F INANCIAL S TATEMENTS. Kansas University Endowment Association Years Ended June 30, 2012 and 2011 With Report of Independent Auditors

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1 F INANCIAL S TATEMENTS Kansas University Endowment Association Years Ended June 30, 2012 and 2011 With Report of Independent Auditors Ernst & Young LLP

2 Financial Statements Years Ended June 30, 2012 and 2011 Contents Report of Independent Auditors...1 Financial Statements Statements of Financial Position...2 Statement of Activities...4 Statements of Cash Flows...6 Notes to Financial Statements

3 Ernst & Young LLP One Kansas City Place Suite Main Street Kansas City, MO Tel: Fax: The Board of Trustees Kansas University Endowment Association Report of Independent Auditors We have audited the accompanying statements of financial position of the Kansas University Endowment Association (KU Endowment) as of June 30, 2012 and 2011, the related statements of cash flows for the years then ended, and the statement of activities for the year ended June 30, These financial statements are the responsibility of KU Endowment s management. Our responsibility is to express an opinion on these financial statements based on our audits. The prior-year summarized financial information has been derived from KU Endowment s June 30, 2011, financial statements and, in our report dated October 19, 2012, we expressed an unqualified opinion on those financial statements. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of KU Endowment s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of KU Endowment s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Kansas University Endowment Association as of June 30, 2012 and 2011, its cash flows for the years then ended, and the changes in its net assets for the year ended June 30, 2012, in conformity with U.S. generally accepted accounting principles. October 19, 2012 EY A member firm of Ernst & Young Global Limited

4 Statements of Financial Position June (In Thousands) Assets Cash and cash equivalents $ 6,808 $ 4,915 Receivables: Loans receivable, less allowance for uncollectible loans of $1,650 in 2012 and $1,634 in ,269 22,085 Contributions pledged, less allowance for uncollectible pledges of $698 in 2012 and $651 in ,138 59,099 Receivables from investment activities 5,912 1,244 Other receivables 6,160 3,435 Total receivables 98,479 85,863 Investments: Securities 1,258,796 1,307,879 Trusts held by others 34,487 37,149 Interest in KU Endowment Charitable Gift Fund Real estate 12,775 12,856 Total investments 1,306,469 1,358,364 Property and facilities on or adjacent to the University campus: Land 8,647 6,643 Buildings 22,064 25,497 Equipment and furnishings 3,047 2,913 33,758 35,053 Less accumulated depreciation 7,779 11,283 Net property and facilities on or adjacent to the University campus 25,979 23,770 Deposits and other assets 5,708 5,859 Total assets $ 1,443,443 $ 1,478,

5 Liabilities and net assets Liabilities: Accounts payable and accrued expenses 13,333 June (In Thousands) $ $ 10,911 Payables from investment activities 10, Life income gift payables 20,839 21,130 Agency funds 61,623 69,982 Total liabilities 106, ,179 Net assets: Unrestricted 154, ,501 Temporarily restricted 775, ,992 Permanently restricted 406, ,099 Total net assets 1,337,380 1,376,592 Total liabilities and net assets $ 1,443,443 $ 1,478,771 See accompanying notes

6 Statement of Activities Summarized Financial Information Year Ended June 30, 2012 for the Temporarily Permanently Year Ended Unrestricted Restricted Restricted Total June 30, 2011 (In Thousands) Revenues, gains (losses), and other support: Fundraising: Contributions and grants received and pledged $ 1,563 $ 100,400 $ 4,485 $ 106,448 $ 103,461 Bequests ,994 4,134 15,315 9,438 Life income gifts Change in value of life income gifts (94) (504) (135) (733) (1,189) Change in net interest in KU Endowment Charitable Gift Fund (68) (68) 45 Total fundraising 1, ,208 8, , ,500 Income (loss) from asset holdings: Investment income 6,755 12,972 19,727 20,726 Realized and unrealized gains (losses) on investments and trusts held by others 6,234 (48,982) (2,048) (44,796) 193,393 Loan interest income 368 1,045 1,413 1,386 Agricultural and mineral income 1,541 1,400 2,941 5,188 Rental, gain on sale of assets, and other income 424 (180) 244 1,754 Total income (losses) from asset holdings 15,322 (33,745) (2,048) (20,471) 222,447 Other receipts 34 3,393 3,427 5,267 Net assets released from restrictions: Satisfaction of program restrictions 113,989 (113,989) Total revenues, gains (losses), and other support 131,001 (33,133) 6, , ,

7 Statement of Activities (continued) Summarized Financial Information Year Ended June 30, 2012 for the Temporarily Permanently Year Ended Unrestricted Restricted Restricted Total June 30, 2011 (In Thousands) Expenses: University support: Student support $ 30,253 $ $ $ 30,253 $ 27,498 Faculty support and contractual services 35,314 35,314 33,976 Construction, furnishings, equipment, and supplies 14,661 14,661 13,240 Program and other educational support 39,085 39,085 37,596 Total University support 119, , ,310 Supporting services: Administrative and fundraising support 17,909 17,909 16,077 Asset management expense Depreciation 1,142 1, Total supporting services 19,671 19,671 17,396 Total expenses 138, , ,706 Excess of revenues (under)/over expenses (7,983) (33,133) 6,494 (34,622) 210,508 Net interfund transfers 1, (2,742) Change in net assets before amortization of pension adjustments (6,100) (32,274) 3,752 (34,622) 210,508 Amortization of pension adjustments (4,590) (4,590) 2,222 Change in net assets (10,690) (32,274) 3,752 (39,212) 212,730 Net assets at beginning of year 165, , ,099 1,376,592 1,163,862 Net assets at end of year $ 154,811 $ 775,718 $ 406,851 $ 1,337,380 $ 1,376,592 See accompanying notes

8 Statements of Cash Flows Year Ended June (In Thousands) Operating activities Change in net assets $ (39,212) $ 212,730 Adjustments to reconcile change in net assets to net cash used in operating activities: Depreciation 1, Net realized and unrealized (gains) losses on investments and trusts held by others 44,796 (193,393) Contributions restricted for long-term investment (25,642) (30,948) Noncash contributions (6,859) (7,556) Changes in operating assets and liabilities: Decrease (increase) in loan receivable (Decrease) increase in accounts payable and accrued expenses 2, Change in contributions pledged (6,039) (2,113) (Increase) decrease in net interest of KU Endowment Charitable Gift Fund 68 (46) Other (9,735) 1,015 Net cash used in operating activities (38,243) (18,664) Investing activities Net expenditures for property and facilities on or adjacent to the University campus (4,849) (7,896) Net losses for sale of real estate held for investment 57 (125) Net proceeds from sale of investments 395, ,590 Purchase of investments (376,492) (128,873) Net cash provided by (used in) investing activities 14,494 (9,304) Financing activities Proceeds from contributions restricted for: Permanent endowment 8,473 7,995 Temporary funds 17,169 22,953 25,642 30,948 Principal debt repayment made on behalf of the University (13) Net cash provided by financing activities 25,642 30,935 Net increase in cash and cash equivalents 1,893 2,967 Cash and cash equivalents at beginning of year 4,915 1,948 Cash and cash equivalents at end of year $ 6,808 $ 4,915 See accompanying notes

9 Notes to Financial Statements June 30, 2012 and Organization The Kansas University Endowment Association (KU Endowment) is an independent, nonprofit organization serving as the official fundraising and fund-management foundation for the University of Kansas (the University). Founded in 1891, KU Endowment is the oldest foundation of its kind and one of the largest at a public university in the United States. KU Endowment partners with donors in providing philanthropic support to build a greater University of Kansas. KU Endowment is an organization as described in Section 501(c)(3) of the Internal Revenue Code (the Code) and has received an Internal Revenue Service (IRS) determination letter stating that its exempt function income is exempt from tax, pursuant to Section 501(a) of the Code. Accordingly, income taxes are not provided for in the financial statements. 2. Summary of Significant Accounting Policies KU Endowment s financial statements have been prepared in accordance with U.S. generally accepted accounting principles. The following is a summary of the significant accounting and reporting policies used in preparing the financial statements. Fund Accounting To ensure observance of limitations and restrictions that donors have placed on the use of resources available to KU Endowment, the accounts of KU Endowment are maintained in accordance with the principles of fund accounting. This is the procedure by which resources for various purposes are classified for accounting and reporting purposes into separate fund accounts established according to their individual nature and purpose. However, separate accounts that have similar characteristics have been combined into fund groups in the accompanying financial statements. Accordingly, all financial transactions have been recorded and reported by fund groups. Funds have been grouped by classification into three categories: unrestricted, temporarily restricted, and permanently restricted. Unrestricted funds represent assets and contributions that are available for the broad benefit of the University but are not otherwise restricted by donors. Temporarily restricted funds represent assets and contributions with a donor-imposed restriction that permits the organization to use or expend the donated assets as specified, and the restriction is satisfied either by the passage of time or by actions of the organization. Permanently restricted funds represent assets and contributions with a donor-imposed restriction that stipulates that the resources be maintained permanently but permits the organization to use or expend part or all of the income derived from the donated assets

10 2. Summary of Significant Accounting Policies (continued) Cash and Cash Equivalents KU Endowment considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Interest on Loans Receivable During the year, KU Endowment recognizes interest as it is received from student loan repayment and, at year-end, recognizes the balance of interest earned but not yet received on loans less than 90 days past due. Interest on loans that are more than 90 days past due is not recognized. As of June 30, 2012 and 2011, there was $2,946,000 and $2,927,000, respectively, of such loans. Interest continues to accrue, but is not recorded on loans that are more than 90 days and less than 180 days past due at 5% and on loans 180 days or more past due at 14%. KU Endowment subsequently writes off uncollectible loans after the collection agencies have determined that they are uncollectible. Pledges, Contributions, Bequests, and Grants Unconditional promises to give cash and other assets are reported at fair value at the date the promise is received. Conditional promises to give and indications of intentions to give are reported at fair value at the date the gift is received or the condition has been satisfied. Contributions are reported as either temporarily or permanently restricted support if they are received with donor stipulations that limit the use of the donated assets. When a donor restriction is satisfied (as to either time or purpose), temporarily restricted net assets are reclassified as unrestricted net assets and reported in the statement of activities as net assets released from restrictions. All unconditional contributions, bequests, and grants are included in revenue of unrestricted net assets at the time they are received or pledged. Donated property is recorded at fair market value on the date it is received or pledged

11 2. Summary of Significant Accounting Policies (continued) Investment Programs Short-Term Investment Program KU Endowment invests the idle cash balances in individual fund accounts by pooling them into a short-term investment program to produce a net investment yield. The total investment yield, less distributions of earnings to certain accounts, is retained by KU Endowment and is allocated to the unrestricted net asset classification to defray administrative costs. Long-Term Investment Program The individual fund accounts also may invest in the Long-Term Investment Program (LTIP), which are pooled together for investment purposes. Investment earnings of the LTIP are allocated to participating fund accounts on a market-value unit basis. Amounts allocated to participating fund accounts, under KU Endowment s spending policy, are based on a fixed rate of return of 4.6% of the 12-quarter moving average market value at September 30. An amount equal to 0.9% of the average market value, as previously defined, is retained by KU Endowment and is allocated to the unrestricted fund group to defray administrative costs. In November 2008, the Executive Committee intervened in the stated spending policy and reduced spending by 10% for the spending year beginning February 1, 2009, which has been held constant for each succeeding year, including the spending year beginning February 1, 2012 and This intervention is intended to smooth the impact of the extreme market volatility during the period and provide a stable spending distribution to participating funds. Investment earnings, including interest, dividends, realized gains (losses), and unrealized gains (losses) in excess of amounts allocated as described above (accumulated investment earnings), are maintained in the LTIP. Such accumulated investment earnings are classified for financial statement purposes as temporarily restricted or agency funds based on the donor s intentions for the use of the income in conjunction with KU Endowment s spending policy

12 2. Summary of Significant Accounting Policies (continued) Investment Earnings Investment earnings that are distributed to individual fund accounts as expendable resources, in accordance with KU Endowment LTIP spending policy, are classified as unrestricted or temporarily restricted primarily based on the donor s intentions for the use of the account (see Long-Term Investment Program). The spending policy determines investment earnings that can be spent and investment earnings that are treated as temporarily restricted funds functioning as an endowment. Realized gains and losses on sales of investments are computed on an average-cost basis. Income from asset holdings is reported net of related investment expenses of $4,758,000 and $4,162,000 as of June 30, 2012 and 2011, respectively. KU Endowment has invested in bank common trust funds that retain all dividends for reinvestment. Such dividends have been recorded as investment earnings and as an increase in the cost of the fund. Property and Facilities Assets acquired are recorded at cost if purchased or at the fair market value at the date of gift. Assets held for future earnings potential are classified as investments in the accompanying statements of financial position. Improvements and replacements are capitalized, and repairs and maintenance are expensed as incurred. Assets held for use by the University or KU Endowment are classified as property and facilities

13 2. Summary of Significant Accounting Policies (continued) Depreciation of assets held for use is computed over the estimated useful lives of the respective assets using the straight-line method. Estimated useful lives used by principal asset groups for calculating depreciation are as follows: Assets Buildings: New: Laboratories Other Used Building improvements Equipment and furnishings Estimated Useful Life 30 years 30 to 50 years 10 to 30 years 8 to 30 years 3 to 15 years Agency Funds KU Endowment holds certain endowment and other funds on behalf of the University and other affiliated third parties. Such funds totaled $61,623,000 and $69,982,000 at June 30, 2012 and 2011, respectively. University Support Expenses include distributions to support purposes of the University as a whole, as well as specific departments or schools of the University. Certain distributions, such as faculty and staff salary support, are made to the University, while others, such as student awards, are paid directly to the recipients. Total University support was $119,313,000 and $112,310,000 during 2012 and 2011, respectively

14 2. Summary of Significant Accounting Policies (continued) Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instruments that appears on the statements of financial position, for which it was practicable to estimate that value (for all categories listed, the carrying value approximates fair value): Cash and Cash Equivalents For the purpose of the statements of cash flows, cash and cash equivalents are defined as cash on hand and cash in demand accounts. The carrying values of KU Endowment s cash equivalents approximate market value. Contributions Pledged Fair value, after allowance for uncollectible pledges, was determined by discounting the expected future cash flows. Loans Receivable Loans receivable are reported in the accompanying statements of financial position as outstanding principal, adjusted for the allowance for doubtful accounts. Management estimates the allowance for doubtful accounts based on historical losses and existing economic conditions. Investments Investments in equity securities with readily determinable fair values and all investments in debt securities are reported at fair value, with gains and losses included in the accompanying statement of activities. The fair value is determined by the investment custodian utilizing prices quoted by securities dealers or brokers, investment bankers, or statistical services on the valuation date. Management s estimate of the fair value of investments is included in Note 5. KU Endowment invests in limited partnerships and commingled vehicles, some of which employ traditional strategies in readily marketable securities and others of which employ less traditional strategies. The fair value of alternative investments is generally determined by an investment manager of the individual investment fund based on the net asset value of the underlying investments. The alternative investments are accounted for using the equity method of accounting. A portion of the underlying alternative investments is not readily marketable. Therefore, its estimated fair value is subject to uncertainty and therefore may differ from the value that would have been used had a ready market for such investment existed

15 2. Summary of Significant Accounting Policies (continued) Trusts Held by Others Trusts that provide an irrevocable beneficial interest to KU Endowment that are administered by third parties for the benefit of KU Endowment are included in the financial statements at the fair value of the assets contributed to the trust. Changes in the fair value of the trusts that exist in perpetuity are recorded in the accompanying statement of activities as permanently restricted. Life Income Gifts Life income gifts consist primarily of gift annuities and charitable remainder trusts and are recognized at fair value in the period the trust is established and adjusted accordingly at year-end. Assets of such gifts are reported as a component of marketable securities. Liabilities incurred related to the acceptance of life income gifts are recognized as the present value of the expected future cash payments and are discounted at rates specified by the Code Section 7520(a). Generally, the terms of the life income gifts require KU Endowment to pay a specified amount or percentage of a fund s market value to a designated beneficiary for a specified term or the beneficiary s life span. Actuarial assumptions related to mortality are based on tables published by the IRS. Use of Estimates The preparation of financial statements in conformity with United States generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue, gains, and other support and expenses during the reporting periods. Actual results could differ from those estimates. Concentrations of Credit Risk Financial instruments that potentially subject KU Endowment to concentrations of credit risk include cash and cash equivalents, investments, loans receivable, and contributions receivable. Investments and cash and cash equivalents are managed within guidelines established by KU Endowment, which, as a matter of policy, requires prudent diversification in order to minimize risk exposures. Concentrations of credit risk with respect to loans receivables and contributions receivable are limited since amounts are generally due from a large number of individual donors or corporations

16 2. Summary of Significant Accounting Policies (continued) KU Endowment s investment programs are exposed to various kinds and levels of risk. Fixedincome securities expose KU Endowment to interest rate risk, credit risk, and liquidity risk. The current value of many fixed-income securities is affected as interest rates change, particularly those with fixed interest rates. Credit risk is the risk that the obligor of the security will not fulfill its obligation. Liquidity risk is affected by the willingness of market participants to buy and sell given securities. Equity securities expose KU Endowment to market risk, performance risk, and liquidity risk. Market risk is the risk associated with major movements of equity markets, both domestic and international. Performance risk is the risk associated with a particular company s operating performance. Liquidity risk, as previously defined, tends to be higher for international equities and small capitalization equity companies Financial Information The financial statements include certain prior-year summarized, comparative information in total but not by net asset class. Such information does not include sufficient detail to constitute a presentation in conformity with U.S. GAAP. Accordingly, such information should be read in conjunction with the organization s financial statements for the year ended June 30, 2011, from which the summarized information was derived. Adoption of New Accounting Standards In January 2010, accounting guidance was issued to further expand disclosure requirements related to fair value measurements. Additional disclosures under this guidance include disclosing transfers in and out of Level 1 and Level 2 fair value measurements and the reasons for those transfers, valuation techniques and inputs used to measure Level 2 and Level 3 fair value measurements, and disclosure of purchases, sales, issuances, and settlements separately within the Level 3 fair value measurements reconciliation. KU Endowment adopted this guidance effective July 1,

17 3. Contributions Receivable Contributions are generally recognized as revenue, gains, and other support, when unconditional contributions are made at fair value. Contributions receivable at June 30, 2012 and 2011, are classified in the financial statements as follows (in thousands): Temporarily restricted $ 65,072 $ 59,192 Permanently restricted $ 65,836 $ 59,750 Contributions receivable at June 30, 2012 and 2011, are due to be received in the following periods (in thousands): Receivable in less than one year $ 23,876 $ 28,008 Receivable in one to five years 40,054 29,553 Receivable after five years 5,871 7,547 Total undiscounted contributions receivable 69,801 65,108 Less present value discount (weighted-average discount rate of 2.45% in 2012 and 3.67% in 2011) (3,965) (5,358) 65,836 59,750 Less allowance for doubtful contributions (698) (651) Contributions receivable, net $ 65,138 $ 59,

18 4. Securities Securities, carried at fair value or amounts that approximate fair value, consist of the following (in thousands): June Money market and short-term investments $ 114,126 $ 77,708 Marketable domestic equity 59,711 76,441 Marketable international equity U.S. treasury obligations 51,301 56,456 Preferred Securities 19 American depository receipts 15 Exchange traded funds 3, Open-Ended Mutual funds 244, ,288 Closed-Ended Mutual funds 58, Collateralized mortgage obligations 49,809 47,277 Common trust funds equities 205, ,971 Common trust funds fixed income 45,225 42,962 Real estate 1,438 1,237 Royalties and mineral interests Marketable alternatives 265, ,361 Nonmarketable alternatives 42,225 26,568 Other LLCs and LLPs 116, ,946 $ 1,258,796 $ 1,307,879 The common trust funds equities and fixed income are generally redeemable in less than 30 days. Marketable alternatives, nonmarketable alternatives, and other LLC and LLP investments (alternative investments) included in the table above represent assets accounted for using the equity method of accounting. The primary objectives for these alternative investments are to improve diversification and reduce volatility. These investments have various liquidity schedules, which are monitored on a continuous basis. The underlying investment strategies for these investments include hedge funds, private equity, venture capital, private real estate, and both domestic and foreign equities

19 5. Fair Value Measurements Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Fair Value Measurements and Disclosures Topic of the Financial Accounting Standards Board Accounting Standards Codification (ASC) establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). In determining fair value, KU Endowment uses various methods, including market, income, and cost approaches. Based on these approaches, KU Endowment utilizes certain assumptions that market participants would use in pricing the assets, including assumptions about risk and the risks inherent in the inputs to the valuation techniques. The inputs can be readily observable, market corroborated, or generally unobservable inputs. KU Endowment uses valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. The observability of the inputs used in the valuation techniques is the basis for determining the appropriate fair value hierarchy level. Certain of KU Endowment s financial assets and financial liabilities are measured at fair value on a recurring basis, including money market, fixed-income, and equity instruments. The three levels of the fair value hierarchy and a description of the valuation methodologies used for instruments measured at fair value are as follows: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities as of the reporting date. Level 1 primarily consists of financial instruments, such as money market securities and listed equities. Level 2 Pricing inputs other than quoted prices included in Level 1 that are either directly observable or that can be derived or supported from observable data as of the reporting date. Instruments in this category include certain U.S. government agency and sponsored entity debt securities and commingled common trust funds. Level 3 Pricing inputs include those that are significant to the fair value of the financial asset or financial liability and are not observable from objective sources. These inputs may be used with internally developed methodologies that result in management s best estimate of fair value

20 5. Fair Value Measurements (continued) KU Endowment s alternative investments are $423,967,000 and $346,875,000 at June 30, 2012 and 2011, respectively. These investments provide KU Endowment with a proportionate share of the investment gains (losses) and are accounted for using the equity method of accounting; thus, they are excluded from the scope of the Fair Value Measurements and Disclosures Topic. The fair value of financial assets and liabilities measured at fair value on a recurring basis was determined using the following inputs at June 30, 2012 (in thousands): Quoted Prices in Active Markets for Identical Assets (Level 1) Fair Value Measurements at Reporting Date Using Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value Assets Money markets and short-term investments $ 114,126 $ 114,126 $ $ Marketable domestic equity 59,711 59,711 Marketable international equity U.S. treasury obligations 51,301 51,301 American depository receipts Open-Ended Mutual funds 244, ,999 Closed-Ended Mutual funds 58,086 58,086 Preferred Securities Exchange traded funds 3,929 3,929 Collateralized mortgage obligations 49,809 49,809 Common trust funds equities 205, ,827 Common trust funds fixed income 45,225 45,225 Real estate 1,438 1,438 Royalties and mineral rights , , ,162 1,654 Trusts held by others 34,487 28,740 2,752 2,995 Interest in KU Endowment Charitable Gift Fund $ 869,727 $ 510,164 $ 354,914 $ 4,649 Fair value measurement using significant unobservable inputs (Level 3) Fair value beginning balance at July 1, 2011 $ 4,666 Realized and unrealized gains on trusts held by others (237) Transfers into Level Fair value ending balance at June 30, 2012 $ 4,

21 5. Fair Value Measurements (continued) The fair value of financial assets and liabilities measured at fair value on a recurring basis was determined using the following inputs at June 30, 2011 (in thousands): Quoted Prices in Active Markets for Identical Assets (Level 1) Fair Value Measurements at Reporting Date Using Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value Assets Money markets and short-term investments $ 77,708 $ 77,701 $ 7 $ Marketable domestic equity 76,441 76,441 Marketable international equity U.S. treasury obligations 56,456 56,456 American depository receipts Open-Ended Mutual funds 293, ,288 Closed-Ended Mutual funds Exchange traded funds Collateralized mortgage obligations 47,277 47,277 Common trust funds equities 364, ,971 Common trust funds fixed income 42,962 42,962 Real estate 1,237 1,237 Royalties and mineral rights , , ,722 1,434 Trusts held by others 37,149 30,734 3,183 3,232 Interest in KU Endowment Charitable Gift Fund $ 998,633 $ 479,062 $ 514,905 $ 4,666 Fair value measurement using significant unobservable inputs (Level 3) Fair value beginning balance at July 1, 2010 $ 4,500 Realized and unrealized gains on trusts held by others 139 Transfers into Level 3 27 Fair value ending balance at June 30, 2011 $ 4,

22 5. Fair Value Measurements (continued) The fair values of the securities included in Level 1 were determined through quoted market prices. The fair values of Level 2 securities were determined through evaluated bid prices based on recent trading activity and other relevant information, including market interest rate curves and referenced credit spreads, and estimated prepayment rates, where applicable, are used for valuation purposes and are provided by third-party pricing services where quoted market values are not available. Level 2 investments include corporate fixed income, government bonds, American depository receipts, and collateralized mortgage obligations and commingled common trust funds. Due to the volatility of the capital markets, there is a reasonable possibility of significant changes in fair value and additional gains (losses) in the near term subsequent to June 30, The fair value of trusts held by others is estimated based on KU Endowment s beneficial interests in the trusts held by others. Certain of the underlying investments within the trusts held by others utilize significant unobservable inputs. Thus, KU Endowment s ownership of these underlying investments is categorized as Level 3 in the fair value hierarchy. The fair values of real estate, royalties, and mineral rights are based on inputs that are not observable in the market. Thus, KU Endowment s ownership of these investments is categorized as Level 3 in the fair value hierarchy. 6. Benefit Plans Pension Plan KU Endowment has a defined-benefit pension plan that provides the participants of the plan with a life annuity benefit. Employees of KU Endowment meeting years of service requirements are eligible to participate in the plan with contributions funded solely by KU Endowment. KU Endowment s policy is to make periodic employer contributions in conformance with at least the minimum funding requirements as set forth in the Employee Retirement Income Security Act of 1974 (ERISA)

23 6. Benefit Plans (continued) The benefit obligation is the present value of benefits for all retired and vested terminated participants, plus a present value of benefits for active participants, based on service rendered prior to June 30, 2012, and projected future pay levels at expected retirement ages. The plan s funded status and amounts recognized in KU Endowment s statements of financial position are as follows (in thousands): Change in benefit obligation Benefit obligation at beginning of year $ 18,244 $ 17,247 Service cost Interest cost 1, Actuarial (gain) loss 4,227 (398) Benefits and expenses paid (497) (452) Benefit obligation at end of year $ 23,919 $ 18,244 Change in plan assets Fair value of plan assets at beginning of year $ 14,728 $ 11,733 Actual return on plan assets 603 2,445 Employer contribution 1,037 1,002 Benefits and expenses paid (496) (452) Fair value of plan assets at end of year $ 15,872 $ 14,728 Unfunded status included in accounts payable and accrued expenses $ (8,047) $ (3,516) Federal legislation requires KU Endowment to fund the value of accrued benefits for the pension plan over time, based on the average discount rate derived from high quality corporate bonds over the most recent 24 months ending on the plan s year-end. The intent of the legislation is to measure the plan s ability to settle benefits already earned by plan participants. For the plan years ended 2012 and 2011, the percentage of the value of accrued benefits then funded in the plan was 99.5% and 98.0%, respectively, as certified by KU Endowment s actuarial consultant

24 6. Benefit Plans (continued) Included in unrestricted net assets at June 30 are the following amounts that have not yet been recognized in net periodic pension cost (in thousands): Unrecognized actuarial losses $ 8,139 $ 3,549 Changes in plan assets and benefit obligations in unrestricted net assets during 2012 and 2011 include (in thousands): Unrecognized actuarial (gain) loss $ 4,753 $ (1,865) Amortization of actuarial loss (163) (357) $ 4,590 $ (2,222) The amount of unrecognized actuarial losses expected to be recognized through net periodic pension cost during 2013 is $542,706. The components of net periodic pension cost were as follows for the years ended June 30 (in thousands): Service cost $ 861 $ 864 Interest cost 1, Expected return on plan assets (1,130) (979) Recognized net actuarial loss Net periodic pension cost $ 978 $ 1,225 KU Endowment s funding policy is to make at least the minimum annual contributions required by ERISA. The expected total contributions during 2013 will be $1,084,

25 6. Benefit Plans (continued) KU Endowment s asset-allocation target is 70% equity and 30% fixed income for pension fund assets. Actual pension plan weighted-average asset allocations by asset category are as follows: March 31 Asset Category Equity securities 67.6% 71.9% Debt securities Other % 100.0% The fair value of pension plan assets was determined using the following inputs at June 30, 2012 (in thousands): Fair Value Measurements Using Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value Money markets and shortterm investments $ 85 $ 85 $ $ International enhanced cash funds 1,496 1,496 Domestic equity funds 5,220 5,220 International equity funds 3,154 3,154 International balanced funds Domestic fixed-income funds 5,059 5,059 $ 15,872 $ 15,872 $ $

26 6. Benefit Plans (continued) The fair value of pension plan assets was determined using the following inputs at June 30, 2011 (in thousands): Fair Value Measurements Using Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value Money markets and shortterm investments $ 57 $ 57 $ $ International enhanced cash funds 1,392 1,392 Domestic equity funds 5,056 5,056 International equity funds 3,274 3,274 International balanced funds Domestic fixed income funds 4,082 4,082 $ 14,728 $ 14,728 $ $ The actuarial valuation of the plan utilized a 7.5% long-term return assumption. This is consistent with the return expectations for a diversified, equity-oriented portfolio of publicly traded stocks and bonds over long-term periods. KU Endowment s review of long-term risk and return assumptions supports this target allocation

27 6. Benefit Plans (continued) The assumptions used in determining pension information for the plans for the years ended June 30, using a June 30 measurement date, were as follows: Benefit obligations: Weighted-average discount rate 4.25% 5.75% Rate of compensation increase 2.50% 6.50% 4.00% 8.00% Benefit costs: Weighted-average discount rate 5.75% 5.50% Expected return on plan assets 7.50% 8.00% Rate of compensation increase 4.00% 8.00% 3.75% 7.75% The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid (in thousands): Fiscal Year Future Expected Benefit Payments 2013 $ ,308 Defined-Contribution Plan KU Endowment also has a 401(k) Plan (the Plan), which is a defined-contribution plan that covers substantially all employees meeting the eligibility requirements set forth under the Plan. KU Endowment contributes an amount based on a percentage of the amount contributed to the Plan by eligible employees. KU Endowment recorded expenses of $408,000 and $391,000 related to the Plan during fiscal year 2012 and fiscal year 2011, respectively, which are included in administrative and fundraising support in the accompanying statement of activities

28 7. Temporary Restrictions Satisfied For the years ended June 30, 2012 and 2011, temporarily restricted net assets were released from restrictions by incurring expenses satisfying the restricted purposes, or by the occurrence of other events specified by donors (in thousands) Program restrictions: University support: Student support $ 29,255 $ 26,878 Faculty support and contractual services 33,587 33,405 Construction, furnishings, equipment, and supplies 14,696 12,776 Program and other educational support 36,451 36,268 $ 113,989 $ 109, Temporarily Restricted Net Assets Temporarily restricted net assets available at June 30 are restricted for the following purposes (in thousands): Scholarships, fellowships, and awards $ 217,932 $ 239,647 Construction 34,791 20,430 Equipment 4,914 8,586 Research 55,962 55,607 Salaries and services 136, ,175 Other University support 325, ,547 $ 775,718 $ 807,

29 9. Permanently Restricted Net Assets Permanently restricted net assets by purpose at June 30 are as follows (in thousands): Scholarships, fellowships, and awards $ 152,282 $ 148,744 Equipment 2,350 2,326 Research 23,669 24,011 Salaries and services 94,529 92,033 Other University support 134, ,985 $ 406,851 $ 403,099 The income generated from these permanently restricted assets is to be used for activities relating to the purpose. 10. Endowment KU Endowment s endowment consists of approximately 2,745 individual fund accounts established for a variety of purposes to benefit the University. Its endowment includes both donor-restricted endowment funds and funds designated by the Board of Trustees to function as endowments. Net assets associated with endowment funds, including funds designated by the Board of Trustees to function as endowments, are classified and reported on the existence or absence of donor-imposed restrictions. The endowment does not include fund accounts that are wholly expendable

30 10. Endowment (continued) Interpretation of Relevant Law KU Endowment has interpreted the Uniform Management of Institutional Funds Act (UMIFA) as requiring the preservation of the fair value of the original gift as of the gift date of the donorrestricted endowment funds absent explicit donor stipulations to the contrary. As a result of this interpretation, KU Endowment classifies as permanently restricted net assets (a) the original value of gifts donated to the permanent endowment, (b) the original value of subsequent gifts to the permanent endowment, and (c) accumulations to the permanent endowment made in accordance with the direction of the applicable donor gift instrument at the time the accumulation is added to the fund. The remaining portion of the donor-restricted endowment fund that is not classified in permanently restricted net assets is classified as temporarily restricted net assets until the donor s restriction is met. Effective July 1, 2008, the state of Kansas adopted the Uniform Prudent Management of Institutional Funds Act (UPMIFA), which added certain prudent spending measures to UMIFA. In accordance with UPMIFA, KU Endowment considers the following factors in making a determination to appropriate or accumulate donorrestricted endowment funds: (1) The duration and preservation of the fund (2) The purposes of the donor-restricted endowment fund (3) General economic conditions (4) The possible effect of inflation and deflation (5) The expected total return from income and the appreciation of investments (6) Other resources of KU Endowment (7) The investment policies of KU Endowment

31 10. Endowment (continued) At June 30, 2012, the endowment net assets composition, by type of fund, consisted of the following (in thousands): Temporarily Restricted Permanently Restricted Unrestricted Total Donor-restricted endowment funds $ 4,012 $ 423,606 $ 361,992 $ 789,610 Board-designated endowment funds 2,816 2,816 Total funds $ 6,828 $ 423,606 $ 361,992 $ 792,426 For the year ended June 30, 2012, the changes in the endowment net assets are as follows (in thousands): Temporarily Restricted Permanently Restricted Unrestricted Total Endowment net assets, beginning of period $ 9,566 $ 463,386 $ 356,042 $ 828,994 Investment return: Investment income 66 10,102 10,168 Net depreciation (162) (41,360) (41,522) Total investment return (96) (31,258) (31,354) Contributions 60 22,011 8,620 30,691 Appropriation of endowment assets for expenditure (185) (24,622) (24,807) Other changes: Other receipts 1, ,191 Interfund transfer within KU Endowment fund accounts, including wholly expendable accounts (3,763) (6,856) (2,670) (13,289) Endowment net assets, end of period $ 6,828 $ 423,606 $ 361,992 $ 792,

32 10. Endowment (continued) At June 30, 2011, the endowment net assets composition, by type of fund, consisted of the following (in thousands): Temporarily Restricted Permanently Restricted Unrestricted Total Donor-restricted endowment funds $ 6,509 $ 463,386 $ 356,042 $ 825,937 Board-designated endowment funds 3,057 3,057 Total funds $ 9,566 $ 463,386 $ 356,042 $ 828,994 For the year ended June 30, 2011, the changes in the endowment net assets are as follows (in thousands): Temporarily Restricted Permanently Restricted Unrestricted Total Endowment net assets, beginning of period $ 7,903 $ 328,621 $ 351,953 $ 688,477 Investment return: Investment income 60 8,318 8,378 Net appreciation , ,440 Total investment return , ,818 Contributions 19,209 7,459 26,668 Appropriation of endowment assets for expenditure (508) (23,559) (24,067) Other changes: Other receipts 2,552 1,563 4,115 Interfund transfer within KU Endowment fund accounts, including wholly expendable accounts (946) 3,299 (3,370) (1,017) Endowment net assets, end of period $ 9,566 $ 463,386 $ 356,042 $ 828,

33 10. Endowment (continued) Funds With Deficiencies From time to time, the fair value of assets associated with individual donor-restricted endowment funds may fall below the level that the donor contributed, which is defined by KU Endowment as the amount required under UPMIFA to be retained as a fund of perpetual duration. In the absence of donor stipulations or law to the contrary, decreases in the value of assets of a donorrestricted endowment fund to an amount below the historical gift value shall reduce temporarily restricted net assets. Accordingly, the aggregate of these deficiencies shall reduce temporarily restricted net assets to the extent there is net appreciation on related funds with donor-imposed temporary restrictions. Deficiencies of this nature that are reported in temporarily restricted net assets were $3,880,530 as of June 30, 2012, and $1,246,882 as of June 30, These deficiencies resulted from unfavorable market fluctuations that occurred shortly after the investment of new permanently restricted contributions and continued appropriation for certain programs that was deemed prudent by the Board of Trustees. Any remaining depreciation in excess of amounts classified as temporarily restricted net assets shall reduce unrestricted net assets. There were no deficiencies sufficient enough to reduce unrestricted net assets as of June 30, 2012 and Return Objectives and Risk Parameters KU Endowment has investment policies that attempt to provide a predictable stream of funding to programs supported by operations, as well as endowment donations. Assets are invested in a manner that is intended to produce results that exceed the respective benchmark while assuming a moderate level of investment risk. KU Endowment expects its endowment funds, over time, to provide an average rate of return of approximately 8% annually. Actual returns in any given year may vary from this amount. Strategies Employed for Achieving Objectives To satisfy its long-term rate-of-return objectives, KU Endowment relies on a total return strategy in which investment returns are achieved through both capital appreciation (realized and unrealized) and current yield (interest and dividends net of fees). KU Endowment targets a diversified asset allocation to achieve its long-term return objectives within prudent risk constraints

34 10. Endowment (continued) Spending Policy and How the Investment Objectives Relate to Spending Policy Except as specified by the donor, KU Endowment has adopted a policy in which earnings are allocated monthly for spending based on 5.5% of the 12 quarterly average market value of the endowment fund investment pool as of September 30. In establishing this policy, KU Endowment considered the long-term expected return on its endowment. Accordingly, over the long term, KU Endowment expects the current spending policy to allow its endowment to grow at an average of the long-term rate of inflation. This is consistent with KU Endowment s objective to maintain the purchasing power of the endowed assets held in perpetuity, as well as to provide additional growth through new gifts. 11. Subsequent Events KU Endowment evaluated events and transactions occurring subsequent to June 30, 2012 through October 19, 2012, the date of issuance of the financial statements. During this period, there were no subsequent events requiring recognition or disclosure in the financial statements