cash equivalents 31 31 - - Bonds and notes 339 - 339 - Equity securities 1,835 - 1,835 - Total deferred compensation assets 2,205 31 2,174 - Interest rate swap 934 - 934 - Total Financial Assets $ 358,448 $ 113,191 $ 168,290 $ 76,967 Financial Liabilities: Funds held on behalf of others $ 7,186 $ 2,021 $ 3,245 $ 1,920 Deferred compensation liability 2,205 31 2,174 - Interest rate swaption 12,543 - 12,543 - Total Financial Liabilities $ 21,934 $ 2,052 $ 17,962 $ 1,920 Level 3 assets comprised approximately 22% of NAS’ total investment portfolio fair value at December 31, 2008. The following table presents the changes in Level 3 assets measured at fair value on a recurring basis for the year ended December 31, 2008 (dollars in thousands). Hedge Private Funds Placements Total Financial Assets Beginning balance January 1, 2008 $ 65,487 $ 13,622 $ 79,109 Net loss on investments (10,704) (2,253) (12,957) Purchases and sales, net 10,500 315 10,815 Transfers in (out) of Level 3 - - - Ending balance December 31, 2008 $ 65,283 $ 11,684 $ 76,967 Effective January 1, 2008, NAS adopted SFAS No. 159, elect, at specified election dates, to measure eligible The Fair Value Option for Financial Assets and Financial financial instruments, as defined in SFAS No. 159, at fair Liabilities. SFAS No. 159 permits all entities to choose to value. Changes in unrealized gains and losses on items for 49

which the fair value option has been elected are reported (3) INVESTMENTS in income at each subsequent reporting date and upfront costs and fees related to those items will be reported in Investments, which are reported at fair value (except as income as incurred and not deferred. At adoption, for noted), consisted of the following as of December 31, those financial assets and financial liabilities which 2008 and 2007 (dollars in thousands): management has elected to carry at fair value, an entity will report the effect of the first remeasurement to fair 2008 2007 value as a cumulative-effect adjustment to the opening Short-term investments: balance of unrestricted net assets. Management did not Cash equivalents $ 5,762 $ 4,570 elect to measure any additional eligible financial assets or Bonds and notes 26,026 29,477 financial liabilities at fair value and as a result, adoption Equity securities 11,668 12,894 of this standard did not have an effect on the results of Total short-term investments $ 43,456 $ 46,941 operations or financial position of NAS. Long-term investments: (k) Other New Accounting Standards Investment pool, including endowment assets: Cash equivalents $ 13,479 $ 22,086 As discussed in note 9, NAS adopted the provisions of Bonds and notes 50,145 58,429 FASB Staff Position 117-1, Endowments of Not-for-Profit Equity securities 147,431 278,421 Organizations: Net Asset Classification of Funds Subject Hedge funds 65,283 65,487 to an Enacted Version of the Uniform Prudent Manage- Private placements 11,684 13,622 ment of Institutional Funds Act and Enhanced Disclo- 288,022 438,045 sures for All Endowment Funds, effective January 1, 2008. Other long-term investments: On January 1, 2007, NAS adopted the provisions of Cash equivalents 687 503 FASB Interpretation No. 48, Accounting for Uncertainty Bonds and notes 7,649 9,054 in Income Taxes (FIN 48). FIN 48 requires that a tax Equity securities 13,382 17,306 position be recognized or derecognized based on a “more 21,718 26,863 likely than not” threshold. This applies to positions taken Total long-term investments $ 309,740 $ 464,908 or expected to be taken in a tax return. The implementa- tion of FIN 48 had no impact on NAS’s statement of Vanguard equity funds comprised approximately financial position or statement of activities. NAS does not $47 million and $119 million of the total equity securities believe its financial statements include any uncertain tax funds at December 31, 2008 and 2007, respectively. positions. NAS holds alternative investments, comprised of private As discussed in note 14, NAS adopted the provisions of placement equity securities and hedge funds, in its long- SFAS No. 158, Employers’ Accounting for Defined term investment pool. At December 31, 2008 and 2007, Benefit Pension and Other Postretirement Plans, effective these funds had a fair value of approximately December 31, 2007. $77.0 million and $79.1 million, respectively. The unrealized gain or loss on the hedge funds was approxi- (l) Use of Estimates mately a $10.7 million loss and a $5.2 million gain for the years ended December 31, 2008 and 2007, respectively, The preparation of these financial statements in confor- and is included as a component of investment income in mity with U.S. generally accepted accounting principles the accompanying statements of activities. Private requires management to make certain estimates and placement equity investments are comprised of limited assumptions. These estimates and assumptions may affect partnership interests. NAS had remaining commitments at the reported amounts of assets and liabilities and disclo- December 31, 2008 and 2007 to provide approximately sures in the financial statements. Actual results could $5.9 million and $5.2 million, respectively, to these differ from those estimates. partnerships. (m) Reclassifications TNAC, a related entity, invests certain of its assets in the NAS long-term investment pool. TNAC investments Certain amounts from the prior year have been reclassi- participate in the investment pool experience proportion- fied to conform to the current year presentation. ally with all other funds in this pool. The NAS obligation to TNAC for these funds held in trust, which totaled approximately $7.2 million and $11.8 million as of 50

December 31, 2008 and 2007, respectively, is reported as At December 31, 2007, the discount on contributions funds held on behalf of others in the statements of receivable was approximately $5.4 million at rates financial position. ranging from 3% to 5% and the allowance for uncollect- ible contributions was approximately $208,000. Investment income is reported net of investment expenses of approximately $597,000 and $566,000 for the years ended December 31, 2008 and 2007, respectively, and is (6) DEFERRED REVENUE comprised of the following (dollars in thousands): Deferred revenue consisted of the following as of 2008 2007 December 31, 2008 and 2007 (dollars in thousands): Interest and dividends income $ 20,038 $ 27,828 2008 2007 Net gain (loss) on investments (165,904) 20,098 Advances from private grants and contract Total investment income (loss) $ (145,866) $ 47,926 sponsors $24,537 $24,082 Advances from U.S. government sponsors 6,958 2,663 Publication subscriptions and other 3,976 4,669 (4) PROPERTY AND EQUIPMENT Total deferred revenue $35,471 $31,414 Property and equipment as of December 31, 2008 and 2007, is comprised of the following (dollars in thou- sands): (7) LINE OF CREDIT 2008 2007 NAS is party to an $18 million unsecured line of credit Land $ 29,689 $ 29,689 from Bank of America which bears interest at LIBOR Furniture and equipment 33,001 32,096 plus 0.40% and expires on August 30, 2010. Interest expense related to the line of credit for the years ended Buildings and improvements 109,199 109,063 December 31, 2008 and 2007, was approximately Construction in progress 4,857 240 $343,000 and $497,000, respectively. Leasehold improvements 7,349 7,286 184,095 178,374 Less accumulated depreciation and (8) TEMPORARILY RESTRICTED NET amortization (55,746) (48,703) ASSETS Total property and equipment, net $ 128,349 $ 129,671 Temporarily restricted net assets were available for the following purposes as of December 31, 2008 and 2007 (5) CONTRIBUTIONS RECEIVABLE (dollars in thousands): Contributions not yet collected are included in contribu- 2008 2007 tions and other receivables (current) and contributions Sponsored research and advisory programs $126,835 $203,182 receivable (long-term) in the statements of financial General endowment 54,157 - position, and mature as follows (dollars in thousands): Prizes and awards 17,903 30,088 Years ending December 31: Woods Hole facility 1,896 5,055 Total temporarily restricted net assets $200,791 $238,325 2009 $ 13,109 2010 4,652 Temporarily restricted net assets were released from 2011 8,807 restriction for the following purposes during the years 2012 5,265 ended December 31, 2008 and 2007 (dollars in thou- 2013 3,633 sands): Thereafter 13,147 48,613 2008 2007 Less discount at rates from 3% to 5% to estimated Sponsored research and advisory programs $ 34,397 $ 32,989 net present value (4,024) General endowment 6,300 - Less allowance for uncollectible contributions (456) Prizes and awards 917 658 44,133 Woods Hole facility 463 344 Less current portion (12,653) Total temporarily restricted net assets Total contributions receivable, long-term $ 31,480 released from restriction $ 42,077 $ 33,991 51

(9) ENDOWMENTS was donated. NAS classifies as permanently restricted net assets (a) the original value of gifts donated to the (a) Permanently Restricted Net Assets permanent endowment, (b) the original value of subse- quent gifts to the permanent endowment, and The income generated by permanently restricted net (c) accumulations to the permanent endowment required assets is available to support donor-specified programs. by the applicable donor gift instrument. The remaining As of December 31, 2008 and 2007, NAS held the portion of donor-restricted endowment funds that are not following permanently restricted net assets, classified by classified as permanently restricted are classified as the purpose for which the income is to be used (dollars in temporarily restricted net assets until those amounts are thousands): appropriated for expenditure by NAS. In making a determination to appropriate or accumulate, NAS adheres 2008 2007 to the standard of prudence prescribed by the Act and considers the following factors. Sponsored research and advisory programs $109,635 $105,720 Prizes and awards 5,115 5,114 (1) The duration and preservation of the endowment fund; Total permanently restricted net assets $114,750 $110,834 (2) The purposes of the institution and the endowment fund; (b) Endowment Assets (3) General economic conditions; (4) The possible effect of inflation or deflation; In August 2008, FASB Staff Position No. FAS 117-1, (5) The expected total return from income and the Endowments of Not-for-Profit Organizations: Net Asset appreciation of investments; Classification of Funds Subject to an Enacted Version of (6) Other resources of the institution; and the Uniform Prudent Management of Institutional Funds (7) The investment policy of the institution. Act and Enhanced Disclosures for All Endowment Funds (FSP 117-1), was issued, and its guidance is effective for fiscal years ending after December 15, 2008. A key Return Objectives and Strategies component of FSP 117-1 is a requirement to classify the portion of a donor-restricted endowment fund that is not NAS has adopted an investment and spending policy for classified as permanently restricted net assets as tempo- endowment assets that is designed to provide a predict- rarily restricted net assets until appropriated for expendi- able stream of funding to programs supported by the ture. NAS recorded the effect of adopting FSP 117-1 as a endowment while seeking to protect the real purchasing reclassification of unrestricted net assets to temporarily power of the assets from inflation. Accordingly, NAS has restricted net assets of $102.8 million as of January 1, adopted guidelines which feature a material commitment 2008. to equity and equity-like investments. The NAS endowment consists of approximately 100 The asset allocation guidelines are as follows: individual funds established to support general operations, sponsored research and advisory programs, prizes and Asset Category Guideline % awards, and the operations of the Woods Hole facility. The endowment is comprised solely of donor-restricted US Large Stocks 25% endowment funds. The investments of the endowment are US Small-Mid Stocks 12% included in the NAS long-term investment pool, as Non-US Stocks (Developed) 20% described in note 3. Non-US Stocks (Emerging) 8% Real Estate Stocks 5% Interpretation of Relevant Law Total Stocks 70% NAS has interpreted the District of Columbia “Uniform US Fixed/Cash 12% Prudent Management of Institutional Funds Act of 2007” Non-US Fixed 3% (the “Act”) as requiring NAS, absent explicit donor Total Fixed 15% stipulations to the contrary, to act in good faith and with the care that an ordinarily prudent person in a like Hedge Funds 12% position would exercise under similar circumstances in Other Alternative 3% making determinations to appropriate or accumulate Total 100% endowment funds, taking into account both its obligation to preserve the value of the endowment and its obligation to use the endowment to achieve the purposes for which it 52

NAS has adopted a spending policy that limits the annual purchasing power of the endowment assets held in spending to 5 percent of the three-year average fair value perpetuity as well as to provide additional real growth of the participating funds in the endowment portfolio. through new gifts and investment return. This is consistent with NAS’ objective to maintain the Changes in Endowment assets for the fiscal year ended December 31, 2008 are as follows (dollars in thousands): Temporarily Permanently Unrestricted Restricted Restricted Total Endowment assets, January 1, 2008 $ 102,814 $ 124,459 $ 102,351 $ 329,624 Net asset reclassification based on change in law (102,814) 102,814 - - Endowment assets after reclassification - 227,273 102,351 329,624 Investment return: Interest and dividend income - 13,605 - 13,605 Net loss on investments (2,358) (116,239) - (118,597) Total investment return (2,358) (102,634) - (104,992) Contributions - - 6,173 6,173 Amounts appropriated for expenditure - (13,828) - (13,828) Other changes: 2007 Appropriation withdrawn in 2008 - (395) - (395) Unspent purpose restricted appropriations - 1,667 - 1,667 Accrued expenses withdrawn in 2009 - 1,377 - 1,377 Endowment assets, December 31, 2008 $ (2,358) $ 113,460 $ 108,524 $ 219,626 Changes in Endowment assets for the fiscal year ended December 31, 2007 are as follows (dollars in thousands): Temporarily Permanently Unrestricted Restricted Restricted Total Endowment assets, January 1, 2007 $ 93,628 $ 108,827 $ 99,228 $ 301,683 Investment return: Interest and dividend income 8,003 11,567 - 19,570 Net gain on investments 5,524 7,718 - 13,242 Total investment return 13,527 19,285 - 32,812 Contributions - - 3,123 3,123 Amounts appropriated for expenditure (5,704) (6,824) - (12,528) Other changes: Unspent purpose restricted appropriations 1,363 3,171 - 4,534 Endowment assets, December 31, 2007 $ 102,814 $ 124,459 $ 102,351 $ 329,624 Funds with Deficiencies unrestricted net assets. These deficiencies were primarily a result of unfavorable market fluctuations that occurred From time to time, the fair value of assets associated with shortly after the investment of new permanently restricted individual donor-restricted endowment funds may fall contributions. Subsequent gains that restore the fair value below the original value of the gift donated to the of the assets of the endowment fund to the required level permanent endowment. Deficiencies of this nature are will be classified as an increase in unrestricted net assets. reported as unrestricted net assets. At December 31, 2008, There were no such deficiencies as of December 31, NAS had deficiencies of $2.4 million reported as 2007. 53

(10) PROGRAM EXPENSES (12) BUILDING PROJECT AND FINANCING Program expenses for the years ended December 31, 2008 and 2007 are summarized as follows (dollars in thou- (a) Building Project Revenue Bonds sands): In January 1999, the District of Columbia issued Series 2008 2007 1999A, Series 1999B, and Series 1999C tax-exempt revenue bonds in the total amount of $130,960,000 on Transportation Research Board $ 91,742 $ 65,179 behalf of NAS. Proceeds from the sale of the revenue Policy and Global Affairs 53,593 55,911 bonds financed the cost of the acquisition of 44,250 Institute of Medicine 23,154 20,388 square feet of land and related construction of an office Earth and Life Sciences 19,319 19,435 building, as well as paid certain costs of issuing the Engineering and Physical Sciences 19,783 18,839 bonds. This building consolidates most of NAS’ program Behavioral and Social Sciences and Education 9,649 13,886 activities into one location. The facility was occupied in Proceedings of the National Academy of July 2002. Sciences 12,477 12,280 National Academy Press 4,573 5,479 In June 2008, the District of Columbia issued Series National Academy of Engineering 4,641 4,950 2008A tax-exempt revenue bonds in the amount of Koshland Science Museum 1,890 1,932 $66,325,000 on behalf of NAS. The proceeds were used NAS and National Sciences Resource to refund the Series 1999B and Series 1999C revenue Center 6,605 6,885 bonds, as well as pay certain costs of issuing the bonds Total program expenses $247,426 $225,164 NAS is obligated under the revenue bonds as follows (dollars in thousands): (11) RECOVERY OF INDIRECT COSTS 2008 2007 NAS receives indirect cost recovery on its federal Series 1999A revenue bonds, serial, contracts and grants. An overhead assessment is applied interest rate 5%, maturing at various dates from January 1, 2009 through to direct salaries, accrued leave, fringe benefits, and 2012 $ 7,440 $ 9,085 services provided by outside contractors (e.g., temporary Series 1999A revenue bonds, term: personnel agencies, consultants) on NAS property. A Interest rate 5%, due January 1, 2019 17,085 17,085 general and administrative assessment (G&A) is applied Interest rate 5%, due January 1, 2028 32,545 32,545 to direct costs and overhead less subcontract costs and Series 2008A revenue bonds, term, at flexible rates (2.1% in 2008) maturing stipends. Therefore, both the overhead and G&A rates are at various dates from January 1, 2029 applied to projects incurring direct salaries and other through 2039 66,325 - direct costs such as travel. If a program does not require Series 1999B revenue bonds, term, at direct salaries, such as a travel grant program, a subcon- flexible rates (2.6% in 2008 and 3.62% in 2007) due January 1, 2039 - 32,500 tract/flow-through administration rate is applied. Certain Series 1999C revenue bonds, term, at off-site work (not performed on NAS property) is variable rates (2.8% in 2008 and assessed reduced overhead rates. 3.62% in 2007) due January 1, 2039 - 32,500 Total bonds, at face value 123,395 123,715 Less unamortized discount and premium (989) (1,003) NAS bills for indirect cost recovery throughout the year based on negotiated rates. At the end of each year, NAS Total bonds payable 122,406 122,712 Less current portion (included in other compares actual expenses incurred in each of its cost current liabilities) (1,725) (1,645) pools to the amounts recovered based on its billing rates. Bonds payable, long-term $ 120,681 $ 121,067 The difference is recorded as its indirect cost carryfor- ward. If NAS overrecovers on its indirect costs during the year, a liability is recorded. If NAS underrecovers, a The serial and term bonds represent unsecured general receivable is recorded. obligations of NAS. Interest on all Series 1999A revenue bonds is payable NAS has a cumulative net underrecovery of approxi- semiannually every January 1 and July 1. Interest on the mately $7.5 million and $3.1 million as of December 31, 2008A, 1999B and 1999C bonds is payable monthly. 2008 and 2007, respectively, which is included in the contracts receivable balance in the statements of financial The carrying value of bonds payable in the financial position. statements was less than their fair value by approximately 54

$1.1 million and $2.4 million on December 31, 2008 and debt to a variable index to manage fluctuations in cash 2007, respectively. flows resulting from interest rate risk. By using derivative financial instruments to hedge exposures to changes in The term bonds maturing on January 1, 2019, and interest rates, NAS exposes itself to credit risk and market January 1, 2028, are subject to mandatory redemption by risk. Credit risk is the failure of the counterparty to operation of sinking fund installments. The installment perform under the terms of the derivative contract. When payments for the term bonds maturing January 1, 2019, the fair value of a derivative contract is positive, the begin on January 1, 2013, and range from $2.1 to counterparty owes NAS, which creates credit risk for $2.8 million per year through the maturity date. Install- NAS. When the fair value of a derivative contract is ment payments for the term bond maturing January 1, negative, NAS owes the counterparty, and therefore, it 2028, begin on January 1, 2020, and range from $2.9 to does not possess credit risk. NAS minimizes the credit $4.3 million per year through the maturity date. risk in derivative instruments by entering into transactions with high-quality counterparties. Scheduled maturities and sinking fund requirements are as follows (dollars in thousands): NAS entered into a swaption agreement on August 21, 2007 that gives the counterparty the option to require Years ending December 31: NAS to enter into an additional swap agreement related to 2009 $ 1,725 the Series 1999A Revenue Bonds. If executed by the 2010 1,810 counterparty (see note 19), the swap will be effective on 2011 1,905 May 1, 2009 and require NAS to pay 5.00% on a notional amount of $55 million and to receive a floating rate equal 2012 2,000 to 67% of 1-month LIBOR plus 0.41%. The counterparty 2013 2,100 paid NAS a premium of $2.2 million in advance to enter Thereafter 113,855 into this agreement. $ 123,395 Under Statement of Financial Accounting Standards Interest expense on the bonds payable for 2008 and 2007 No. 133 (SFAS 133), Accounting for Derivative Instru- totaled $4.5 million and $5.3 million, respectively. ments and Hedging Activities, the fair value of the swap and swaption must be recorded in the NAS financial (b) Interest Rate Swaps statements. Accordingly, for the years ended Decem- ber 31, 2008 and 2007, NAS recorded a loss on the In October 1999, NAS entered into a swap agreement, change in the fair value of its swap agreement of with an effective date of February 1, 2000, relating to the $803,000 and $185,000, respectively, which is included in $66 million face amount of its Series 1999A revenue other income in the accompanying statements of activi- bonds. The agreement provides for NAS to receive 4.97% ties. The fair value of the interest rate swap was $934,000 in interest on a notional amount of $65 million and to pay and $2.0 million as of December 31, 2008 and 2007, interest at a floating rate option based on the weekly respectively, and is included in contributions and other interest rate resets of tax-exempt variable-rate issues per receivables and other assets on the statements of financial the SIFMA Municipal Swap Index. NAS amended the position. agreement for the 2005-2020 period by agreeing to give up the benefit of any 30-day period during which the The fair value of the swaption at December 31, 2008 and SIFMA index remains below 2.25% for the entire 30 2007 is recorded as a liability of $12.5 million and $4.3 days. Each time this occurs, the rate on the swap portfolio million, respectively, in other long-term liabilities and reverts to the fixed rate noted above for that month only. represents the estimated cost to NAS to cancel the agreement at the reporting date and is based on pricing NAS entered into this swap agreement to manage its models that consider interest rates and other market exposure to interest rate changes. The fixed-rate debt factors. The change in the fair value of the swaption is a obligations expose NAS to variability in the cost recovery net loss of approximately $8.3 million and $2.2 million stream due to changes in interest rates. NAS recovers the for the years ended December 31, 2008 and 2007, costs of borrowing through a capital investment incentive respectively, and is included in other income in the rate that is set by the U.S. government and is tied to a statements of activities. variable index. If interest rates increase, the capital investment incentive recovery increases. Conversely, if interest rates decrease, the capital invest- ment incentive recovery decreases. Therefore, NAS entered into a derivative instrument that ties the fixed-rate 55

(13) NOTE PAYABLE (c) Postretirement and Postemployment Benefits During 2006, NAS entered into a loan agreement with NAS provides certain health and life insurance benefits Bank of America for an amount up to $5 million. The for employees retired due to length of service. All principal balance of this note is payable in equal monthly benefit-eligible employees may become eligible for installments until January 1, 2012. On December 31, 2008 service retiree benefits if they reach age 60 while working and 2007, the principal balance was approximately for NAS and complete 5 years of service in a bene- $2.3 million and $3.0 million, respectively. The note fit-eligible status for medical and life insurance benefits. bears interest at 30-day LIBOR plus 40 basis points. The In addition, certain health and life insurance benefits are interest rate at December 31, 2008 was 0.86%. provided for employees retired due to disability. A benefit-eligible employee may become eligible for disabled retiree benefits if deemed totally disabled under (14) EMPLOYEE BENEFITS NAS’ long-term disability insurance or if they are eligible for disability benefits from the Social Security Admini- (a) Retirement Plans stration. Life insurance benefits are provided based on coverage at date of disability and health insurance may be NAS has a noncontributory defined contribution retire- continued if the disabled retiree had participated in an ment plan covering substantially all of its employees NAS health insurance plan for 5 years at the date of (based on certain benefit eligibility requirements). The disability. Insurance companies whose premiums are plan is intended to qualify under Section 401(a) of the determined on an experience-rated basis provide life and Internal Revenue Code and uses Teachers Insurance and health insurance benefits for retirees. Medicare supple- Annuity Association/College Retirement Equities Fund ment insurance is not experience rated. The retiree (TIAA/CREF) group retirement annuity contracts as the welfare benefit plan is contributory for health insurance investment vehicle. Participants in this plan vest immedi- purposes for employees who retired on or after January 1, ately. NAS has received a favorable determination letter 1990. Participant contributions for health insurance are from the IRS on the qualification of this plan under based on a percentage of the monthly premium paid by Section 401(a) of the Internal Revenue Code. NAS (from 25% to 100%). The participant contribution is also based on their date of retirement, length of service In addition, NAS has a voluntary employee contribution and choice of health insurance carrier. retirement plan that is funded solely by employee contributions made on a pretax salary-reduction basis NAS has elected to recognize the initial postretirement under Section 403(b) of the Internal Revenue Code. The benefit obligation over a period of 20 years. The accrued investment vehicles under this voluntary plan are postretirement benefit obligation is reported in accrued retirement annuity contracts issued by TIAA/CREF and employee benefits on the statements of financial position. mutual funds offered by the Vanguard Group, Inc. In 2006, the Financial Accounting Standards Board issued Pension expense for the years ended December 31, 2008 SFAS No. 158, Employers’ Accounting for Defined and 2007, amounted to approximately $10.3 million and Benefit Pension and Other Postretirement Plans, which $9.8 million, respectively. The NAS policy is to fund NAS has adopted for the year ended December 31, 2007. pension benefits as they are earned. The NAS normal This statement requires that an employer recognize the retirement age is 60, but there is no mandatory age for funded status of its benefit plans in its statement of retirement. financial position and report the corresponding gains and losses in its statement of activities. NAS reported the (b) Deferred Compensation funded status of the accumulated postretirement benefit obligation of $1.8 million as a component of accrued NAS holds long-term investments as part of a frozen employee benefits liability at December 31, 2007. NAS deferred compensation arrangement for certain employ- recorded the effect of adopting SFAS No. 158 of ees. The fair value of these investments was approxi- $604,000 for the year ended December 31, 2007. mately $2.2 million and $4.1 million as of December 31, 2008 and 2007, respectively, which is reported within other assets in the statements of financial position. The related obligation is included in accrued employee benefits in the statements of financial position. 56

The effects of applying SFAS No. 158 on NAS’ financial The following table presents the changes in benefit position as of December 31, 2007 were as follows (dollars obligations, changes in plan assets, funded status, and the in thousands): components of net periodic benefit cost for the year ended December 31, 2008 and 2007 (dollars in thousands): Before SFAS After SFAS No. No. 158 158 2008 2007 Accrued employee benefits $ 5,275 $ 5,879 Change in benefit obligations: Total liabilities 220,887 221,491 Benefit obligation, January 1 $ 16,461 $ 16,525 Service cost 608 660 Total net assets 540,893 540,289 Interest cost 963 927 Post-retirement changes other than net periodic benefit Plan participant contributions 131 117 cost are as follows (dollars in thousands): Actuarial loss (gain) 1,161 (1,152) Benefits paid (732) (616) 2008 Benefits obligation, December 31 18,592 16,461 Net actuarial (gain) loss $ 6,555 Change in plan assets, combined: Recognized actuarial gain (loss) 18 Fair value of plan assets, January 1 14,660 11,920 Recognized prior service (cost) credit (210) Actual return on plan assets (4,325) 797 Recognized net initial asset (obligation) (26) Employer contributions 1,865 2,442 Total $ 6,337 Plan participants contributions - 117 Benefits paid - (616) Items not yet recognized as a component of net periodic Fair value of plan assets, December 31 12,200 14,660 benefit cost at December 31, 2008 and 2007 are as Funded status $ (6,392) $ (1,801) follows (dollars in thousands). Components of net periodic benefit 2008 2007 cost: Service cost $ 608 $ 661 Net actuarial loss (gain) $ 5,447 $ (1,125) Interest cost 963 927 Prior service cost (credit) 1,352 1,562 Expected return on plan assets (1,069) (899) Unrecognized net initial obligation 142 167 Recognized prior service cost (credit) 210 210 Total $ 6,941 $ 604 Recognized actuarial (gain) loss (18) (2) Recognized net initial obligation (asset) 26 26 The estimated amounts, measured at year-end, that are Net periodic benefit cost $ 720 $ 923 expected to be recognized in the net periodic benefit cost over the next fiscal year for the postretirement benefit The assumptions used to determine net periodic benefit plan are as follows (dollars in thousands): cost for years ended December 31, 2008 and 2007 are as follows: 2008 2007 Prior service cost $ 210 $ 210 2008 2007 Recognized actuarial loss (gain) 469 (18) Discount rate 6.00% 6.00% Recognized net initial obligation 26 26 Expected long-term return on plan assets 7.50% 7.50% Total $ 705 $ 218 The assumptions used to calculate the accumulated postretirement benefit obligation for the years ended December 31, 2008 and 2007 are as follows: 2008 2007 Discount rate 6.00% 6.00% 57

NAS postretirement benefit plan asset allocations at gradually to 5% in the year 2019. The healthcare cost December 31, 2008 and 2007, by asset category are as trend rate assumption has a significant impact on the follows: postretirement benefit costs and obligations. The effect of a 1% change in the assumed healthcare cost trend rate at 2008 2007 December 31, 2008, would have resulted in an estimated Cash 3% 11% $1.7 million increase or $1.5 million decrease in the Bonds and notes 11% 15% postretirement benefit obligation and an estimated $201,000 increase or $165,000 decrease in the 2008 Equity securities 86% 74% benefit expense. 100% 100% The effect of a 1% change in the assumed healthcare cost The investment objective of the Plan is to produce a rate trend rate at December 31, 2007, would have resulted in of return over the long term that will provide for fund an estimated $1.5 million increase or $1.3 million growth, protect against the effect of inflation, and provide decrease in the postretirement benefit obligation and an for some stability in different market environments. The estimated $203,000 increase or $167,000 decrease in the fund is diversified between fixed income and equity 2007 benefit expense). investments. With this diversification and investment in broader market funds, there is reasonable assurance that no single security or class of securities will have a (15) CONDITIONAL ASSET disproportionate impact on the Plan assets. The Plan RETIREMENT OBLIGATION assets are invested with a long-term growth strategy, with a 70% equity guideline. In March 2005, the Financial Accounting Standards Board (FASB) issued the FASB Interpretation No. 47 The overall long-term rate of return was developed by (FIN 47). This interpretation clarifies the term “condi- estimating the long-term real rate of return for the Plan’s tional asset retirement obligation” as it is used in FASB asset mix, while taking into account the effects of Statement No. 143, Accounting for Asset Retirement inflation. This estimate was developed by evaluating the Obligations, and requires a liability to be recorded if the history and similar asset allocation of the NAS Endow- fair value of the obligation to retire an asset can be ment. reasonably estimated. Asset retirement obligations covered by FIN 47 include those for which an entity has a NAS expects to contribute to the Plan the actuarially legal obligation to perform an asset retirement activity. determined net periodic cost for 2009, which is approxi- However, the timing and/or method of settling the mately $1,500,000. obligation are conditional on a future event that may or may not be within the control of the entity. The following benefit payments, which reflect future services, are expected to be paid in future years as noted, In accordance with FIN 47, NAS recorded an asset as of December 31, 2008 (dollars in thousands): retirement obligation for which fair value of the liability could be reasonably estimated relating to the regulatory Years ending December 31: remediation of asbestos and other hazardous materials in 2009 $ 906 one of its office buildings. Accordingly, NAS recorded a 2010 1,028 charge to management and general expense of 2011 1,139 $1.5 million for the year ended December 31, 2007. NAS 2012 1,221 recorded a liability for asset retirement obligations of $1.7 million in other long-term liabilities and increased 2013 1,294 the carrying value of the related building assets by 2014-2017 7,115 $364,000, less accumulated depreciation of $291,000. $ 12,703 During 2008, NAS recognized accretion expense of The measurement date of the plan assets and benefit $80,000, increasing the value of the liability to approxi- obligations for 2008 and 2007 is December 31, 2008 and mately $1.8 million at December 31, 2008. There were no 2007, respectively: additional liabilities incurred or settled and no revisions to estimated cash flows in 2008. The trend rate for growth in healthcare costs used in calculating the accumulated postretirement benefit obligation was 8.7% and 9.5% for the years ended December 31, 2008 and 2007, respectively, declining 58

(16) RELATED PARTY TRANSACTIONS Audit Agency, which has completed its examinations through December 31, 2005. A contingency exists The NAS Council has authorized two agreements relating to unexamined periods and final settlements of providing noninterest bearing, collateralized advances to examined periods to refund any amounts received in two employees in connection with the purchase of each excess of allowable costs. Management is of the opinion employee’s residence. The agreements between the that no material liability will result from such audits. parties were executed in May 2005 and May 2007. They each provide that the repayment obligation will be (c) Litigation adjusted to allocate to each party its proportional share of the appreciation or depreciation in the value of the NAS is involved in one litigation matter. While the residence, which is based on the relative financing ultimate outcome of the litigation is uncertain, NAS percentage provided by each party. The agreements will management believes that it has a strong legal position, terminate upon pay-back of the advance, sale of the intends to vigorously defend against any liability, and has property, or the end of each individual’s employment with concluded that the probable outcome will not have a NAS, which will not exceed 12 years. The estimated material impact on NAS. present value of the receivables at December 31, 2008 and 2007, is $3.3 million and $3.5 million, respectively, and is included in other assets on the statements of financial (18) RISKS AND UNCERTAINTIES position. NAS invests in various investment securities. Investment securities are exposed to various risks such as interest (17) COMMITMENTS AND rate, market and credit risks. Due to the level of risk associated with investment securities, it is at least CONTINGENCIES reasonably possible that changes in the values of invest- ment securities will occur in the near term and that such (a) Leases changes could materially affect the amounts reported. NAS is committed to several noncancelable operating leases for office space. Future minimum rental payments due under noncancelable operating leases are as follows (19) SUBSEQUENT EVENT (dollars in thousands): As described in Note 12(b), NAS is party to a swaption agreement. On March 17, 2009, the counterparty exer- Year ending December 31: cised its option to require NAS to enter into an additional 2009 $ 2,440 swap agreement related to the Series 1999A Revenue 2010 2,380 Bonds. The swap becomes effective on May 1, 2009, 2011 2,017 requiring NAS to pay 5.00% on a notional amount of $55 2012 1,686 million and to receive a floating rate equal to 67% of 1- month LIBOR plus 0.41%. 2013 1,730 Thereafter 5,119 On April 30, 2009 the District of Columbia issued $ 15,372 $57.5 million of variable rate tax exempt revenue bonds on behalf of NAS. The proceeds were used to refund the Rental expense amounted to approximately $2.1 million existing Series 1999A fixed rate revenue bonds in the for both years ended December 31, 2008 and 2007, amount of $55.3 million and pay for certain costs of respectively. issuance. (b) Contingencies NAS receives a portion of its revenues directly or indirectly from federal government grants and contracts, all of which are subject to audit by the Defense Contract 59

OFFICERS Ralph J. Cicerone, President Barbara A. Schaal, Vice President John I. Brauman, Home Secretary Michael T. Clegg, Foreign Secretary Jeremiah P. Ostriker, Treasurer FINANCE COMMITTEE Jeremiah P. Ostriker, Chair Elwyn R. Berlekamp Claude R. Canizares Ralph J. Cicerone Ronald L. Graham David M. Kipnis Lawrence R. Klein William J. Rutter Paul A. Samuelson IOM Representative: Gail Cassell BUDGET AND INTERNAL AFFAIRS COMMITTEE Jeremiah P. Ostriker, Chair Rita R. Colwell Sharon R. Long Elliot M. Meyerowitz Stanley B. Prusiner Barbara A. Schaal AUDITING COMMITTEE Purnell W. Choppin, Chair Susan Gottsman Ronald L. Graham Gerald M. Rubin Sean C. Solomon FINANCIAL MANAGEMENT STAFF Julie Englund, Chief Financial Officer Didi Salmon, Controller 60

Report of the Treasurer for the Year Ended December 31, 2008 Get This Book
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This Report of the Treasurer of the National Academy of Sciences presents the financial position and results of operations, as well as a review of the endowment, trust, and other long-term investments pool activities of the Academy for the year ended December 31, 2008.

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