Report of the Treasurer for the Year Ended December 31, 2013 (2014)

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III. Financial Condition 43 

Auditing Committee June 10, 2014 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, 2013, 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, Auditing Committee 44 

KPMG LLP Suite 12000 1801 K Street, NW Washington, DC 20006 Independent Auditors’ Report The Auditing Committee National Academy of Sciences: Report on the Financial Statements We have audited the accompanying financial statements of the National Academy of Sciences (NAS), which comprise the statements of financial position as of December 31, 2013 and 2012, and the related statements of activities, and cash flows for the years then ended, and the related notes to the financial statements. Management’s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with U.S. generally accepted accounting principles; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditors’ Responsibility 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 from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to NAS’ preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of NAS’ internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. KPMG LLP is a Delaware limited liability partnership, the U.S. member firm of KPMG International Cooperative 45 (“KPMG International”), a Swiss entity. 

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, 2013 and 2012, and the changes in its net assets and its cash flows for the years then ended in accordance with U.S. generally accepted accounting principles. May 21, 2014 46 

NATIONAL ACADEMY OF SCIENCES Statements of Financial Position December 31, 2013 and 2012 (In thousands) Assets 2013 2012 Current assets: Cash and cash equivalents $ 3,014 $ 2,429 Short-term investments (notes 3 and 4) 55,656 60,691 Contracts receivable 70,127 87,321 Contributions and other receivables, net (note 6) 37,648 13,931 Other current assets 8,538 6,664 Total current assets 174,983 171,036 Other assets (notes 2, 13, 14, and 16) 8,528 6,366 Long-term investments (notes 3 and 4) 456,322 413,560 Contributions receivable, net (note 6) 454,320 14,950 Property and equipment, net (notes 5 and 15) 178,367 180,790 Einstein Memorial 1,723 1,723 Total assets $ 1,274,243 $ 788,425 Liabilities and Net Assets Liabilities: Current liabilities: Accounts payable and accrued expenses $ 39,326 $ 45,986 Deferred revenue (notes 7 and 12) 33,908 31,703 Lines of credit (note 8) 13,569 35,069 Other current liabilities (note 13) 6,460 5,238 Total current liabilities 93,263 117,996 Bonds payable (note 13) 171,920 175,507 Funds held on behalf of others (notes 3 and 4) 11,109 10,006 Accrued employee benefits (note 14) 1,802 6,934 Other long-term liabilities (notes 2, 13 and 15) 10,762 14,783 Total liabilities 288,856 325,226 Net assets: Unrestricted 107,901 90,167 Temporarily restricted (note 9) 751,544 247,348 Permanently restricted (note 10) 125,942 125,684 Total net assets 985,387 463,199 Commitments and contingencies (notes 3, 12, 13, 14, 17, and 18) Total liabilities and net assets $ 1,274,243 $ 788,425 See accompanying notes to financial statements. 47 

NATIONAL ACADEMY OF SCIENCES Statements of Activities Years ended December 31, 2013 and 2012 (In thousands) 2013 2012 Temporarily Permanently Temporarily Permanently Unrestricted restricted restricted Total Unrestricted restricted restricted Total Revenues, gains, and other support: Government contracts and grants (note 12) $ 231,295 - - 231,295 $ 251,585 - - 251,585 Private contracts and grants 18,551 32,831 - 51,382 17,565 23,136 - 40,701 Gulf Research Program - 471,407 - 471,407 - - - - Other contributions 2,300 1,034 258 3,592 1,817 435 3,683 5,935 Fees and publications 19,966 - - 19,966 17,631 - - 17,631 Investment income (note 3) 12,241 40,874 - 53,115 11,651 29,578 - 41,229 Other income (note 13) 16,709 - - 16,709 13,114 - - 13,114 Net assets released from restriction (note 9) 41,950 (41,950) - - 40,805 (40,805) - - Total revenues, gains, and other support 343,012 504,196 258 847,466 354,168 12,344 3,683 370,195 Expenses (notes 13, 14, and 15): Programs (note 11) 275,482 - - 275,482 289,508 - - 289,508 Management and general 51,947 - - 51,947 56,109 - - 56,109 Fundraising 2,584 - - 2,584 2,355 - - 2,355 Total expenses 330,013 - - 330,013 347,972 - - 347,972 Postretirement changes other than net periodic benefit cost (note 14) (4,735) - - (4,735) (712) - - (712) Change in net assets 17,734 504,196 258 522,188 6,908 12,344 3,683 22,935 Net assets at beginning of year 90,167 247,348 125,684 463,199 83,259 235,004 122,001 440,264 Net assets at end of year $ 107,901 751,544 125,942 985,387 $ 90,167 247,348 125,684 463,199 See accompanying notes to financial statements. 48 

NATIONAL ACADEMY OF SCIENCES Statements of Cash Flows Years ended December 31, 2013 and 2012 (In thousands) 2013 2012 Cash flows from operating activities: Change in net assets $ 522,188 $ 22,935 Adjustments to reconcile change in net assets to net cash provided by (used in) operating activities: Depreciation and amortization 8,253 7,897 Loss on disposal of property and equipment 31 788 Bad debt expense 23 146 Net gain on investments (40,634) (30,193) Net gain on investments held on behalf of others (966) (669) Amounts collected on behalf of others (6,604) (4,178) Amounts remitted on behalf of others 5,395 3,881 Change in value of interest rate swap (4,109) (495) Change in value of split-interest agreements 158 70 Contributions restricted for construction or endowment (2,588) (3,014) (Increase) decrease in assets: Other receivables (463,110) 1,454 Contracts receivable 17,194 5,089 Other current assets (1,874) 920 Other assets (2,312) 692 Increase (decrease) in liabilities: Accounts payable and accrued expenses (6,660) (13,206) Deferred revenue 2,205 (1,394) Other current liabilities 1,986 (284) Funds held on behalf of others 1,103 821 Other long-term liabilities 257 (217) Accrued employee benefits (5,132) (731) Net cash provided by (used in) operating activities 24,804 (9,688) Cash flows from investing activities: Additions to property and equipment (5,992) (29,964) Sales or maturities of investments 206,421 187,021 Purchases of investments (202,411) (183,920) Net cash used in investing activities (1,982) (26,863) Cash flows from financing activities: Contributions restricted for construction or endowment 2,588 3,014 Proceeds from lines of credit 59,500 181,868 Payments on lines of credit (81,000) (167,684) Payments on bank note - (63) Payments on bond principal (3,325) (2,100) Decrease in bond proceeds held by trustee - 22,512 Net cash (used in) provided by financing activities (22,237) 37,547 Net increase in cash and cash equivalents 585 996 Cash and cash equivalents, beginning of year 2,429 1,433 Cash and cash equivalents, end of year $ 3,014 $ 2,429 Supplemental disclosure of cash flow information: Interest paid $ 6,074 $ 5,303 See accompanying notes to financial statements. 49 

NATIONAL ACADEMY OF SCIENCES and the relevant professions. IOM was established as a separate membership organization within NAS. The Notes to financial activities and results of IOM are included in the NAS financial statements. Financial Statements (d) National Academy of Engineering December 31, 2013 and 2012 The National Academy of Engineering (NAE) was established in 1964 under the charter of NAS as a related parallel organization, autonomous in its governance, (1) ORGANIZATION AND RELATED administration, and the selection of its members. NAE ENTITIES shares with NAS the responsibility for advising the federal government on scientific issues. The NAE (a) National Academy of Sciences conducts independent program activities and activities The National Academy of Sciences (NAS) was formed through the NRC. The results of both of these activities under a charter that was passed as an Act of Incorporation are included in the NAS financial statements. by the United States Congress and signed into law on March 3, 1863. NAS operates as a private cooperative (e) National Academy of Engineering Fund society of distinguished scholars engaged in scientific or The National Academy of Engineering Fund (NAEF) is a engineering research, dedicated to the furtherance of separately incorporated not-for-profit organization science and its use for the general welfare. established and controlled by NAE to raise funds to support its goals. The financial activities and results of (b) National Research Council NAEF are not included in the NAS financial statements. Most of the activities undertaken by NAS are carried out through the divisions and boards of the National Research (f) The National Academies’ Corporation Council (NRC). The NRC draws on a wide cross section The National Academies’ Corporation (TNAC) was of the nation’s leading scientists and engineers for separately incorporated in 1986 as a not-for-profit advisory services to government agencies and Congress. corporation for the purpose of constructing and maintain- To respond effectively to both the disciplinary concerns ing a study and conference facility. This facility, the of the research community and the complex interdiscipli- Arnold and Mabel Beckman Center, located in Irvine, nary problems facing American society, NRC performs its California, operates to expand and support the general studies and workshops through the following six major activities of NAS, NRC, IOM, and NAE. TNAC is divisions: controlled by NAS and NAEF. The financial position and results of TNAC are not consolidated in the NAS Behavioral and Social Sciences and Education financial statements. NAS manages the operations of the Earth and Life Studies Beckman Center. TNAC contributed $16,610 and $0 to Engineering and Physical Sciences the NRC for the years ended December 31, 2013 and Policy and Global Affairs 2012, respectively, to be spent on programs conducted in Transportation Research Board whole or in part at the Beckman Center. Gulf Research Program NRC activities are under the control of the NAS govern- (2) SUMMARY OF SIGNIFICANT ance structure and, therefore, are included in the NAS financial statements. ACCOUNTING POLICIES (c) Institute of Medicine (a) Basis of Accounting The Institute of Medicine (IOM), established in 1970, Net assets, revenues, gains, and losses are classified based conducts studies of policy issues related to health and on the existence or absence of donor-imposed restrictions. medicine. IOM issues position statements on these Accordingly, net assets of NAS are classified and policies, cooperates with the major scientific and reported as follows: professional societies in the field, identifies qualified Permanently restricted – Net assets subject to do- individuals to serve on study groups in other organiza- nor-imposed stipulations that they be maintained in tional units, and disseminates information to the public 50 

perpetuity by NAS. Generally, the donors of these assets Allowances are recorded for estimated uncollectible permit NAS to use all or part of the income earned on contributions based upon management’s judgment and related investments for general or specific purposes. analysis of the credit worthiness of the donor, past collection experience, and other relevant factors. Contri- Temporarily restricted – Net assets subject to do- butions to be received after one year are discounted at an nor-imposed stipulations that may or will be met either by appropriate rate commensurate with risks involved. actions of NAS and/or the passage of time. When a donor Amortization of the discount is recorded as additional restriction expires, temporarily restricted net assets are revenue and is used in accordance with donor imposed reclassified to unrestricted net assets. restrictions, if any, on the contributions. These inputs represent Level 3 inputs in the fair value hierarchy. The Unrestricted – Net assets arising from exchange transac- carrying value of contributions receivable approximates tions and contributions not subject to donor-imposed fair value because of the relatively short maturity of these stipulations. assets. (b) Cash Equivalents NAS performs certain fundraising activities on behalf of NAEF. NAS collected a total of $6.3 million and $3.9 NAS reports liquid, temporary investments purchased million in 2013 and 2012, respectively, on behalf of with original maturities of three months or less as cash NAEF. NAS disbursed $5.4 million and $3.8 million to equivalents. NAEF from these collected amounts in 2013 and 2012, respectively. Amounts collected but not yet remitted to (c) Investments NAEF are included in other current liabilities in the Investments are stated at fair value. Changes in the fair statements of financial position. value of investments are reported within investment Gulf Research Program revenue relates to two agreements income in the statements of activities. between NAS and BP Exploration and Production, Inc. Certain investments are pooled for long-term investment (BP) and Transocean Deepwater Inc. (Transocean), purposes. Investments in the pool are administered as an respectively. As a result of separate plea agreements open-end investment trust, with shares of the pool funds between those corporations and the federal government expressed in terms of participating capital units (PCUs). related to the 2010 Deepwater Horizon disaster, NAS was PCU values are used to determine equity in the allocation asked to establish a program focused on human health and of investment income among funds in the pool whenever environmental protection in the Gulf of Mexico. BP will additional funds are contributed or withdrawn. pay $350.0 million over five years, and Transocean will pay $150.0 million over four years, to fund this 30-year, (d) Contributions $500.0 million program. The present value of these payments is $471.4 million as of December 31, 2013. The Contributions, including unconditional promises to give, unpaid balance due for each agreement is reflected in are recognized as revenues in the period received. contributions and other receivables, net and contributions Conditional promises to give are not recognized until all receivable, net in the statement of financial position as of conditions are substantially met. December 31, 2013. Revenues from nonfederal grants qualifying as contribu- (e) Contracts and Grants tions are recorded by NAS upon notification of the grant award. Such grants are classified as temporarily restricted The majority of NAS activities are performed under net assets when use of the grant funds is limited to cost-reimbursable contracts and grants with the specific areas of study or is designated for use in future U.S. government. For the years ended December 31, 2013 periods. and 2012, the Department of Transportation provided 48% and 40%, respectively, of NAS government contract Gifts of land, buildings, or equipment are reported as and grant revenue. unrestricted net assets unless explicit donor stipulations specify how the donated assets must be used. Temporary NAS records federal contracts and grants as exchange restrictions on gifts that must be used to acquire transactions, recognizing revenue as recoverable costs are long-lived assets are released in the period in which the incurred. Revenues from nonfederal contracts and grants assets are acquired or placed in service. classified as exchange transactions are also recognized as recoverable costs are incurred. 51 

Contracts receivable consisted of $21.1 million of billed (i) Deferred Revenue receivables and $49.0 million of unbilled receivables as of December 31, 2013. Contracts receivable consisted of For both federal and nonfederal grants and contracts that $33.7 million of billed receivables and $53.6 million of are determined to be exchange transactions, revenue is unbilled receivables as of December 31, 2012. recognized as the related costs are incurred. Funds received in advance of being earned for these grants are (f) Inventories recorded as deferred revenue in the statements of financial position. Inventories are stated at the lower of cost or net realizable value and include both work in-process and finished (j) Income Taxes goods related to publication activities. The majority of NAS publication inventories and supplies reside with an NAS is exempt from federal income taxes under Sec- NAS unit, the National Academy Press (NAP). NAP uses tion 501(c)(3) of the Internal Revenue Code, except for the full absorption costing methodology in pricing unrelated business income. NAS recognizes the effect of finished products. This methodology includes direct income tax positions only if those positions are more printing and related indirect costs. Inventories are likely than not of being sustained. NAS does not believe included in other current assets in the statements of its financial statements include any uncertain tax posi- financial position. tions. (g) Property and Equipment (k) Risks and Uncertainties Depreciation of NAS buildings and equipment is NAS invests in various investment securities. Investment computed on a straight-line basis using the following securities are exposed to various risks such as interest lives: rate, market and credit risks. Due to the level of risk associated with investment securities, it is at least Asset Class Depreciable Lives reasonably possible that changes in the values of invest- Buildings 40 years ment securities will occur in the near term and that such Buildings and leasehold Lesser of the remaining changes could materially affect the amounts reported. improvements life of the building or improvement (l) Recently Adopted Accounting Pronouncements Furniture and equipment 4 to 10 years Capitalized software 3 to 10 years Effective December 31, 2012, NAS applied the guidance in Financial Accounting Standards Board (FASB) The Einstein Memorial sculpture is valued at cost and is Accounting Standards Update 2011-04, Fair Value not depreciated. Work-in-progress is not depreciated until Measurement (Topic 820): Amendments to Achieve the related assets are placed in service. Capitalized Common Fair Value Measurement and Disclosure software is amortized over its depreciable life when it is Requirements in U.S. GAAP and IFRSs. This update ready for its intended use and placed in service. provides guidance on how fair value measurement should be applied where existing GAAP already requires or (h) Split-Interest Agreements permits fair value measurements. In addition, this guidance requires expanded disclosures regarding fair Charitable gift annuity agreements are classified as other value measurements. The adoption of the measurement assets and other long-term liabilities in the statements of guidance did not have a material impact on the financial financial position. Periodically, NAS pays a fixed amount statements. of the assets to the beneficiary designated by the donor. Upon termination of an annuity, the remainder interest in (m) Use of Estimates the assets is available for use by NAS as restricted or unrestricted assets in accordance with the donor’s The preparation of these financial statements in conformi- designation. At December 31, 2013 and 2012, NAS had ty with U.S. generally accepted accounting principles charitable gift annuity assets of $2.9 million and requires management to make certain estimates and $2.1 million, respectively. NAS has recorded a liability of assumptions. These estimates and assumptions may affect $1.6 million and $1.3 million at December 31, 2013 and the reported amounts of assets and liabilities and disclo- 2012, respectively, representing the present value of sures in the financial statements. Actual results could estimated future cash payments to annuitants based on the differ from those estimates. annuitant’s life expectancy. 52 

(3) INVESTMENTS ended December 31, 2013 and 2012, respectively, and is comprised of the following (in thousands): Investments, which are reported at fair value (except as noted), consisted of the following as of December 31, 2013 2012 2013 and 2012 (in thousands): Interest and dividends income $ 12,481 $ 11,036 Net gain on investments 40,634 30,193 2013 2012 Total investment income $ 53,115 $ 41,229 Short-term investments: Cash equivalents $ 8,114 $ 5,520 Bonds and notes 35,760 45,269 Equity 11,782 9,902 (4) FAIR VALUE MEASUREMENTS Total short-term investments $ 55,656 $ 60,691 Fair value is defined as the exchange price that would be Long-term investments: received for an asset or paid to transfer a liability (an exit Investment pool, including endowment assets: price) in the principal or most advantageous market for Cash equivalents $ 4,490 $ 5,413 the asset or liability in an orderly transaction between Bonds and notes 40,507 23,302 market participants on the measurement date. FASB ASC Equity 298,279 259,788 Topic 820 establishes a fair value hierarchy, which requires an entity to maximize the use of observable Hedge funds 54,157 66,790 inputs and minimize the use of unobservable inputs when Private equity 15,070 20,657 measuring fair value. The standard describes three levels 412,503 375,950 of inputs that may be used to measure fair value: Gulf Research Program investments: Level 1: Quoted prices in active markets for identical Cash equivalents 29 - assets or liabilities. Bonds and notes 2,522 - Equity 2,902 - Level 2: Observable inputs other than Level 1 prices such 5,453 - as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that Other long-term investments: are observable or can be corroborated by observable Cash equivalents 247 1,549 market data for substantially the full term of the assets or liabilities. Bonds and notes 17,453 17,163 Equity 20,666 18,898 Level 3: Unobservable inputs that are supported by little 38,366 37,610 or no market activity and that are significant to the fair Total long-term investments $ 456,322 $ 413,560 value of the assets or liabilities. The following discussion describes the valuation method- TNAC, a related entity, invests certain of its assets in the ologies used for financial assets measured at fair value. NAS long-term investment pool. TNAC investments The techniques utilized in estimating the fair values are participate in the investment pool proportionally with all affected by the assumptions used, including discount rates other funds in this pool. and estimates of the amount and timing of future cash flows. Care should be exercised in deriving conclusions The NAS obligation to TNAC for these funds held in about NAS’ business, its value or financial position based trust, which totaled approximately $11.1 million and on the fair value information of financial assets presented $10.0 million as of December 31, 2013 and 2012, below. respectively, is reported as funds held on behalf of others in the statements of financial position. Fair value estimates are made at a specific point in time, based on available market information and judgments Investment income is reported net of investment expenses about the financial asset, including estimates of timing, of approximately $709,000 and $699,000 for the years amount of expected future cash flows and the credit 53 

standing of the issuer. In some cases, the fair value investment fund managers include estimates, appraisals, estimates cannot be substantiated by comparison to assumptions and methods that are reviewed by manage- independent markets. In addition, the disclosed fair value ment. When necessary, NAS adjusts NAV for contribu- may not be realized in the immediate settlement of the tions and distributions subsequent to the latest NAV financial asset. Furthermore, the disclosed fair values do valuation date when calculating fair value. NAS analyzes not reflect any premium or discount that could result from the NAVs provided by alternative investment fund offering for sale at one time an entire holding of a managers on a regular basis considering relevant econom- particular financial asset. Potential taxes and other ic and market conditions, applicable benchmarks and our expenses that would be incurred in an actual sale or understanding of the nature and related risks of the settlement are not reflected in amounts disclosed. investments. Since the most significant valuation inputs are not observable in the marketplace, the alternative The following methods, assumptions, and inputs were investment valuations are disclosed in Level 2 or Level 3. used to estimate the fair value of each class of financial The distinction is that those funds which are available for instruments: redemption in the near term at NAV are included in Level 2. The carrying value of cash equivalents such as money market funds approximates the fair value because of the Charitable gift annuity investments and deferred compen- short maturity of these investments. These amounts are sation investments are held in debt and equity mutual disclosed in Level 1. funds along with some U.S. Treasury securities, all of which are included in Level 1. The deferred compensation NAS’ fixed maturity investments (bonds and notes) obligation to employees is equal to the fair value of the include U.S. Treasury securities, mortgage-backed investments held and is disclosed in the same levels as the securities, corporate bonds, and mutual funds that invest investment assets. in these types of securities. Other than U.S. Treasury securities and mutual funds, these investments generally NAS has interest rate swap agreements covering the do not trade on a daily basis. The fair value estimates of variable-rate bonds payable. The fair value of the swaps such debt securities are based on prices provided by NAS’ are determined using pricing models based on observable investment managers and custodian bank. Both the market data such as prices of instruments with similar investment managers and the custodian bank use a variety maturities and characteristics, interest rate yield curves, of pricing sources to determine market valuations. Each and measures of interest rate volatility. The value was designate specific pricing services or indexes for each determined after considering the potential impact of sector of the market based upon the provider’s expertise. collateralization and netting agreements, adjusted to NAS’ debt securities portfolio is highly liquid, which reflect nonperformance risk of both the counterparty and allows for a high percentage of the portfolio to be priced NAS. Accordingly, the interest rate swaps are included in through pricing services. Accordingly, the estimates of Level 2. fair value for such debt securities are included in Level 2 inputs. The estimated values of U.S. Treasury securities The funds held on behalf of others liability approximates and debt mutual funds are based on actively traded market the investments held in NAS’ long-term investment pool prices and are accordingly included in the bonds and on behalf of TNAC. Therefore, the liability is disclosed in notes amount in Level 1. the same levels as the investment assets. Fair values of exchange-traded equity securities and NAS’ policy is to recognize transfers between levels of mutual funds that invest in equity securities have been the fair value hierarchy as of the end of the reporting determined by NAS from observable market quotations period in which the event or change in circumstances on major trade exchanges. Accordingly, such equity occurred. During 2013 certain amounts were transferred securities are disclosed in Level 1. from level 3 to level 2 due to the ability to redeem the investments within the near term as of December 31, 2013 Fair value of alternative investments including private and certain amounts were transferred from level 2 to level equity securities and hedge funds is based on the alterna- 3 due to investment of cash held by the fund manager at tive investment fund managers’ net asset value (NAV). December 31, 2012. There were no transfers among levels Private equity investments are comprised of limited during 2012. partnership interests. Valuations provided by alternative 54 

The following table presents NAS’ fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis at December 31, 2013 (in thousands): Fair Fair value measurements using value Level 1 Level 2 Level 3 Financial Assets: Short-term and long-term investments: Cash equivalents $ 12,880 $ 12,880 $ - $ - Bonds and notes U.S. treasuries/government bonds 4,110 4,110 - - Mortgage-backed securities 41,591 16,804 24,787 - Corporate bonds 24,635 12,373 12,262 - Non-U.S. fixed income 25,906 25,906 - - Equity U.S. large equity 69,006 69,006 - - Long/short equity funds 50,689 - 50,689 - U.S. small/mid equity 64,399 64,399 - - Non-U.S. equity (developed) 83,007 83,007 - - Non-U.S. equity (emerging) 52,508 52,508 - - Real estate 14,020 14,020 - - Hedge funds Multi-strategies/multi-vehicle 47,924 - 16,965 30,959 Fixed income single strategy 4,858 - 4,858 - Commodity futures contracts 1,375 1,375 - - Private equity Asia 11,967 - - 11,967 Global 2,199 - - 2,199 Domestic 904 - - 904 Total short-term and long-term invest- ments 511,978 356,388 109,561 46,029 Charitable gift annuity assets: Cash equivalents 172 172 - - Bonds and notes U.S. treasuries/government bonds 209 209 - - Mortgage-backed securities 471 43 428 - Corporate bonds 130 130 - - Non-U.S. fixed income 151 151 - - Equity U.S. large equity 735 735 - - U.S. small/mid equity 487 487 - - Non-U.S. equity (developed) 232 232 - - Non-U.S. equity (emerging) 156 156 - - Real estate 117 117 - - Total charitable gift annuity assets 2,860 2,432 428 - Deferred compensation assets: Cash equivalents 306 306 - - Bonds and notes Corporate bonds 157 157 - - Equity U.S. large equity 390 390 - - U.S. small/mid equity 596 596 - - Non-U.S. equity (developed) 232 232 - - Total deferred compensation assets 1,681 1,681 - - Total financial assets $ 516,519 $ 360,501 $ 109,989 $ 46,029 55 

Fair Fair value measurements using (Continued) value Level 1 Level 2 Level 3 Financial Liabilities: Funds held on behalf of others $ 11,109 $ 7,915 $ 1,954 $ 1,240 Deferred compensation liability 1,681 1,681 - - Interest rate swaps 9,304 - 9,304 - Total financial liabilities $ 22,094 $ 9,596 $ 11,258 $ 1,240 The following table presents NAS’ fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis at December 31, 2012 (in thousands): Fair Fair value measurements using value Level 1 Level 2 Level 3 Financial Assets: Short-term and long-term investments: Cash equivalents $ 12,482 $ 12,482 $ - $ - Bonds and notes U.S. treasuries/government bonds 7,610 7,610 - - Mortgage-backed securities 31,946 1,020 30,926 - Corporate bonds 23,935 12,458 11,477 - Non-U.S. fixed income 22,243 22,243 - - Equity U.S. large equity 70,411 70,411 - - Long/short equity funds 33,597 - 24,768 8,829 U.S. small/mid equity 46,789 46,789 - - Non-U.S. equity (developed) 74,407 65,040 9,367 - Non-U.S. equity (emerging) 50,007 50,007 - - Real estate 13,377 13,377 - - Hedge funds Fund of funds – multi-strategies 27,175 - 27,175 - Multi-strategies/multi-vehicle 35,170 - 22,965 12,205 Fixed income single strategy 4,445 - 4,445 - Private equity Asia 16,360 - - 16,360 Global 2,999 - - 2,999 Domestic 1,298 - - 1,298 Total short-term and long-term investments 474,251 301,437 131,123 41,691 Charitable gift annuity assets: Cash equivalents 39 39 - - Bonds and notes U.S treasuries/government bonds 153 153 - - Mortgage-backed securities 340 340 - - Corporate bonds 105 105 - - Equity U.S. small/mid equity 1,477 1,477 - - Total charitable gift annuity assets 2,114 2,114 - - Deferred compensation assets: Cash equivalents 61 61 - - Bonds and notes Corporate bonds 344 344 - - 56 

Fair Fair value measurements using (Continued) value Level 1 Level 2 Level 3 Equity U.S. large equity 169 169 - - U.S. small/mid equity 967 967 - - Non-U.S. equity (developed) 231 231 - - Total deferred compensation assets 1,772 1,772 - - Total financial assets $ 478,137 $ 305,323 $ 131,123 $ 41,691 Financial Liabilities: Funds held on behalf of others $ 10,006 $ 6,535 $ 2,361 $ 1,110 Deferred compensation liability 1,806 1,806 - - Interest rate swaps 13,589 - 13,589 - Total financial liabilities $ 25,401 $ 8,341 $ 15,950 $ 1,110 The following table presents the changes in Level 3 assets measured at fair value on a recurring basis for the year ended December 31, 2013 (in thousands): Balance Net gain Transfers Balance beginning (loss) on into/ end of of year investments (out of) year Purchases Sales level 3 Equity: Long/short equity funds $ 8,829 $ 2,774 $ - $ - $ (11,603) $ - Hedge funds: Multi-strategies/multi-vehicle 12,205 2,754 4,500 - 11,500 30,959 Private equity: Asia 16,360 (2,841) 953 (2,505) - 11,967 Global 2,999 (269) - (531) - 2,199 Domestic 1,298 67 - (461) - 904 $ 41,691 $ 2,485 $ 5,453 $ (3,497) $ (103) $ 46,029 The following table presents the changes in Level 3 assets measured at fair value on a recurring basis for the year ended December 31, 2012 (in thousands): Balance Net gain Transfers Balance beginning (loss) on into/ end of of year investments (out of) year Purchases Sales level 3 Equity: Long/short equity funds $ 7,725 $ 1,104 $ - $ - $ - $ 8,829 Hedge funds: Multi-strategies/multi-vehicle 11,223 982 - - - 12,205 Private equity: Asia 20,450 (3,836) 967 (1,221) - 16,360 Global 3,560 (23) - (538) - 2,999 Domestic 1,545 (109) - (138) - 1,298 $ 44,503 $ (1,882) $ 967 $ (1,897) $ - $ 41,691 Gains and losses included in changes in net assets are presented in investment income in the statements of activities. Level 3 assets had unrealized gains of approximately $2.5 million and unrealized losses of approximately $1.9 million, respectively, for the years ended December 31, 2013 and 2012. 57 

The following table presents the nature and risk of assets with fair values estimated using NAV held at December 31, 2013 (in thousands): Unfunded Redemption notice Fair value commitments Redemption frequency period Long/short equity funds – U.S. large equity (a) $ 39,274 N/A Quarterly/Annually 45 days/365 days Long/short equity funds – Non- U.S. equity (developed) (b) 11,415 N/A Monthly 45 days Hedge fund – multi-strategies/multi-vehicle (c) 47,924 N/A Quarterly/Annually 45 days/365 days Hedge fund – fixed income single strategy (d) 4,858 N/A Quarterly 30 days Private equity – Asia (e) 11,967 4,998 N/A N/A Private equity – Global (f) 2,199 229 N/A N/A Private equity – Domestic (g) 904 303 N/A N/A Total $ 118,541 $ 5,530 Notes: (d) This class includes an investment in a single strategy hedge fund focused on undervalued fixed income (a) This category relates to long-short equity hedge funds securities. Investments held by this fund consist of U.S. comprised of equity investments in U.S. large cap. Each government agency mortgage-backed securities and of these funds buys investments long and sells short with derivatives, primarily in the form of collateralized the ability to use leverage. These funds can also invest in mortgage obligations. Securities are generally held in the derivative instruments such as forward, futures and option portfolio as long as interest rates and repayment rates are contracts. The fair values of the investments in this unfolding as anticipated. The majority of the investment category have been estimated using the net asset value per return is expected to come from trading mortgage-backed share of the investments. All of the investments in this securities in an attempt to maximize interest income. The category are redeemable within the near term from fair value of the investment in this class has been December 31, 2013. estimated using the NAV per share of the investment. The investment in this category is redeemable within the near (b) This category relates to a long-short equity hedge fund term from December 31, 2013. comprised of equity investments in Non-U.S. developed countries. This fund buys investments long and sells short (e) This class includes several private equity funds that with the ability to use leverage. This fund can also invest invest in equity, debt or debt-oriented instruments, in derivative instruments such as forward, futures and primarily in privately held companies which own or option contracts. The fair value of the investment in this contractually control operating entities located in the category has been estimated using the net asset value per People’s Republic of China and India. Investments held in share of the investment. The investment in this category is India primarily include equity securities of “early to early redeemable within the near term from December 31, growth stage” companies in multiple sectors, except real 2013. estate. The fair values of these investments have been estimated using the NAV of NAS’ ownership interest in (c) This class includes investments in multi-strategy, partners’ capital. These investments can never be multi-vehicle hedge funds with the objective of maximiz- redeemed with the funds. Instead, the nature of the ing long-term, risk-adjusted returns and capital apprecia- investments in this class is that distributions are received tion by investing in securities, investment funds, discre- through liquidation of the underlying assets of the funds. tionary accounts, and investment partnerships across a It is estimated that the underlying assets of the funds will broad range of marketable and alternative asset classes. be liquidated over 1 to 9 years. Asset classes include domestic and international marketa- ble equity securities, hedged equity, real estate, natural (f) This class includes several global private equity funds resource, fixed income, and private equity and absolute with diverse portfolios consisting primarily of venture return strategies, primarily focused in the United States. capital funds, leveraged buyout funds, mid-stage growth The fair values of the investments in this class have been capital funds, and international private equity funds. estimated using the NAV per share of the investments. These investments are focused on several industries Approximately $17.0 million of investments in this including, but not limited to, insurance, services, and category are redeemable within the near term from consumer-related industries. The fair values of these December 31, 2013. investments have been estimated using the NAV of NAS’ 58 

ownership interest in partners’ capital. These investments receivable (long-term) in the statements of financial can never be redeemed with the funds. Instead, the nature position, and mature as follows (in thousands): of the investments in this class is that distributions are received through liquidation of the underlying assets of Less than one year $ 36,316 the funds. It is estimated that the underlying assets of the One to five years 483,428 funds will be liquidated over 1 to 2 years. 519,744 (g) This class includes several domestic private equity Less: Discount at rates from 0.73% to 6.75% to estimated funds which make investments in domestic equity net present value (29,108) securities, warrants or other securities that are generally Allowance for uncollectible contributions (845) not actively traded at the time of investment. These investments are focused on several industries including, 489,791 but not limited to, insurance, financial services, consum- Less current portion (35,471) er-related, and communications. The fair values of these Total contributions receivable, long-term $ 454,320 investments have been estimated using the NAV of NAS’ ownership interest in partners’ capital. These investments As of December 31, 2013, 95% of contributions receiva- can never be redeemed with the funds. Instead, the nature ble was due from two corporations. NAS does not of the investments in this class is that distributions are believe there is any significant risk associated with received through liquidation of the underlying assets of collection of these receivables. the funds. It is estimated that the underlying assets of the funds will be liquidated over 1 year. At December 31, 2012, the discount on contributions receivable was approximately $894,000 at rates ranging from 0.73% to 6.75% and the allowance for uncollectible (5) PROPERTY AND EQUIPMENT contributions was approximately $845,000. Property and equipment as of December 31, 2013 and 2012, is comprised of the following (in thousands): (7) DEFERRED REVENUE 2013 2012 Deferred revenue consisted of the following as of Land $ 29,689 $ 29,689 December 31, 2013 and 2012 (in thousands): Furniture and equipment 31,564 31,167 Buildings and improvements 177,074 174,395 2013 2012 Capitalized software 13,812 13,291 Advances from private grants and contract sponsors $19,020 $16,767 Work in progress 1,825 312 Advances from U.S. government sponsors 8,032 8,368 Leasehold improvements 3,327 3,327 Publication subscriptions and other 6,856 6,568 257,291 252,181 Less accumulated depreciation and Total deferred revenue $33,908 $31,703 amortization (78,924) (71,391) Total property and equipment, net $ 178,367 $ 180,790 (8) LINES OF CREDIT (6) CONTRIBUTIONS RECEIVABLE Until December 2012, NAS was party to a $34 million unsecured line of credit from Bank of America, which Contributions not yet collected are included in contribu- bore interest at LIBOR plus 0.65%. NAS was also party tions and other receivables (current) and contributions 59 

to a $15 million unsecured line of credit from Wells (10) ENDOWMENT Fargo, which bore interest at LIBOR plus 0.65%. (a) Permanently Restricted Net Assets In December 2012, NAS terminated the lines of credit with Bank of America and Wells Fargo and entered into The income generated by permanently restricted net two new line of credit agreements. Under the new lines of assets is available to support donor-specified programs. credit, NAS is party to a $55 million line of credit from As of December 31, 2013 and 2012, NAS held the Wells Fargo, which bears interest at LIBOR plus 0.55% following permanently restricted net assets, classified by and expires on March 3, 2014, and a $15 million line of the purpose for which the income is to be used (in credit from TD Bank, which bears interest at LIBOR plus thousands): 0.55% and expires on August 31, 2014. NAS has pledged and granted to each bank a security interest in NAS’ gross 2013 2012 revenues. Sponsored research and advisory programs $ 84,918 $ 84,505 General Endowment 32,368 32,524 Interest expense related to the lines of credit for the years Prizes and awards 5,117 5,116 ended December 31, 2013 and 2012, was approximately $304,000 and $213,000, respectively. Woods Hole facility 3,539 3,539 Total permanently restricted net assets $125,942 $125,684 (9) TEMPORARILY RESTRICTED NET (b) Endowment Assets ASSETS The NAS endowment consists of approximately 115 Temporarily restricted net assets were available for the individual funds established to support general operations, following purposes as of December 31, 2013 and 2012 sponsored research and advisory programs, prizes and (in thousands): awards, and the operations of the Woods Hole facility. The endowment is comprised solely of donor-restricted 2013 2012 endowment funds. The investments of the endowment are Gulf Research Program $470,491 $ - included in the NAS long-term investment pool, as Other sponsored research and advisory programs 164,977 143,984 described in note 3. General endowment 82,562 74,007 Interpretation of Relevant Law Prizes and awards 29,958 26,334 Woods Hole facility 3,556 3,023 NAS has interpreted the District of Columbia “Uniform Total temporarily restricted net assets $751,544 $247,348 Prudent Management of Institutional Funds Act of 2007” (the Act) as requiring NAS, absent explicit donor stipulations to the contrary, to act in good faith and with Temporarily restricted net assets were released from the care that an ordinarily prudent person in a like restriction for the following purposes during the years position would exercise under similar circumstances in ended December 31, 2013 and 2012 (in thousands): making determinations to appropriate or accumulate endowment funds, taking into account both its obligation 2013 2012 to preserve the value of the endowment and its obligation to use the endowment to achieve the purposes for which it Gulf Research Program $ 1,372 $ - was donated. NAS classifies as permanently restricted net Other sponsored research and advisory programs 34,973 35,561 assets (a) the original value of gifts donated to the General endowment 4,524 4,203 permanent endowment, (b) the original value of subse- Prizes and awards 812 779 quent gifts to the permanent endowment, and (c) accumulations to the permanent endowment required Woods Hole facility 269 262 by the applicable donor gift instrument. The remaining Total temporarily restricted net assets released from restriction $ 41,950 $ 40,805 portion of donor-restricted endowment funds that are not classified as permanently restricted are classified as 60 

temporarily restricted net assets until those amounts are The asset allocation guidelines are as follows: appropriated for expenditure by NAS. In making a determination to appropriate or accumulate, NAS adheres Guideline Asset category percentage to the standard of prudence prescribed by the Act and U.S. large equity 19% considers the following factors: U.S. small/mid cap equity 9 (1) The duration and preservation of the endowment Non-U.S. equity (developed) 20 fund; Non-U.S. equity (emerging) 15 (2) The purposes of the institution and the endowment Real estate 3 fund; Total equity 66 (3) General economic conditions; (4) The possible effect of inflation or deflation; U.S. fixed income/cash 9 (5) The expected total return from income and the Non-U.S. fixed income 5 appreciation of investments; Total fixed 14 (6) Other resources of the institution; and (7) The investment policy of the institution. Multi-strategy and private equity funds 20 Total 100% Return Objectives and Strategies NAS has adopted an investment and spending policy for NAS has adopted a spending policy that limits the annual endowment assets that is designed to provide a predicta- spending to 5% of the three-year average fair value of the ble stream of funding to programs supported by the participating funds in the endowment portfolio. This is endowment while seeking to protect the real purchasing consistent with NAS’ objective to maintain the purchas- power of the assets from inflation. Accordingly, NAS has ing power of the endowment assets held in perpetuity as adopted guidelines which feature a material commitment well as to provide additional real growth through new to equity and equity-like investments. gifts and investment return. Changes in endowment assets for the fiscal year ended December 31, 2013 are as follows (in thousands): Temporarily Permanently Unrestricted restricted restricted Total Endowment assets, beginning of year $ (2) $ 172,129 $ 122,831 $ 294,958 Investment return: Interest and dividend income - 8,298 - 8,298 Net gain on investments 2 28,266 - 28,268 Total investment return 2 36,564 - 36,566 Contributions - 703 2,312 3,015 Amounts appropriated for expenditure - (11,614) - (11,614) Other changes: 2012 appropriation expended in 2013 - (6,124) - (6,124) Unspent purpose restricted appropriations - 8,000 - 8,000 Accrued expenses withdrawn in 2014 - (1) - (1) Endowment assets, end of year $ - $ 199,657 $ 125,143 $ 324,800 61 

Changes in endowment assets for the fiscal year ended December 31, 2012 are as follows (in thousands): Temporarily Permanently Unrestricted restricted restricted Total Endowment assets, beginning of year $ (160) $ 155,031 $ 119,817 $ 274,688 Investment return: Interest and dividend income - 7,262 - 7,262 Net gain on investments 158 19,459 - 19,617 Total investment return 158 26,721 - 26,879 Contributions - - 3,014 3,014 Amounts appropriated for expenditure - (10,681) - (10,681) Other changes: 2011 appropriation expended in 2012 - (5,066) - (5,066) Unspent purpose restricted appropriations - 5,864 - 5,864 Accrued expenses withdrawn in 2013 - 260 - 260 Endowment assets, end of year $ (2) $ 172,129 $ 122,831 $ 294,958 Funds with Deficiencies (11) PROGRAM EXPENSES From time to time, the fair value of assets associated Program expenses for the years ended December 31, with individual donor-restricted endowment funds may 2013 and 2012 are summarized as follows (in thou- fall below the original value of the gift donated to the sands): permanent endowment. Deficiencies of this nature are reported as unrestricted net assets. At December 31, 2013 2012 2013, there were no endowment funds with a fair value Transportation Research Board $110,658 $100,840 below the original value of the gift. At December 31, Policy and Global Affairs 60,479 66,521 2012, there was one endowment fund with a fair value Institute of Medicine 31,267 45,779 below the original value of the gift. This deficiency was Earth and Life Studies 16,317 17,688 primarily a result of unfavorable market fluctuations that occurred shortly after the investment of new Engineering and Physical Sciences 15,553 17,828 Behavioral and Social Sciences and permanently restricted contributions. Subsequent gains Education 11,404 10,825 that restored the fair value of the assets of the endow- Proceedings of the National Academy of ment fund to the required level were classified as an Sciences 13,746 12,968 increase in unrestricted net assets. National Academy Press 3,358 3,096 National Academy of Engineering 2,918 3,879 Koshland Science Museum 1,250 2,307 Gulf Research Program 934 - NAS 7,598 7,777 Total program expenses $275,482 $289,508 62 

(12) RECOVERY OF INDIRECT COSTS to refund the Series 1999B and Series 1999C revenue bonds, as well as pay certain costs of issuing the bonds. NAS receives indirect cost recovery on its federal contracts and grants. An overhead assessment is applied In April 2009, the District of Columbia issued Se- to direct salaries, accrued leave, fringe benefits, and ries 2009A tax-exempt revenue bonds in the amount of services provided by outside contractors (e.g., tempo- $57,500,000 on behalf of NAS. The proceeds were used rary personnel agencies, consultants) on NAS property. to refund the Series 1999A revenue bonds, as well as A general and administrative assessment (G&A) is pay certain costs of issuing the bonds. applied to direct costs and overhead less subcontract costs and stipends. Therefore, both the overhead and In May 2010, the District of Columbia issued Se- G&A rates are applied to projects incurring direct ries 2010A tax-exempt revenue bonds in the amount of salaries and other direct costs such as travel. If a $59,550,000 on behalf of NAS. These bonds were sold program does not require direct salaries, such as a travel to finance the cost to restore the NAS headquarters grant program, a subcontract/flow-through administra- building on Constitution Avenue in Washington, D.C. tion rate is applied. Certain off-site work (not performed and pay for certain costs of issuance. The restoration on NAS property) is assessed reduced overhead rates. was completed in 2012. NAS bills for indirect cost recovery throughout the year In December 2012, NAS remarketed the Series 2008A based on negotiated rates. At the end of each year, NAS and 2009A bonds as direct bank purchases. The Series compares actual expenses incurred in each of its cost 2008A bonds were purchased by Wells Fargo Municipal pools to the amounts recovered based on its billing Capital Strategies LLC; the Series 2009A bonds were rates. The difference is recorded as its indirect cost purchased by TD Bank, N.A. Both agreements stipulate carryforward. If NAS over recovers on its indirect costs mandatory repurchase in December 2020 at which point during the year, a liability is recorded. If NAS under NAS could renew the direct purchase agreements, recovers, a receivable is recorded. remarket the bonds, or repurchase the bonds. NAS has a cumulative net over recovery of approxi- NAS is obligated under the revenue bonds as follows (in mately $0.8 million and $5.1 million as of December thousands): 31, 2013 and 2012, respectively. The over recovery is included in the deferred revenue balance in the state- 2013 2012 ments of financial position. Series 2008A revenue bonds, term, at flexible rates (1.1% in 2013 and 0.3% in 2012) maturing at various dates from January 1, 2013 through 2039 $ 65,090 $ 66,325 (13) BUILDING PROJECT AND Series 2009A revenue bonds, term, at FINANCING flexible rates (0.7% in 2013 and 0.3% in 2012) maturing at various dates (a) Building Project Revenue Bonds from January 1, 2013 through 2028 51,150 52,120 In January 1999, the District of Columbia issued Series 2010A revenue bonds, serial, with interest rates ranging from 3.0% to Series 1999A, Series 1999B, and Series 1999C 5.0%, maturing at various dates from tax-exempt revenue bonds on behalf of NAS. Proceeds April 1, 2013 through 2030 28,265 29,385 from the sale of the revenue bonds financed the cost of Series 2010A revenue bonds, term, the acquisition of 44,250 square feet of land and related Interest rate 5%, maturing April 1, 2035 13,205 13,205 construction of an office building, as well as paid Interest rate 5%, maturing April 1, 2040 16,960 16,960 certain costs of issuing the bonds. This building consolidates most of NAS’ program activities into one Total bonds, at face value 174,670 177,995 location. Plus unamortized premium 837 967 In June 2008, the District of Columbia issued Se- Total bonds payable 175,507 178,962 ries 2008A tax-exempt revenue bonds in the amount of Less current portion (included in other $66,325,000 on behalf of NAS. The proceeds were used current liabilities) (3,587) (3,455) Bonds payable, long-term $ 171,920 $ 175,507 63 

The serial and term bonds represent unsecured general Association (SIFMA) Municipal Swap Index. NAS obligations of NAS. amended the agreement for the 2005 – 2020 period by agreeing to give up the benefit of any 30-day period Interest on the 2008A and 2009A bonds is payable during which the SIFMA index remains below 2.25% monthly. Interest on the 2010A bonds is payable for the entire 30 days. Each time this occurs, the rate on semiannually every April 1 and October 1. the swap portfolio reverts to the fixed rate noted above for that month only. The term bonds maturing on April 1, 2035, and April 1, 2040, are subject to mandatory redemption by operation NAS entered into this fixed-to-variable swap agreement of sinking fund installments. Installment payments for to manage its exposure to interest rate changes. The the term bond maturing April 1, 2035, begin on April 1, fixed-rate debt obligations exposed NAS to variability 2031, and range from $2.4 to $2.9 million per year in the cost recovery stream due to changes in interest through the maturity date. Installment payments for the rates. NAS recovers the costs of borrowing through a term bond maturing April 1, 2040, begin on April 1, capital investment incentive rate that is set by the 2036, and range from $3.1 to $3.8 million per year U.S. government and is tied to a variable index. If through the maturity date. interest rates increase, the capital investment incentive recovery increases. Scheduled maturities and sinking fund requirements are as follows (in thousands): Conversely, if interest rates decrease, the capital investment incentive recovery decreases. Therefore, Years ending December 31: NAS entered into a derivative instrument that ties the 2014 $ 3,475 fixed-rate debt to a variable index to manage fluctua- 2015 3,645 tions in cash flows resulting from interest rate risk. By 2016 3,820 using derivative financial instruments to hedge expo- 2017 4,005 sures to changes in interest rates, NAS exposes itself to credit risk and market risk. Credit risk is the failure of 2018 4,195 the counterparty to perform under the terms of the Thereafter 155,530 derivative contract. When the fair value of a derivative $ 174,670 contract is positive, the counterparty owes NAS, which creates credit risk for NAS. When the fair value of a derivative contract is negative, NAS owes the counter- The carrying value of bonds payable in the financial party, and therefore, it does not possess credit risk. NAS statements was approximately $0.9 million and $5.2 minimizes the credit risk in derivative instruments by million less than fair value as of December 31, 2013 and entering into transactions with high-quality counterpar- 2012, respectively. NAS estimated the fair value of ties. bonds payable through valuations provided by an independent financial institution. If measured at fair In May 2009, NAS entered into an additional swap value in the statement of financial position, the bonds agreement as a result of a counterparty exercising a payable would be categorized as Level 2 in the fair swaption related to the Series 1999A Revenue Bonds. value hierarchy. The variable-to-fixed swap requires NAS to pay 5.00% on a notional amount of $55 million and to receive a Interest expense on the bonds payable for 2013 and floating rate equal to 67% of 1-month LIBOR plus 2012 totaled $3.6 million and $2.9 million, respectively. 0.41%. Of this amount, $1.1 million was capitalized as part of the building restoration project for 2012. There was no NAS entered into this variable-to-fixed swap agreement interest capitalized in 2013. in order to preserve the synthetic variable rate achieved through the 1999 swap agreement once the fixed-rate (b) Interest Rate Swaps Series 1999A bonds were refunded with the varia- In October 1999, NAS entered into a swap agreement, ble-rate Series 2009A bonds. with an effective date of February 1, 2000, relating to With regard to the fixed-to-variable interest rate swap, the $66 million face amount of its Series 1999A revenue NAS recorded a gain on the change in the fair value of bonds. The agreement provides for NAS to receive its swap agreement of $7,000 and $163,000, for the 4.97% in interest on a notional amount of $65 million years ended December 31, 2013 and 2012, respectively, and to pay interest at a floating rate option based on the which is included in other income in the accompanying weekly interest rate resets of tax-exempt variable-rate statements of activities. The fair value of the interest issues per the Securities Industry and Financial Markets 64 

rate swap was recorded as an asset of $208,000 and mately $1.7 million and $1.8 million as of December $201,000 as of December 31, 2013 and 2012, respec- 31, 2013 and 2012, respectively, which is reported tively, and is included in other assets in the statements within other assets in the statements of financial of financial position. position. The related obligation is included in accrued employee benefits in the statements of financial Pertaining to the swaption and resultant variable-to- position. fixed interest rate swap, NAS recorded a gain on the change in the fair value of approximately $4,278,000 (c) Postretirement and Postemployment Benefits and $516,000, for the years ended December 31, 2013 and 2012, respectively, which is included in other NAS provides certain health and life insurance benefits income in the statements of activities. The fair value of for employees retired due to length of service. All the swap is recorded as a liability of approximately $9.3 benefit-eligible employees may become eligible for million and $13.6 million as of December 31, 2013 and service retiree benefits if they reach age 60 while 2012, respectively, and is included in other current working for NAS and complete 5 years of service in a liabilities and other long term liabilities. benefit-eligible status for medical and life insurance benefits. In addition, certain health and life insurance benefits are provided for employees retired due to (14) EMPLOYEE BENEFITS disability. A benefit-eligible employee may become eligible for disabled retiree benefits if deemed totally (a) Retirement Plans disabled under NAS’ long-term disability insurance or if they are eligible for disability benefits from the Social NAS has a noncontributory defined contribution Security Administration. Life insurance benefits are retirement plan covering substantially all of its employ- provided based on coverage at date of disability and ees (based on certain benefit eligibility requirements). health insurance may be continued if the disabled retiree The funding vehicles under the plan consist of group had participated in an NAS health insurance plan for investments issued by Teachers Insurance and Annuity 5 years at the date of disability. Insurance companies Association (TIAA) and College Retirement Equities whose premiums are determined on an experience-rated Fund (CREF), known collectively as TIAA-CREF, as basis provide life and health insurance benefits for well as mutual funds issued by TIAA-CREF, Vanguard retirees. Medicare supplement insurance is not experi- Fiduciary Trust Company, and other third-parties. ence rated. The retiree welfare benefit plan is contribu- Participants in this plan vest immediately. NAS has tory for health insurance purposes for employees who received a favorable determination letter from the IRS retired on or after January 1, 1990. Participant contribu- on the qualification of this plan under Section 401(a) of tions for health insurance are based on a percentage of the Internal Revenue Code. the monthly premium paid by NAS (from 25% to 100%). The participant contribution is also based on In addition, NAS has a voluntary employee contribution their date of retirement, length of service and choice of retirement plan that is funded solely by employee health insurance carrier. contributions made on a pretax salary-reduction basis under Section 403(b) of the Internal Revenue Code. The NAS has elected to recognize the initial postretirement funding vehicles under the plan consist of group benefit obligation over a period of 20 years. The investments issued by TIAA and CREF, as well as accrued postretirement benefit obligation is reported in mutual funds issued by TIAA-CREF, Vanguard accrued employee benefits in the statements of financial Fiduciary Trust Company, and other third-parties. position. Pension expense for the years ended December 31, 2013 Postretirement changes other than net periodic benefit and 2012, amounted to approximately $12.0 million and cost are as follows (in thousands): $12.6 million, respectively. The NAS policy is to fund pension benefits as they are earned. The NAS normal 2013 2012 retirement age is 60, but there is no mandatory age for Net actuarial (gain)/ loss $ (3,208) $ 216 retirement. Recognized net actuarial loss (584) (692) Prior service credit (707) - (b) Deferred Compensation Recognized prior service cost (210) (210) NAS holds long-term investments as part of a frozen Recognized net initial obligation (26) (26) deferred compensation arrangement for certain employ- Total $ (4,735) $ (712) ees. The fair value of these investments was approxi- 65 

Items not yet recognized as a component of net periodic The assumptions used to determine net periodic benefit benefit cost at December 31, 2013 and 2012 are as cost for the years ended December 31, 2013 and 2012 follows (in thousands): are as follows: 2013 2012 2013 2012 Net actuarial loss $ 3,172 $ 6,964 Discount rate 4.00% 4.50% Prior service (credit) cost (392) 512 Expected long-term return on plan assets 7.50 7.50 Unrecognized net initial obligation - 39 Rate of increase in healthcare costs: Under age 65 8.00 7.50 Total $ 2,780 $ 7,515 Over age 65 5.00 5.50 The estimated amounts, measured at year-end, that are expected to be recognized in the net periodic benefit The assumptions used to calculate the accumulated cost over the next fiscal year for the postretirement postretirement benefit obligation for the years ended benefit plan are as follows (in thousands): December 31, 2013 and 2012 are as follows: 2013 2012 2013 2012 Prior service cost $ (49) $ 210 Discount rate 4.75% 4.00% Recognized actuarial loss 49 583 Rate of increase in healthcare costs for next Recognized net initial obligation - 26 year: Under age 65 8.00 8.00 Total $ - $ 819 Over age 65 5.00 5.00 The following table presents the changes in benefit The trend rate for growth in healthcare costs was obligations, changes in plan assets, funded status, and assumed to decline gradually beginning in 2016 to 5% the components of net periodic benefit cost for the year in the year 2021 for under age 65 and to remain at 5% ended December 31, 2013 and 2012 (in thousands): for over age 65 for the years ended December 31, 2013 2013 2012 and 2012. Change in benefits obligation: The healthcare cost trend rate assumption has a Benefits obligation, beginning of year $ 28,796 $ 25,938 significant impact on the postretirement benefit costs Service cost 909 803 and obligations. The effect of a 1% increase in the Interest cost 1,132 1,146 assumed healthcare cost trend rate would have resulted Plan participants’ contributions 120 110 in the following effects (in thousands): Amendments (707) - Actuarial (gain) loss (1,205) 1,443 2013 2012 Benefits provided (777) (644) Postretirement benefit obligation $ 3,280 $ 3,535 Benefits obligation, end of year 28,268 28,796 Benefit expense 332 305 Change in plan assets, combined: Fair value of plan assets, beginning of year 23,668 20,204 The effect of a 1% decrease in the assumed healthcare Actual return on plan assets 3,780 2,742 cost trend rate would have resulted in the following Employer contributions 1,391 1,362 effects (in thousands): Benefits paid (692) (640) Fair value of plan assets, end of year 28,147 23,668 2013 2012 Funded status $ (121) $ (5,128) Postretirement benefit obligation $ (2,714) $ (2,902) Benefit expense (264) (244) Components of net periodic benefit cost: Service cost $ 909 $ 803 Interest cost 1,132 1,146 Expected return on plan assets (1,775) (1,515) Recognized prior service cost 210 210 Recognized actuarial loss 584 692 Recognized net initial obligation 26 26 Net periodic benefit cost $ 1,086 $ 1,362 66 

NAS postretirement benefit plan asset allocations at The following table presents the fair value hierarchy for December 31, 2013 and 2012, by asset class are as the postretirement benefit plan assets at December 31, follows: 2012 (in thousands): 2013 2012 Fair value measure- Fair ments using Cash 6% 7% Value Level 1 Level 2 Bonds and notes 35 36 Financial Assets: Equity 59 57 Retiree Welfare Benefit Plan investments: 100% 100% Cash equivalents $ 1,759 $ 1,759 $ - Bonds and notes U.S. treasuries/gov. bonds 1,119 1,119 - The investment objective of the Plan is to produce a rate Mortgage-backed of return over the long term that will provide for fund securities 1,667 - 1,667 growth, protect against the effect of inflation, and Corporate bonds 5,792 4,697 1,095 provide for some stability in different market environ- Equity ments. The fund is diversified between fixed income U.S. small/mid equity 9,850 9,850 - and equity investments. With this diversification and Non-U.S. equity (developed) 3,233 3,233 - investment in broader market funds, there is reasonable Non-U.S. equity assurance that no single security or class of securities (emerging) 248 248 - will have a disproportionate impact on the Plan assets. Total investments $ 23,668 $20,906 $ 2,762 The Plan assets are invested with a long-term growth strategy, with a 70% equity guideline. The methods and assumptions used to estimate the fair The overall long-term rate of return was developed by value of each class of financial instrument are further estimating the long-term real rate of return for the discussed in footnote 4, Fair Value Measurements. Plan’s asset mix, while taking into account the effects of inflation. This estimate was developed by evaluating the NAS expects to contribute to the Plan the actuarially history and similar asset allocation of the NAS Endow- determined net periodic cost for 2014, which is ment. approximately $95,000. The following table presents the fair value hierarchy for The following benefit payments, which reflect future the postretirement benefit plan assets at December 31, services, are expected to be paid in future years as 2013 (in thousands): noted, as of December 31, 2013 (in thousands): Fair value measure- Fair ments using 2014 $ 1,161 Value Level 1 Level 2 2015 1,371 Financial Assets: 2016 1,477 Retiree Welfare Benefit 2017 1,595 Plan investments: 2018 1,718 Cash equivalents $ 1,818 $ 1,818 $ - 2019-2023 9,426 Bonds and notes $ 16,748 Mortgage-backed securities 1,979 - 1,979 Corporate bonds 7,002 4,660 2,342 The measurement date of the plan assets and benefit Non-U.S. fixed income 749 749 - obligations for 2013 and 2012 is December 31, 2013 Equity and 2012, respectively. U.S. large equity 4,212 4,212 - U.S. small/mid equity 8,677 8,677 - Non-U.S. equity (developed) 3,440 3,440 - (15) CONDITIONAL ASSET Non-U.S. equity (emerging) 270 270 - RETIREMENT OBLIGATION Total investments $ 28,147 $23,826 $ 4,321 NAS recorded an asset retirement obligation for which fair value of the liability could be reasonably estimated relating to the regulatory remediation of asbestos and other hazardous materials in one of its office buildings. 67 

Remediation of the asbestos and other hazardous the noncancelable operating lease are as follows (in materials began in 2010 and was completed in 2012. thousands): NAS recognized a gain on the settlement of the asset retirement obligation of $56,000 for the year ended Years ending December 31: December 31, 2012, which is included in other income 2014 $ 435 in the statement of activities. As of December 31, 2013 2015 448 and 2012, NAS had no remaining liability for remedia- 2016 545 tion costs. 2017 589 2018 607 Thereafter 4,978 (16) RELATED-PARTY TRANSACTIONS $ 7,602 The NAS Council has authorized two agreements providing noninterest-bearing, collateralized advances Rental expense amounted to approximately $0.4 million to two employees in connection with the purchase of and $2.0 million for the years ended December 31, 2013 each employee’s residence. The agreements between the and 2012, respectively. parties were executed in May 2005 and April 2013. The agreement executed in May 2005 provides that the During the year ended December 31, 2011, NAS repayment obligation will be adjusted to allocate to each exercised an option to terminate one of its leases early. party its proportional share of the appreciation or The lease was originally scheduled to end December 31, depreciation in the value of the residence, which is 2017, and under the revised agreement ended on based on the relative financing percentage provided by December 31, 2012. NAS’ obligation under the lease each party. That agreement will terminate upon pay- terminated on that date. back of the advance, sale of the property, or the end of the individual’s employment with NAS, which will not (b) Contingencies exceed 12 years. The agreement executed in April 2013 will terminate upon the first to occur of the date the NAS receives a portion of its revenues directly or individual ceases to occupy the property as principal indirectly from federal government grants and contracts, residence, sale of the property, or the end of the all of which are subject to audit by the Defense Contract individual’s employment with NAS. The estimated Audit Agency, which has completed its examinations present value of both receivables is $3.8 million and through December 31, 2005. A contingency exists $2.3 million at December 31, 2013 and 2012, respec- relating to unexamined periods and final settlements of tively, and is included in other assets in the statements examined periods to refund any amounts received in of financial position. excess of allowable costs. Management is of the opinion that no material liability will result from such audits. An agreement authorized by the NAS Council in May 2007 to provide a noninterest-bearing, collateralized advance to an employee in connection with the purchase (18) SUBSEQUENT EVENTS of that employee’s residence terminated during 2013. The estimated present value of that receivable was $0.9 In March 2014, NAS renewed its line of credit with million at December 31, 2012 and was included in other Wells Fargo for $45 million. The line of credit bears current assets in the statement of financial position. interest at LIBOR plus 0.55% and expires on June 30, 2015. (17) COMMITMENTS AND NAS has evaluated subsequent events from the state- CONTINGENCIES ment of financial position date through May 21, 2014, the date at which the financial statements were available (a) Leases to be issued, and determined that there are no other items to disclose. NAS is committed to one noncancelable operating lease for space. Future minimum rental payments due under 68 

OFFICERS Ralph J. Cicerone, President Diane E. Griffin, Vice President Susan Wessler, Home Secretary Michael T. Clegg, Foreign Secretary Jeremiah P. Ostriker, Treasurer FINANCE COMMITTEE Jeremiah P. Ostriker, Chair Elwyn R. Berlekamp Ralph J. Cicerone Maureen Cropper David Donoho Robert Engle Ronald L. Graham IOM Representative: William Stead BUDGET AND INTERNAL AFFAIRS COMMITTEE Jeremiah P. Ostriker, Chair Diane E. Griffin Richard P. Lifton Douglas S. Massey Maria Zuber AUDITING COMMITTEE Robert H. Wurtz, Chair Claude R. Canizares Susan Gottesman Ronald L. Graham Brian W. Matthews FINANCIAL MANAGEMENT STAFF Didi Salmon, Chief Financial Officer Craig Meyer, Controller 69