National Academy of Sciences

The National Academy of Sciences (“NAS”) was formed under a charter that was passed as an Act of Incorporation by the United States Congress and signed into law on March 3, 1863. NAS operates as a private membership organization of distinguished scholars engaged in scientific or engineering research, dedicated to the furtherance of science and its use for the general welfare.

National Research Council

Most of the activities undertaken by NAS are carried out through the divisions and boards of the National Research Council (“NRC”). The NRC draws on a wide cross section of the nation’s leading scientists and engineers for advisory services to government agencies and Congress. To respond effectively to both the disciplinary concerns of the research community and the complex interdisciplinary problems facing American society, NRC performs its studies and workshops through the following major divisions:

• Behavioral and Social Sciences and Education
• Earth and Life Studies
• Engineering and Physical Sciences
• Gulf Research Program
• Health and Medicine
• Policy and Global Affairs
• Transportation Research Board

NRC activities are under the control of the NAS governance structure and, therefore, are included in the NAS financial statements.

National Academy of Medicine

The Institute of Medicine (“IOM”), which was established in 1970, was reconstituted as the National Academy of Medicine (“NAM”) effective June 1, 2015. NAM is a separate membership organization within NAS, and issues position statements on policy issues related to health and medicine, cooperates with the major scientific and professional societies in the field, identifies qualified individuals to serve on study groups in other organizational units, and disseminates information to the public and the relevant professions. The financial activities and results of NAM are included in the NAS financial statements.

National Academy of Engineering

The National Academy of Engineering (“NAE”) was established in 1964 under the charter of NAS as a related parallel organization, autonomous in its governance, administration, and the selection of its members. NAE shares with NAS the responsibility for advising the federal government on scientific issues. The NAE conducts independent program activities and activities through the NRC. The results of both of these activities are included in the NAS financial statements.

Basis of Accounting

Net assets, revenues, gains, and losses are classified based on the existence or absence of donor-imposed restrictions. Accordingly, the net assets of NAS are classified and reported as follows:

Permanently restricted - Net assets subject to donor-imposed stipulations that they be maintained in perpetuity by NAS. Generally, the donors of these assets permit NAS to use all or part of the income earned on related investments for general or specific purposes.

Temporarily restricted - Net assets subject to donor-imposed stipulations that may or will be met either by actions of NAS and/or the passage of time. When a donor restriction expires, temporarily restricted net assets are reclassified to unrestricted net assets.

Unrestricted - Net assets arising from exchange transactions and contributions not subject to donor-imposed stipulations.

Cash Equivalents

NAS reports liquid, temporary investments purchased with original maturities of three months or less as cash equivalents. Cash equivalents managed by NAS’ investment managers as part of its long-term investment strategy are included in investments.

Restricted Cash

Restricted cash includes deposits that are legally restricted for the repayment of NAS’ outstanding bonds.

Investments

Investments are stated at fair value. Changes in the fair value of investments are reported within investment income in the accompanying statements of activities.

Purchases and sales of securities are reflected on a trade-date basis. Gains and losses on sales of securities are based on average cost and are recorded in the accompanying statements of activities in the period in which the securities are sold. Dividends are accrued based on the ex-dividend date. Interest is recognized as earned.

Contributions

Contributions, including unconditional promises to give, are recognized as revenues in the period received. Conditional promises to give are not recognized until all conditions are substantially met.

Revenues from non-federal grants qualifying as contributions are recorded by NAS upon notification of the grant award. Such grants are classified as temporarily restricted net assets when use of the grant funds is limited to specific areas of study or is designated for use in future periods.

Gifts of land, buildings, or equipment are reported as unrestricted net assets unless explicit donor stipulations specify how the donated assets must be used. Temporary restrictions on gifts that must be used to acquire or construct long-lived assets are released in the period in which the assets are acquired and placed in service.

Allowances are recorded for estimated uncollectible contributions based upon management’s judgment and analysis of the creditworthiness of the donor, past collection experience, and other relevant factors. Contributions to be received after one year are discounted at an appropriate rate commensurate with risks involved. Amortization of the discount is recorded as additional revenue and is used in accordance with donor-imposed restrictions, if any, on the contributions.

Gulf Research Program revenue relates to two agreements between NAS and BP Exploration and Production, Inc. (BP) and Transocean Deepwater Inc. (Transocean), respectively. As a result of separate plea agreements between those corporations and the federal government, related to the 2010 Deepwater Horizon disaster, NAS was asked to establish a program focused on human health and environmental protection in the Gulf of Mexico. BP will pay $350.0 million over five years, and Transocean will pay $150.0 million over four years, to fund this 30-year, $500.0 million program. The present value of these payments in 2013 was $471.4 million, which was recognized as revenue in that year. As of December 31, 2017 and 2016, the present value of the balance of these payments due is $115.0 million and $262.3 million, respectively. The unpaid balance due for each agreement is reflected in contributions and other receivables, net (current) in the accompanying statement of financial position as of December 31, 2017. The unpaid balance due for each agreement is reflected in contributions and other receivables, net (current) and contributions receivable, net (long-term) in the accompanying statement of financial position as of December 31, 2016.

Contracts and Grants

The majority of NAS activities are performed under cost-reimbursable contracts and grants with the U.S. government. For the years ended December 31, 2017 and 2016, the Department of Transportation provided 38% and 36%, respectively, of NAS’ government contract and grant revenues.

NAS records federal contracts and grants as exchange transactions, recognizing revenue as recoverable costs are incurred. Revenues from non-federal contracts and grants classified as exchange transactions are also recognized as recoverable costs are incurred.

Contracts receivable consisted of $22.4 million of billed receivables, $42.5 million of unbilled receivables, and $3.4 million of indirect costs under-recovered on federal contracts and grants as of December 31, 2017. Contracts receivable consisted of $19.1 million of billed receivables, $44.6 million of unbilled receivables, and $3.3 million of indirect costs under-recovered on federal contracts and grants as of December 31, 2016.

Allowances are recorded for estimated uncollectible contracts and grants based upon management’s judgment and analysis of the creditworthiness of the sponsoring organization, past collection experience, and other relevant factors. As of December 31, 2017 and 2016, NAS has an allowance for estimated uncollectible contracts and grants of $4.8 million and $4.7 million, respectively, which is reported net of contracts receivable in the accompanying statements of financial position.

Property and Equipment

Depreciation of NAS’ property and equipment is computed on a straight-line basis using the following lives:

The Einstein Memorial sculpture is valued at cost and is not depreciated. Work in progress is not depreciated until the related assets are placed in service. Capitalized software is amortized over its depreciable life when it is ready for its intended use and placed in service.

Split-Interest Agreements

Charitable gift annuity agreements are classified as other assets and other long-term liabilities in the accompanying statements of financial position. Periodically, NAS pays a fixed amount of the assets to the beneficiary designated by the donor. Upon termination of an annuity, the remainder interest in the assets, if any, is available for use by NAS as restricted or unrestricted assets in accordance with the donor’s stipulation. At December 31, 2017 and 2016, NAS had charitable gift annuity assets of approximately $3.0 million and $2.7 million, respectively. NAS has recorded a liability of approximately $1.8 million at December 31, 2017 and 2016 representing the present value of estimated future cash payments to annuitants based on the annuitants’ life expectancies.

Deferred Revenue

For both federal and non-federal grants and contracts that are determined to be exchange transactions, revenue is recognized as the related costs are incurred. Funds received in advance of being earned for these grants are recorded as deferred revenue in the accompanying statements of financial position.

Income Taxes

NAS is exempt from federal income taxes under Section 501(c)(3) of the Internal Revenue Code, except for unrelated business income. NAS recognizes the effect of income tax positions only if those positions are more likely than not of being sustained upon examination. NAS does not believe its financial statements include any uncertain tax positions.

Risks and Uncertainties

NAS invests in various investment securities. Investment securities are exposed to various risks such as interest rate, market, and credit risks. Due to the level of risk associated with investment securities, it is at least reasonably possible that changes in the values of investment securities will occur in the near term and that such changes could materially affect the amounts reported. NAS maintains its cash and cash equivalents in various bank accounts and money market funds that, at times, may exceed federally insured limits. NAS’ cash and cash equivalents have been placed with high credit quality financial institutions. NAS has not experienced, nor does it anticipate, any losses with respect to such accounts.

Recently Adopted Accounting Pronouncements

In November 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (ASU 2016-18). The amendments within ASU 2016-18 require that a statement of cash flows explain the change during the period in total cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for fiscal years beginning after December 15, 2019 for entities that are not public business entities and early adoption is permitted. NAS has elected to early adopt this accounting pronouncement for the year ended December 31, 2017 and has applied the amendments using a retrospective transition method to each period presented.

Use of Estimates

The preparation of these financial statements in conformity with U.S. generally accepted accounting principles requires management to make certain estimates and assumptions. These estimates and assumptions may affect the reported amounts of assets and liabilities and disclosures in the financial statements. Actual results could differ from those estimates.

Reclassifications

Certain amounts from the prior year have been reclassified to conform to the current year presentation. There were no changes to total assets, liabilities, net assets, revenues, expenses or changes in net assets as previously reported in the fiscal 2016 financial statements.

Investments, which are reported at fair value, consist of the following as of December 31, 2017 and 2016 (in thousands):

The National Academies’ Corporation (TNAC, see Note 15), a related entity, invests certain of its assets in the NAS investment pool. TNAC investments participate in the investment pool proportionally with all other funds in this pool.

The NAS obligation to TNAC for these funds held in trust, which totaled approximately $13.3 million and $12.1 million as of December 31, 2017 and 2016, respectively, is reported as funds held on behalf of others in the accompanying statements of financial position. The funds held on behalf of others liability equals the investments held in NAS’ investment pool on behalf of TNAC.

Investment income is reported net of investment expenses of approximately $834,000 and $806,000 for the years ended December 31, 2017 and 2016, respectively, and is comprised of the following (in thousands):

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB Accounting Standards Codification section 820 establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1- Quoted prices in active markets for identical assets or liabilities.

Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The following discussion describes the valuation methodologies used for financial assets measured at fair value. The techniques utilized in estimating the fair values are affected by the assumptions used, including discount rates and estimates of the amount and timing of future cash flows. Care should be exercised in deriving conclusions about NAS’ business, its value or financial position based on the fair value information of financial assets presented.

Fair value estimates are made at a specific point in time, based on available market information and judgments about the financial asset, including estimates of timing, amount of expected future cash flows, and the credit standing of the issuer. In some cases, the fair value estimates cannot be substantiated by comparison to independent markets. In addition, the disclosed fair value may not be realized in the immediate settlement of the financial asset. Furthermore, the disclosed fair values do not reflect any premium or discount that could result from offering for sale at one time an entire holding of a particular financial asset. Potential taxes and other expenses that would be incurred in an actual sale or settlement are not reflected in amounts disclosed.

The following methods, assumptions, and inputs were used to estimate the fair value of each class of financial instruments:

Property and equipment as of December 31, 2017 and 2016, is comprised of the following (in thousands):

Depreciation and amortization expense was approximately $7.0 million and $7.9 million for the years ended December 31, 2017 and 2016, respectively.

Contributions not yet collected are included in contributions and other receivables, net (current) and contributions receivable, net (long-term) in the accompanying statements of financial position, and mature as follows (in thousands):

As of December 31, 2017, 81% of contributions receivable were due from one corporation. As of December 31, 2016, 88% of contributions receivable were due from two corporations. NAS does not believe there is any significant risk associated with collection of these receivables.

During the year ended December 31, 2016, NAS entered into an agreement with a donor to give up to $10 million. The gift is conditioned on receipt of matching gifts for one of NAS’ endowment funds. NAS recognized revenue totaling approximately $7.1 million and $1.7 million for the years ended December 31, 2017 and 2016, respectively, the extent to which the conditions on the pledge have been met. During the year ended December 31, 2017, NAS entered into agreements for two additional conditional contributions totaling $1.7 million. One is conditioned on receipt of matching gifts and one conditioned on the awarding of a prize. NAS recognized revenue totaling approximately $73,000 pertaining to these conditional contributions for the year ended December 31, 2017.

Deferred revenue consisted of the following as of December 31, 2017 and 2016 (in thousands):

Until September 2017, NAS was party to a $35 million line of credit from Wells Fargo, which bore interest at LIBOR plus 0.55% (2.11% and 1.31% as of December 31, 2017 and 2016, respectively). In September 2017, NAS renewed its line of credit with Wells Fargo for $35 million from October 1, 2017 through December 31, 2017, for $45 million from January 1, 2018 through April 30, 2018, and for $35 million from May 1, 2018 through September 30, 2018. The renewed line of credit bears interest at LIBOR plus 0.55% and expires on September 30, 2018. NAS is also party to a $15 million line of credit from TD Bank, which bears interest at LIBOR plus 0.55% (2.12% and 1.17% as of December 31, 2017 and 2016, respectively) and expires on August 31, 2018. NAS has pledged and granted to each bank a security interest in NAS’ gross revenues.

Interest expense related to the lines of credit for the years ended December 31, 2017 and 2016 totaled approximately $115,000 and $107,000, respectively.

Temporarily restricted net assets were available for the following purposes as of December 31, 2017 and 2016 (in thousands):

Temporarily restricted net assets were released from restriction for the following purposes during the years ended December 31, 2017 and 2016 (in thousands):

Permanently Restricted Net Assets

The income generated by permanently restricted net assets is available to support donor-specified programs and general operations. As of December 31, 2017 and 2016, NAS held the following permanently restricted net assets, classified by the purpose for which the income is to be used (in thousands):

Endowment Assets

The NAS endowment consists of 128 individual funds established to support general operations, sponsored research and advisory programs, prizes and awards, and the operations of the Woods Hole facility. The endowment solely comprises donor-restricted endowment funds. The investments of the endowment are included in the NAS investment pool, as described in Note 3.

Interpretation of Relevant Law

NAS has interpreted the District of Columbia “Uniform 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 the care that an ordinarily prudent person in a like position would exercise under similar circumstances in making determinations to appropriate for expenditure or accumulate 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 was donated. NAS classifies as permanently restricted net assets (a) the original value of gifts donated to its permanent endowment, (b) the original value of subsequent gifts to its permanent endowment, and (c) accumulations to its permanent endowment required by the applicable donor gift instrument. The remaining portion of donor-restricted endowment funds that are not classified as permanently restricted are classified as temporarily restricted net assets until those amounts are appropriated for expenditure by NAS. In making a determination to appropriate or accumulate, NAS adheres to the standard of prudence prescribed by the Act and considers the following factors:

Return Objectives and Strategies

NAS has adopted investment and spending policies for endowment assets that are designed to provide a predictable stream of funding to programs supported by its endowment while seeking to protect the real purchasing power of the assets from inflation. Accordingly, NAS has adopted guidelines, which feature a commitment to minimizing volatility while maximizing risk-adjusted return.

The NAS spending policy limits the annual spending to 5% of the three-year average fair value of the participating funds in the endowment portfolio. This is consistent with NAS’ objective to maintain the purchasing power of the endowment assets held in perpetuity as well as to provide additional real growth through new gifts and investment return.

Changes in endowment assets for the fiscal year ended December 31, 2017 are as follows (in thousands):

Changes in endowment assets for the fiscal year ended December 31, 2016 are as follows (in thousands):

Funds with Deficiencies

From time to time, the fair value of assets associated with individual donor-restricted endowment funds may fall below the original value of the gift donated to the permanent endowment. Deficiencies of this nature are reported as unrestricted net assets. At December 31, 2017, there were no endowment funds with a fair value below the original value of the gift. At December 31, 2016, there was one endowment fund with a fair value below the original value of the gift. This deficiency was primarily a result of unfavorable market fluctuations that occurred shortly after the investment of new permanently restricted contributions. Subsequent gains that restore the fair value of the assets of the endowment fund to the required level are classified as an increase in unrestricted net assets.

NAS is obligated under the revenue bonds as follows (in thousands):

The serial and term bonds represent unsecured general obligations of NAS.

Interest on the 2008A and 2009A bonds is payable monthly. Interest on the 2010A and 2017A bonds is payable semiannually every April 1 and October 1.

Scheduled maturities are as follows (in thousands):

Interest expense on the bonds payable for the years ended December 31, 2017 and 2016 totaled $3.4 million and $3.7 million, respectively.

Interest Rate Swaps

In October 1999, NAS entered into an interest-rate swap agreement, with an effective date of February 1, 2000, relating to the $66 million face amount of its Series 1999A revenue bonds. The agreement provides for NAS to receive 4.97% in interest on a notional amount of $65 million and to pay interest at a floating rate option based on the weekly interest rate resets of tax-exempt variable-rate issues per the Securities Industry and Financial Markets Association (“SIFMA”) Municipal Swap Index. NAS amended the agreement for the 2005−2020 period by agreeing to give up the benefit of any 30-day period during which the SIFMA index remains below 2.25% for the entire 30 days. Each time this occurs, the rate on the swap portfolio reverts to the fixed rate noted above for that month only.

NAS entered into this fixed-to-variable swap agreement to manage its exposure to interest rate changes. The fixed-rate debt obligations exposed NAS to variability in the cost recovery stream due to changes in interest rates. NAS recovers the costs of borrowing through a capital investment incentive rate that is set by the U.S. government and is tied to a variable index. If interest rates increase, the capital investment incentive recovery increases.

Conversely, if interest rates decrease, the capital investment incentive recovery decreases. Therefore, NAS entered into a derivative instrument that ties the fixed-rate debt to a variable index to manage fluctuations in cash flows resulting from interest rate risk. By using derivative financial instruments to hedge exposures to changes in interest rates, NAS exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative 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 counterparty, and therefore, it does not possess credit risk. NAS minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties.

In May 2009, NAS entered into an additional swap agreement as a result of a counterparty exercising a swaption related to the Series 1999A Revenue Bonds. The variable-to-fixed swap requires NAS to pay 5.00% on a notional amount of $55 million and to receive a floating rate equal to 67% of one-month LIBOR plus 0.41%.

with some U.S. Treasury securities, all of which are valued using Level 1 inputs (Note 4). The deferred compensation obligation to employees is equal to the fair value of the investments held.

Postretirement and Postemployment Benefits

NAS provides certain health and life insurance benefits for employees retired due to length of service. All benefit-eligible employees may become eligible for service retiree benefits if they reach age 60 while working for NAS and complete five years of service in a benefit-eligible status for medical and 10 years of service for life insurance benefits. In addition, certain health and life insurance benefits are provided for employees retired due to disability. A benefit-eligible employee may become eligible for disabled retiree benefits if deemed totally disabled under NAS’ long-term disability insurance or if they are eligible for disability benefits from the Social Security Administration. Life insurance benefits are provided based on coverage at date of disability and health insurance may be continued if the disabled retiree had participated in an NAS health insurance plan for five years at the date of disability. Insurance companies whose premiums are determined on an experience-rated basis provide life and health insurance benefits for retirees. Medicare supplement insurance is not experience rated. The retiree welfare benefit plan is contributory for health insurance purposes for employees who retired on or after January 1, 1992. Participant contributions for health insurance are based on a percentage of the monthly premium paid by NAS (from 25% to 100%). The participant contribution is also based on their date of retirement, length of service, and choice of health insurance carrier.

The accrued postretirement benefit obligation is reported in accrued employee benefits in the accompanying statements of financial position.

Postretirement changes other than net periodic benefit cost are as follows (in thousands):

Items not yet recognized as a component of net periodic benefit cost at December 31, 2017 and 2016 are as follows (in thousands):

The estimated amounts, measured at year-end, that are expected to be recognized in the net periodic benefit cost over the next fiscal year for the postretirement benefit plan are as follows (in thousands):

The following table presents the changes in benefit obligations, changes in plan assets, funded status, and the components of net periodic benefit cost for the years ended December 31, 2017 and 2016 (in thousands):

The assumptions used to determine net periodic benefit cost for the years ended December 31, 2017 and 2016 are as follows:

The assumptions used to calculate the accumulated postretirement benefit obligation for the years ended December 31, 2017 and 2016 are as follows:

The trend rate for growth in healthcare costs was assumed to decline gradually beginning in 2018 to 4.5% in the year 2038 for the years ended December 31, 2017 and 2016.

The healthcare cost trend rate assumption has a significant impact on the postretirement benefit costs and obligations. The effect of a 1% increase in the assumed healthcare cost trend rate would have resulted in the following effects (in thousands):

The effect of a 1% decrease in the assumed healthcare cost trend rate would have resulted in the following effects (in thousands):

NAS postretirement benefit plan asset allocations at December 31, 2017 and 2016, by asset class are as follows:

The investment objective of the Plan is to produce a rate of return over the long-term that will provide for fund growth, protect against the effect of inflation, and provide for some stability in different market environments. The fund is diversified between fixed income and equity 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 disproportionate impact on the Plan assets. The Plan assets are invested with a long-term growth with reduced volatility strategy.

The overall long-term rate of return was developed by estimating the long-term real rate of return for the Plan’s asset mix, while taking into account the effects of inflation. This estimate was developed by evaluating the history of investments with similar asset allocations.

The following table presents the fair value hierarchy for the postretirement benefit plan assets at December 31, 2017 (in thousands):

The following table presents the fair value hierarchy for the postretirement benefit plan assets at December 31, 2016 (in thousands):

The methods and assumptions used to estimate the fair value of each class of financial instrument are further discussed in Note 4.

NAS expects to contribute to the Plan the actuarially determined net periodic cost for 2018, which is approximately $1.1 million.

The following benefit payments, which reflect future services, are expected to be paid in future years as noted, as of December 31, 2017 (in thousands):

The measurement date of the plan assets and benefit obligations for 2017 and 2016 is December 31, 2017 and 2016, respectively.