VIRGINIA COMMONWEALTH UNIVERSITY RICHMOND, VIRGINIA REPORT ON AUDIT FOR THE YEAR ENDED JUNE 30, 2002

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1 VIRGINIA COMMONWEALTH UNIVERSITY RICHMOND, VIRGINIA REPORT ON AUDIT FOR THE YEAR ENDED JUNE 30, 2002

2 AUDIT SUMMARY Our audit of Virginia Commonwealth University for the year ended June 30, 2002, found the following: the financial statements are presented fairly, in all material respects; internal control matters that we consider to be a reportable conditions; however, we do not consider these to be material weaknesses; an instance of noncompliance that is required to be reported under Government Auditing Standards; and the University has not taken adequate corrective action with respect to the previously reported finding Improve Controls Over Cash Collections. Adequate corrective action was taken with respect to audit findings reported in the prior year that are not repeated in this report.

3 - T A B L E O F C O N T E N T S - AUDIT SUMMARY INDEPENDENT AUDITOR S REPORTS: Report on Financial Statements Report on Compliance and on Internal Control over Financial Reporting INTERNAL CONTROL FINDINGS AND RECOMMENDATIONS MANAGEMENT S DISCUSSION AND ANALYSIS FINANCIAL STATEMENTS: Statement of Net Assets Statement of Revenues, Expenses, and Changes in Net Assets Statement of Cash Flows Notes to Financial Statements SUPPLEMENTARY INFORMATION: Schedule of Auxiliary Enterprises Revenue and Expenditures UNIVERSITY OFFICIALS

4 December 11, 2002 The Honorable Mark R. Warner Governor of Virginia The Honorable Kevin G. Miller Chairman, Joint Legislative Audit and Review Commission The Board of Visitors Virginia Commonwealth University We have audited the accounts and records of Virginia Commonwealth University and its discretely presented component unit, as of and for the year ended June 30, 2002, and submit herewith our complete reports on financial statements and compliance and internal control over financial reporting. INDEPENDENT AUDITOR S REPORT ON FINANCIAL STATEMENTS We have audited the accompanying basic financial statements of Virginia Commonwealth University, a component unit of the Commonwealth of Virginia, and its discretely presented component unit as of and for the year ended June 30, 2002, as listed in the table of contents. These financial statements are the responsibility of the University's management. Our responsibility is to express an opinion on these financial statements based on our audit. We did not audit the financial statements of the Virginia Commonwealth University Health System Authority, a discretely presented component unit, which statements reflect total assets and revenues of $578,179,879 and $678,896,710, respectively, as of and for the year ended June 30, Those statements were audited by other auditors whose report has been furnished to us and our opinion, insofar as it relates to the amounts included for the Virginia Commonwealth University Health System Authority is based solely upon the report of the other auditors. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit and the report of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audit and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the respective financial position of Virginia Commonwealth

5 University and of its discretely presented component unit as of June 30, 2002, and the respecitve changes in financial position and cash flows thereof for the year then ended, in conformity with accounting principles generally accepted in the United States of America. As described in Note 1 in the Notes to Financial Statements, the University has implemented a new financial reporting model as required by the provisions of Governmental Accounting Standards Board Statement 34, Basic Financial Statements and Management s and Analysis for State and Local Governments, and Statement 35, Basic Financial Statements Discussion and Management s Discussion and Analysis for Public Colleges and Universities as of June 30, The Management s Discussion and Analysis presented on pages 7 through 13 is not a required part of the basic financial statements, but is supplemental information required by the Governmental Accounting Standards Board. We have applied certain limited procedures, which consisted principally of inquiries of management regarding the methods of measurement and presentation of the required supplemental information. However, we did not audit the information and express no opinion on it. Our audit was conducted for the purpose of forming an opinion on the basic financial statements. The accompanying Schedule of Auxiliary Enterprises Revenues and Expenditures is presented for the purpose of additional analysis and is not a required part of the financial statements. The information in that schedule has been subjected to the auditing procedures applied in the audit of the financial statements and, in our opinion, such information is fairly presented in all material respects in relation to the financial statements taken as a whole. INDEPENDENT AUDITOR S REPORT ON COMPLIANCE AND ON INTERNAL CONTROL OVER FINANCIAL REPORTING In planning and performing our audit of the financial statements of Virginia Commonwealth University as of and for the year ended June 30, 2002, we considered internal controls over financial reporting and tested compliance with certain provisions of laws, regulations, contracts, and grants in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards. Compliance As part of obtaining reasonable assurance about whether the University s financial statements are free of material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts and grants, noncompliance which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit and, accordingly, we do not express such an opinion. The results of our tests disclosed an instance of noncompliance that is required to be reported under Government Auditing Standards. Internal Control Over Financial Reporting In planning and performing our audit, we considered the University s internal control over financial reporting in order to determine our auditing procedures for the purpose of expressing our opinion on the financial statements and not to provide assurance on the internal control over financial reporting. However, we noted certain matters involving the internal control over financial reporting and its operation that we consider to be reportable conditions. Reportable conditions involve matters coming to our attention relating to

6 significant deficiencies in the design or operation of the internal control over financial reporting that, in our judgment, could adversely affect the University s ability to record, process, summarize, and report financial data consistent with the assertions of management in the financial statements. These reportable conditions are described in the section titled Internal Control Finding and Recommendations. A material weakness is a condition in which the design or operation of one or more of the internal control components does not reduce to a relatively low level the risk that misstatements in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. Our consideration of the internal control over financial reporting would not necessarily disclose all matters in the internal control over financial reporting that might be material weaknesses. However, we believe that the reportable conditions described above are not material weaknesses. Status of Prior Findings Virginia Commonwealth University has not taken adequate corrective action with respect to the previously reported finding Improve Controls Over Cash Collections. Accordingly, we included this finding in the section entitled Internal Control Findings and Recommendations. Virginia Commonwealth University has taken adequate corrective action with respect to audit findings reported in the prior year that are not repeated in this report. The Independent Auditor s Report on Compliance and on Internal Control over Financial Reporting is intended solely for the information and use of the Governor and General Assembly of Virginia, Board of Visitors and management, and is not intended to be and should not be used by anyone other than these specified parties. However, this report is a matter of public record and its distribution is not limited. EXIT CONFERENCE We discussed this report with management at an exit conference held on January 16, MSM/cam cam: AUDITOR OF PUBLIC ACCOUNTS

7 INTERNAL CONTROL FINDINGS AND RECOMMENDATIONS Ensure Proper Stewardship and Control Over Fixed Assets The University did not adequately maintain and safeguard fixed assets in accordance with the University s fixed asset policies and procedures and the Commonwealth s Accounting Policies and Procedures. Exceptions noted in our test work included being unable to locate fixed assets, assets having unreadable or non-visible identification tags, assets without identification tags, assets with incorrect location or other description data in the fixed asset system, and assets not appearing on the department s inventory verification listing. These exceptions arose from individual department custodians not following procedures for properly maintaining and tracking fixed assets. Management should ensure that each department follows the requirements and guidelines in the University s fixed asset policies and procedures and properly conducts an annual inventory of its fixed assets. Management should establish a uniform procedure of tagging fixed assets so tags are visible for tracking purposes, and update the policies and procedures to reflect changes caused by the new online fixed asset system. Improve Controls over Cash Collection University policy requires the deposit of cash receipts over $100 by the next business day. Our review of five cash collections points found two departments that did not consistently comply with this policy. The University has written policies and procedures regarding the handling of cash transactions and provides employee training. However, departmental management has the responsibility for ensuring employee awareness and commitment to strong internal controls over cash receipts. These controls are necessary to prevent mishandling of funds and safeguard against loss. Improve Construction Project Management The University did not clearly document the authority and responsibilities of all persons involved in the contract administration, project management, and oversight of construction projects. For the West Hospital Fire/Safety Renovation project, the project inspector was one month behind in completing required daily inspection reports, and the reports did not include the inspector s signature and project number. The Construction and Professional Services Manual requires these reports to show the progress of and changes in a project during construction, and provide useful information for the University in case the need arises to enforce contractor performance. In addition, the project files did not clearly designate the department responsible for the administration of the contract and we could not determine whether it was the Construction Management Department or the Planning and Design Department. The University should improve its project management by clearly designating responsible departments and ensuring project inspectors complete required reports timely to protect the University in the event of a dispute with the contractor. Improve Controls Over Small Purchase Charge Card Program The University has received certain exemptions from the Department of Accounts on how it may operate and use the small purchase charge cards. The exemptions allow the University to set rules, policies, and procedures that best meet its operating environment. However, none of the exemptions allow the University to bypass fundamental internal controls and more importantly, the exemptions require the University to enforce its own rules, policies, and procedures.

8 One of the key internal controls with the small purchase charge card is ensuring that the University only pays for authorized and approved purchases and has a procedure to detect statement errors and misbillings. The Department of Accounts has allowed the University to establish its procedures and documentation standards for this process. The University has not clearly communicated its standards to the departments resulting in inconsistencies in documentation. Our review found departments do not clearly identify discrepancies. Not following University purchasing and usage guidelines could allow improper payments. The University should enforce its policies and procedures to reduce the risk of improper payments.

9 New Accounting Standards MANAGEMENT S DISCUSSION AND ANALYSIS In June 1999, the Governmental Accounting Standards Board (GASB) issued Statement 34, Basic Financial Statements and Management s Discussion and Analysis for State and Local Governments, which established new financial reporting requirements. In November 1999, GASB issued Statement 35, Basic Financial Statements and Management s Discussion and Analysis for Public Colleges and Universities an Amendment of GASB Statement 34, which applies the new reporting standards to public higher education institutions. The new financial reporting standards significantly change the appearance and nature of the required financial information. The major changes are: (1) financial statements are presented on an entity-wide basis and not by major fund groups; (2) depreciation expense is recognized, previously it was not; (3) expenses rather than expenditures are reported; and (4) the basic financial statements are preceded by this Management s Discussion and Analysis. As required by the new accounting pronouncements, the basic financial statements are: the Statement of Net Assets; the Statement of Revenues, Expenses, and Changes in Net Assets; and the Statement of Cash Flows. The following analysis discusses elements from each of these statements, as well as provides an overview of University activities. Since this is a transition year for the new reporting format, only one year of information is presented in the audited financial statements. Virginia Commonwealth University s Management Discussion and Analysis (MD&A) of its financial condition provides an overview of financial activity, identifies changes in financial position, and assists the reader in focusing on significant financial issues. While maintaining financial health is crucial to the long-term viability of a university, the primary mission of a public institution of higher education is to provide education, research, and public service. Therefore, net assets are accumulated only as required to ensure that there are sufficient reserve funds for future operations and implementation of new programs. The MD&A provides summary level financial information; therefore, it should be read in conjunction with the accompanying financial statements. Financial Highlights Operating University: The University s income before other revenues and expenses was $ 7.6 million. State appropriations decreased $6.6 million of which $2.3 million was offset by reductions in the contribution to state employee benefit plans, and $1.6 million was applied to the budget reduction for fiscal year State appropriations receivable decreased $9.1 million as the University accumulated its reserves in non-general fund sources. The University negotiated a Federal facilities and administrative (indirect) cost rate of 50 percent effective for fiscal years

10 Authority: Patient service revenues comprise the majority of the Authority revenues. Net patient services revenue increased 3.3 percent from the prior year due to an increase in selected hospital services and revenue improvement processes. The premium revenue of Virginia Premier increased by $64 million as a result of participation in the Department of Medical Assistance Medallion II managed care expansion throughout the state. During the year, the Authority s expenses increased by $75.8 million from prior year. The majority of the increase is the result of the medical claims expense increase of $58 million, which resulted from Virginia Premier s network expansion. Financial Highlights Capital University: The University acquired the Capitol Medical Center in fiscal year 2002 to provide additional student housing. Construction was also substantially completed on the Bowe Street Parking Deck. VCU Real Estate Foundation started construction of the second student apartment complex, which will be managed by the University. Authority: The major capital expenditure was the completion and opening of the Gateway Building. Using the Annual Report This annual report consists of a series of financial statements, prepared in accordance with the Governmental Accounting Standards Board Statement 34, Basic Financial Statements-and Management s Discussion and Analysis - for State and Local Governments. The financial statements presented in prior years focused on the accountability of funds, while these statements focus on the financial condition of the University, the results of operations, and cash flows of the University as a whole. The financial statements presented have been prepared using the most current implementation guidelines of the Governmental Accounting Standards Board. One of the most important questions asked about University finances is, Is the University as a whole better or worse as a result of the year s activities? The key to understanding that question is the Statement of Net Assets, the Statement of Revenues, Expenses and Changes in Net Assets, and the Statement of Cash Flows. These statements present financial information in a form similar to that used by corporations. The University s net assets (the difference between assets and liabilities) is one indicator of the University s financial health. Over time, increases or decreases in net assets are indicators of the improvement or erosion of the University s financial health when considered with non-financial facts such as enrollment levels and the condition of the facilities. The Statement of Net Assets includes all assets (property that we own and what we are owed by others) and liabilities (what we owe to others and have collected from others before we have provided the service). It is prepared under the accrual basis of accounting, whereby revenues and assets are recognized

11 when the service is provided, and expenses and liabilities are recognized when others provide the service to us, regardless of when cash is exchanged. The Statement of Revenues, Expenses and Changes in Net Assets presents the revenues earned and expenses incurred during the year. Activities are reported as either operating or nonoperating. Because the financial reporting model classifies State appropriations and gifts as nonoperating revenues, a public university s dependency on state aid and gifts will generally result in operating deficits. The utilization of longlived assets, referred to as Capital Assets, is reflected in the financial statements as depreciation, which amortizes the cost of an asset over its expected useful life. Another important factor to consider when evaluating financial viability is the University s ability to meet financial obligations as they mature. The Statement of Cash Flows presents information related to cash inflows and outflows summarized by operating, capital, financing, and investing activities. Statement of Net Assets The following table reflects the condensed Statement of Net Assets of the University and the Authority. VCU Health University System Authority Current and other assets $ 197,542,523 $ 330,741,422 Capital assets - net 369,020, ,438,457 Total assets 566,563, ,179,879 Current and other liabilities 101,972, ,598,631 Long term liabilities 150,707, ,930,339 Total liabilities 252,679, ,528,970 Net assets: Invested in capital assets, net of related debt 235,774, ,435,381 Restricted 44,513,529 16,487,808 Unrestricted 33,595, ,646,720 Total net assets $ 313,883,064 $ 356,569,909 For more detailed information see the accompanying Statement of Net Assets. Six basic transactions affect the Statement of Net Assets: The issuance of notes or bonds will increase current assets and increase long-term liabilities. Spending note or bond proceeds on capital acquisitions will change the composition of the assets: current assets will decrease and capital assets will increase. Likewise, the classification of net assets changes: Restricted Net Assets will decrease and Invested in Capital Assets, Net of Debt will increase.

12 Spending other resources on capital acquisitions will decrease current assets and increase capital assets. A second effect will be the decrease of Unrestricted Net Assets and the increase of Invested in Capital Assets, Net of Debt. Principal payments on liabilities will decrease current assets and decrease longterm liabilities. These payments will also increase Invested in Capital Assets, Net of Debt and decrease Unrestricted Net Assets. Depreciation expense, which is reflected as an operating expense, will reduce capital assets and Invested in Capital Assets, Net of Debt. Operating results, excluding depreciation expense, will affect (increase or decrease) all of the categories other than capital assets and Invested in Capital Assets, Net of Debt. During fiscal year 2002, University net assets increased $12.3 million. Buildings and equipment, capital assets increased while other assets decreased, as the result of the expenditure of cash converted from investments and capital appropriations on land. Statement of Revenues, Expenses and Changes in Net Assets The following is a schedule of the revenues and expenses for the University and the Authority for the current year: VCU Health University System Authority Operating revenues: Student tuition and fees $ 73,603,341 $ - Grants and contracts 137,185,745 - Sales and services of educational departments 7,949,171 - Auxiliary enterprises 45,674,175 - Hospital services 17,638, ,896,710 Other revenues 30,301,385 - Total operating revenues 312,352, ,896,710 Operating expenses: Program activities: Instruction 195,292,359 - Research 92,026,054 - Public service 6,040,423 - Supporting services: Academic support 47,252,643 - Student services 9,071,480 - Institutional support 38,257,610 - Operations and maintenance of plant 26,565,981 - Student aid 11,317,322 - Auxiliary enterprises 33,749,319 - Hospital services 16,676, ,473,785 Depreciation expense 26,169,077 23,644,150 Other expenses 674,682 - Total operating expenses 503,093, ,117,935 Operating gain/(loss) (190,740,769) 2,778,775

13 Nonoperating revenues(expenses): State appropriations 188,057,625 - Gifts 16,634,974 - Investment income (net of investment expense) 626,660 3,553,343 Interest on capital asset-related debt (6,978,351) (2,447,228) Other - 100,665 Total nonoperating revenues 198,340,908 1,206,780 Income before other revenues and expenses 7,600,139 3,985,555 Additions to permanent endowments 11,614 - Capital appropriations 1,879,092 - Capital gifts 1,750,718 78,000 Decrease in beneficial interest in trusts - (3,053,196) Increase in net assets 11,241,563 1,010,359 Net assets beginning of year 302,641, ,559,550 Net assets - end of year $313,883,064 $356,569,909 Nine basic transactions affect the levels of revenues and expenses. Revenues: Enrollment levels directly affect tuition and fee revenues and auxiliary enterprise sales, services, and fee revenues. The number of potential students, overall economic condition, and acceptance levels at other institutions affect enrollment levels. The mix of on-campus and off-campus students will affect auxiliary enterprise sales and services. The Commonwealth of Virginia contributes a significant portion of University revenues through state appropriations and also directs the tuition policy for Virginia undergraduate resident students. Thus, the economic health and budget priorities of the Commonwealth may directly affect revenues. The University derives the majority of grant and contract revenues and student financial aid from the Federal Government. As such, changes in Federal budget priorities and award levels may affect sponsored program activities and enrollment levels. Investment income is affected by changes in interest rates and the stock market, as well as by the funds available for investing. Expenses: Enrollment levels may directly affect expenses by increasing or decreasing the resources required to support the students.

14 The implementation of new programs or additional services within the existing functional expense categories directly affects the level of services. The Commonwealth of Virginia establishes salary increases for cost of living and merit pay for classified staff as well as overall increase levels for faculty. Generally, the portion of the increase attributable to state supported activities is funded through state appropriations. Federal laws and regulations regarding research activities can require the University to increase the level of support to maintain grant and contract funding. Changes in prices caused by inflation or changes in energy prices affect the nonpersonnel costs of the University. Significant changes in energy prices can require the reallocation of resources from the maintenance of facilities to support increased operating costs during a fiscal year. Overall operating revenues for the University increased by $20.8 million primarily from increases in Federal grants and contracts. The student head count increased by 994 to 24,915 for the fall semester and credit hours increased 3.9 percent in fiscal year The Authority s total revenues increased by 13.5 percent or $80.5 million. This significant increase in revenues resulted from new services, such as the expansion of Virginia Premier, pricing and the mix of hospital services. While total operating costs of the University increased by less than two percent, the Authority costs increased approximately 12.6 percent or $75.8 million. This is primarily attributable to a $58.0 million increase in medical claims expenses associated with the expansion of Virginia Premier s network. Additional personnel costs of $10 million required to meet market demands and the reduction in selected segments of the workforce contributed to the increase. Depreciation increased as the result of additional investment in capital assets. Capital Assets The University has started construction of the Bowe Street Parking Deck and continued the renovation projects in Sanger Hall, West Hospital, and student housing. The projects are either fully funded by state appropriations or will be financed through the Virginia College Building Authority s Pooled Bond Program, which is not dependent on the bond rating of the University. The Authority completed the Gateway Building ($58.0 million), which was funded through the 1998 revenue bond debt issue. Future Financial Effects The following are known facts and circumstances that will affect future financial results. The Governor of the Commonwealth of Virginia has reduced the state appropriation by 9.8 percent or $15.3 million in fiscal year 2003, and 12 percent or $18.1 million in fiscal year University employees will not receive base salary increases in fiscal year 2003.

15 Employees received a one-time 2.5 percent bonus based on their annual salary in fiscal year In lieu of receiving their bonus in cash, some classified employees may have elected to receive all or part of their bonus as additional paid time-off. The Board of Visitors approved a 6.6 percent increase in resident tuition and mandatory fee rates, a 7.5 percent increase in nonresident tuition, and mandatory fees for the fiscal year 2003 and approved a surcharge of $600 per year per student effective with the Spring 2003 semester. On November 6, 2002, the University issued a note to the Virginia College Building Authority (VCBA) in the amount of $32,945,000. The proceeds of the note will be used to finance the academic housing project, the Bowe Street Deck project, the renovation of Gladding Residence Hall, and Student Commons Phase III. The note bears interest at rates ranging from 3 percent to 5.25 percent.

16 VIRGINIA COMMONWEALTH UNIVERSITY STATEMENT OF NET ASSETS As of June 30, 2002 VCU Health University System Authority ASSETS Current assets: Cash and cash equivalents (Note 2) $ 78,427,124 $ 30,495,045 Short-term investments (Note 2) 12,078,156 13,946,651 Accounts receivable: Student, Net of allowance of $1,766,728 5,567,678 - Sponsors, Net of allowance of $200,000 11,965,099 - Patient, Net of allowance of $23,050,000-72,916,774 Third-party and non-patient - 44,612,041 Due from VCU Health System Authority 1,264,112 - Due from Commonwealth of Virginia 1,832,898 - Appropriations receivable 4,136,868 - Student loans receivable, current portion 4,121,106 - Other assets 1,810,552 8,475,074 Total current assets 121,203, ,445,585 Noncurrent assets: Endowment investments (Note 2) 2,572,230 - Other investments (Note 2) 50,689, ,365,571 Student loans receivable, Net of allowance of $3,587,644 19,312,374 - Due from VCU Health System Authority 3,007,876 - Other long-term assets 756,859 11,930,266 Capital assets, Net (Note 4) 369,020, ,438,457 Total noncurrrent assets 445,359, ,734,294 Total assets $ 566,563,036 $ 578,179,879 LIABILITIES Current liabilities: Accounts payable and accrued liabilities 42,879,065 98,439,198 Deferred revenue 23,883,656 - Due to Virginia Commonwealth University - 1,264,112 Long-term liabilities - current portion (Note 6) 11,924,192 15,887,445 Total current liabilities 78,686, ,590,755 Noncurrent liabilities: Deposits 23,285,233 - Due to Virginia Commonwealth University - 3,007,876 Long-term liabilities (Note 6) 150,707, ,930,339 Total noncurrent liabilities 173,993, ,938,215 Total liabilities 252,679, ,528,970 NET ASSETS Invested in capital assets, net of related debt 235,774, ,435,381 Restricted for: Nonexpendable: Scholarships and fellowships 2,018,526 - Departmental uses 553,703 16,487,808 Expendable: Scholarships and fellowships 7,225,183 - Research 11,969,213 - Departmental uses 14,923,791 - Loans 4,392,619 - Capital projects 3,430,494 - Unrestricted 33,595, ,646,720 Total net assets $ 313,883,064 $ 356,569,909 The accompanying Notes to Financial Statements are an integral part of this statement.

17 VIRGINIA COMMONWEALTH UNIVERSITY STATEMENT OF REVENUES, EXPENSES, AND CHANGES IN NET ASSETS As of June 30, 2002 University VCU Health System Authority Operating revenues: Student tuition and fees, Net of scholarship allowances of $18,707,315 $ 73,603,341 $ - Federal grants and contracts 108,075,566 - State grants and contracts 7,718,179 - Local grants and contracts 1,336,804 - Nongovernmental grants and contracts 20,055,196 - Sales and services of educational departments 7,949,171 - Auxiliary enterprises: Sales and services 28,303,357 - Student fees, Net of scholarship allowances of $943,022 17,370,818 - Hospital services 17,638, ,896,710 Other revenues 30,301,385 - Total operating revenues 312,352, ,896,710 Operating expenses: Instruction 195,292,359 - Research 92,026,054 - Public service 6,040,423 - Supporting services: Academic support 47,252,643 - Student services 9,071,480 - Institutional support 38,257,610 - Operations and maintenance of plant 26,565,981 - Student aid 11,317,322 - Auxiliary enterprises 33,749,319 - Hospital services 16,676, ,473,785 Depreciation expense 26,169,077 23,644,150 Other expenses 674,682 - Total operating expenses 503,093, ,117,935 Operating gain/(loss) (190,740,769) 2,778,775 Nonoperating revenues (expenses): State appropriations (Note 18) 188,057,625 - Gifts 16,634,974 - Investment income, Net of investment expense of $115, ,660 3,553,343 Interest on capital asset-related debt 6,978,351) (2,447,228) Other - 100,665 Net nonoperating revenues 198,340,908 1,206,780 Income before other revenues and expenses 7,600,139 3,985,555 Other revenues: Additions to permanent endowments 11,614 - Capital appropriations 1,879,092 - Capital gifts 1,750,718 78,000 Decrease in beneficial interest in trusts - (3,053,196) Increase in net assets 11,241,563 1,010,359 Net assets - beginning of year 302,641, ,559,550 Net assets - end of year $ 313,883,064 $ 356,569,909 The accompanying Notes to Financial Statements are an integral part of this statement.

18 VIRGINIA COMMONWEALTH UNIVERSITY STATEMENT OF CASH FLOWS For the Year Ended June 30, 2002 VCU Health University System Authority Cash flows from operating activities: Tuition and fees $ 73,317,098 $ - Grants and contracts 139,295,750 - Auxiliary enterprise charges 45,578,760 - Hospital services charges 17,638, ,998,612 Payments to suppliers (135,036,233) (276,361,687) Payments to employees (343,961,688) (333,481,153) Loans issued to students (4,454,795) - Collection of loans to students 4,021,693 - Other receipts (payments) 39,249,396 (3,887,934) Net cash used by operating activities (164,351,185) 53,267,838 Cash flows from noncapital financing activities: State appropriations 188,057,625 - Direct lending receipts 89,559,540 - Direct lending disbursements (89,559,540) - Gifts 16,646,588 - Virginia Commonwealth University Health System Authority loan repayment 272,246 - Noncapital long term-debt (322,830) - Net cash provided by noncapital financing activities 204,653,629 - Cash flows from capital financing activities: Proceeds from issuance of note payable - 23,000,000 State appropriations for capital assets 11,036,637 Gifts for capital assets 1,750,718 78,000 Purchase of capital assets (47,251,103) (54,915,303) Principal paid on capital-related debt 3,361,726 (5,454,936) Interest paid on capital-related debt (6,978,351) (2,447,228) Decrease in accrued interest payable - (116,239) Net cash used by capital financing activities (38,080,373) (39,855,706) Cash flows from investing activities: Proceeds from sales and maturities of investments 120,015, ,126,899 Investment income 3,899,065 3,141,362 Purchases of investments (123,032,495) (240,801,621) Payments received on notes receivable - 176,512 Other - 19,667 Net cash provided by investing activities 882,218 (18,337,181) Net increase (decrease) in cash 3,104,289 (4,925,049) Cash and cash equivalents - Beginning of year 75,322,835 35,420,094 Cash and cash equivalents - End of year $ 78,427,124 $ 30,495,045

19 VIRGINIA COMMONWEALTH UNIVERSITY STATEMENT OF CASH FLOWS, cont. For the Year Ended June 30, 2002 RECONCILIATION OF NET OPERATING EXPENSES TO NET CASH USED BY OPERATING ACTIVITIES: Operating gain/(loss) $ (190,740,769) $ 2,778, Adjustments to reconcile net gain/(loss) to net cash used by operating activities: Depreciation expense 26,169,077 23,644,150 Loss on asset disposition 634,800 - Provision for uncollectible accounts (484,676) 42,972,099 Changes in assets and liabilities: Receivables (1,913,206) (47,612,195) Other assets (148,307) 1,128,238 Accounts payable (3,176,038) 30,963,903 Deferred revenue 3,522,209 - Compensated absences and deferred compensation 638,578 (607,132) Deposits 1,147,147 - Net cash used by operating activities $ (164,351,185) $ 53,267,838 Noncash financing transactions: Terminated of capital lease, reduction in long-term liabilities $ 321,999 $ - The accompanying Notes to Financial Statements are an integral part of this statement.

20 VIRGINIA COMMONWEALTH UNIVERSITY NOTES TO FINANCIAL STATEMENTS AS OF JUNE 30, SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES As one of only three Carnegie Doctoral/Research University-Extensive Universities in Virginia, Virginia Commonwealth University plays a significant role in providing a college-trained workforce, high quality health care, and cultural enrichment for the Richmond area and the Commonwealth. More than 25,400 undergraduate, graduate, and professional students pursue 162 degree programs on VCU's two campuses: the Academic Campus, situated in the historic Fan District, and the MCV Campus, located two miles east in the commercial and governmental district of downtown Richmond. VCU's one college and eleven schools include the School of Engineering, one of the largest School of Arts in the country, as well as the South's oldest School of Social Work. The University also is the site for the VCU Health System, one of the most comprehensive academic health centers in the nation. The University s accounting policies conform with generally accepted accounting principles as prescribed by the Governmental Accounting Standards Board (GASB), including all applicable GASB pronouncements, as well as applicable Financial Accounting Standards Board (FASB) statements and interpretations, Accounting Principles Board opinions, and Accounting Research Bulletins of the Committee on Accounting Procedure issued on or before November 30, 1989, unless those pronouncements conflict with or contradict GASB pronouncements. The Authority applies all FASB statements and interpretations, Accounting Principles Board opinions, and Accounting Research Bulletins of the Committee on Accounting Procedure issued, unless those pronouncements conflict with or contradict GASB pronouncements. The accompanying financial statements of the University are prepared in accordance with generally accepted accounting principles as prescribed by GASB Statement 34 Basic Financial Statements - and Management s Discussion and Analysis - for State and Local Governments and GASB Statement 35, Basic Financial Statements and Management s Discussion and Analysis of Public College and Universities. Since the University is a component unit of the Commonwealth of Virginia, it is included in the Comprehensive Annual Financial Report of the Commonwealth. A. Reporting Entity The accompanying financial statements include the accounts of all organizational units of Virginia Commonwealth University (University) and the Virginia Commonwealth University Intellectual Property Foundation, a component unit, which is blended (consolidated) with University operations. These statements are presented as stand-alone statements of the University. The Virginia Commonwealth University Health System Authority (VCUHSA) is a discretely presented component unit. The Virginia Commonwealth University Health System Authority (the Authority) is a public corporate body and political subdivision of the Commonwealth of Virginia created and

21 established by an Act of the General Assembly of the Commonwealth of Virginia during The Authority is a tax-exempt, not-for-profit organization under the provisions of Internal Revenue Code Section 115. The Authority s principal activity is the operation of the Medical College of Virginia Hospitals (the Hospitals), University Health Services, Inc. and Subsidiaries (UHS), and MCV Associated Physicians (MCVAP). The Hospitals, a division of the Authority, is an approximately 900-bed teaching hospital, which provides inpatient and outpatient services primarily to patients in the Commonwealth of Virginia. MCVAP, formed in 1991 as a nonstock, not-for-profit charitable educational organization, functions as the group practice plan for those physicians and health care professionals who have faculty appointments in Virginia Commonwealth University (VCU) School of Medicine. Separate financial statements for MCVAP may be obtained from MCVAP s corporate office. The Hospitals, UHS, and MCVAP are included in the enterprise funds of the Authority. UHS, a component unit of the Authority, is a not-for-profit, non-stock, tax-exempt corporation which was incorporated on January 26, 1995 to support the educational, scientific, and charitable purposes and activities of the University and, in particular, the activities of the Medical College of Virginia/Virginia Commonwealth University (MCV/VCU) and the Hospitals. These activities include, but are not limited to, activities undertaken pursuant to Section B of the Code of Virginia. UHS is a blended component unit of the Authority due to the significance of the operational and financial relationship between the two entities. Virginia Premier Health Plan, Inc. (VA Premier) is a wholly owned subsidiary of UHS. VA Premier is a for-profit health maintenance organization (HMO) whose primary purpose is to provide quality health care within a managed care framework. The accounts of VA Premier are included in the consolidated financial statements of UHS. Separate consolidated financial statements for UHS may be obtained from UHS s corporate office. The University also benefits from a number of organizations that exist mainly to support the various purposes and activities of the University and Authority. The assets of these affiliated organizations, which are separately incorporated and managed by their own Boards, are not included in these statements. The affiliated organizations are listed below and are described in Note 8: VCU Foundation VCU Real Estate Foundation Virginia Biotechnology Research Park Authority Virginia Commonwealth University Alumni Association Medical College of Virginia Foundation MCV/VCU Dental Faculty Practice Association Virginia Commonwealth University School of Engineering Foundation Medical College of Virginia Alumni Association of VCU B. Basis of Accounting The financial statements of the University have been prepared on the accrual basis. Under the accrual basis, revenues are recognized when earned, expenses are recorded when a liability is incurred, regardless of the timing of related cash flows, and depreciation expense relating to capitalized fixed assets is included. Revenues for the summer term are prorated on the basis of student class days occurring before and after June 30.

22 The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. C. Investments Investments are reported at market, if purchased, or fair value (market) at the date of receipt, if received as a gift. Investments held in the liquidity fund (securities with a maturity of less than one year) of the University are reported as current assets with the remaining investments reported as noncurrent assets. D. Inventories Inventories are valued at the lower of cost (generally determined on the first-in, firstout method) or market. E. Restricted Resources The Authority s investment balances include resources restricted for debt service under a bond indenture agreement, resources restricted under malpractice trust agreement, resources restricted by insurance regulations of the Commonwealth of Virginia, and resources restricted under the pension plan agreement. Restricted resources limited by donors to a specific period or purpose are reported as restricted net assets. The Authority restricted net assets consist principally of beneficial interests in perpetual trust funds established by split interest agreements. Split interest agreements are trust agreements established by donors under which the Authority receives benefits that are shared with other beneficiaries. The trust agreements established by donors provide for a third party to hold the trust assets. These trusts do not permit donors to revoke their charitable contributions. Trust assets of $16,466,000, which are restricted by donors for the Authority in perpetuity, are reported at fair value, which approximates the present value of the future cash receipts from the trust assets. F. Investment Income Investment income, including net realized and unrealized gains or losses on investment transactions, is recorded as nonoperating revenue, and investment transactions of restricted funds are added to the fund that owns the investment. This income is restricted primarily for indigent care. G. Accrued Compensated Absences University full-time classified, part-time classified, and faculty employed on or after January 1, 1999 who are also active members of the Virginia Retirement System (VRS) are covered under the Virginia Sickness and Disability Program (VSDP). The plan provides for sick leave, family and personal leave, short-term disability benefits, and long-term disability

23 benefits. Full-time classified, part-time classified, and faculty employed prior to January 1, 1999, who are active members of VRS, participate in VSDP under one of two options or remain under the traditional sick leave program in which classified employees and twelve month faculty earn five hours of leave each pay period regardless of the length of state service and nine month faculty accrue 48 hours per semester. One VSDP option permitted eligible employees to convert accumulated sick leave balances to short-term disability credits. The other allowed for the conversion of sick leave balances to VRS service credit. The University was not required to currently fund the cost of conversion to VRS service credit. Enrollment in the VSDP is irrevocable, and no additional enrollments are planned. Under VSDP, unused VSDP sick leave and family and personal leave balances do not carry forward from one year to the next, and employees are not paid for unused balances upon termination. The converted short-term disability credits of classified employees are payable upon termination in accordance with the Commonwealth of Virginia s sick leave payout policy discussed below. Faculty who converted sick leave balances to short-term disability credits are not compensated for these balances at termination. Full-time and part-time twelve-month faculty and classified employees earn annual leave based upon the number of years of continuous state service. Faculty may carry forward up to 384 hours of annual leave from one year to the next and classified employees may carry forward up to 432 hours of annual leave. Upon termination, unused annual leave balances of up to 288 hours for faculty and up to 336 hours for classified staff are paid in full. The liability recorded in the financial statements is limited to the amount of payment received at termination. Employees who are not subject to the overtime provisions of the Fair Labor Standards Act may be eligible to earn compensatory leave. Leave is earned on an hour-for-hour basis for having worked additional hours in a workweek, holidays, or scheduled days off. Compensatory leave may be used for paid time off and is payable upon termination. Accrued compensatory leave lapses within 12 months from the date it is earned and once lapsed may not be used or paid upon termination. The University records a liability for all unused annual, non-vsdp sick, and compensatory leave and unused short-term disability credits as well as related fringe benefits. Annual and compensatory leave balances are paid in full upon termination. Non-VSDP sick leave and short-term disability credits are payable upon employment termination and are limited to 25 percent of the value accumulated or $5,000, whichever is less, under the Commonwealth of Virginia's sick leave pay-out policy for employees with 5 or more years of service. The Authority records a liability for all paid time off and related FICA taxes expected to be paid. H. Capital Assets Capital assets are stated at cost or, if donated, at fair market value on the date of acquisition. Equipment costing $5,000 or more with a useful life of two or more years is capitalized, except for assets acquired under the Higher Education Equipment Trust Fund, which are capitalized at $500 as required by the State Council of Higher Education. Infrastructure assets are included in the financial statements and are depreciated. The

24 University and the Authority record depreciation on property, plant and equipment, including capital leases and excluding land and construction in progress, computed over the estimated useful lives of the assets based on the straight-line method. The general range of estimated useful lives for the University and the Authority is 10 to 40 years for buildings and fixtures, 5 to 20 years for equipment, 5 years for library books, and 10 to 25 years for land improvements and infrastructure. Expenditures for construction in progress are capitalized as incurred and reflected in net investment in plant. Interest expense relating to construction is capitalized net of interest income earned on resources set aside for this purpose. Capital assets at the time of disposal revert to the Commonwealth of Virginia for disposition. I. Hospital Services In addition to the services provided by the Authority to patients, the University provides facilities, graduate medical education, clinical support, and administrative support to hospitals. The revenues and expenditures necessary to provide the services are classified as hospital services. J. Charity Care The Authority provides care to patients who meet certain criteria under its indigent care policy without charge or at amounts less than its established rates. Because the Authority does not pursue collection of amounts determined to qualify as charity care, they are not reported as revenue. The costs and expenses incurred in providing these services are included in operating expenses. Charges written off to charity care for the year ended June 30, 2002, measured at established rates, approximated $154,171,000 (see Note 16). K. Net Patient Service Revenue Net patient service revenue is reported in hospital services at the estimated net realizable amounts from patients, third-party payors, and others for services rendered, and includes estimated retroactive adjustments due to future audits, reviews, and investigations. Retroactive adjustments are considered in the recognition of revenue on an estimated basis in the period the related services are rendered, and such amounts are adjusted in future periods as adjustments become known or as years are no longer subject to such audits, reviews, and investigations. A summary of the payment arrangements with major third-party payors follows: Trigon. Inpatient acute care services rendered to Trigon subscribers are paid at a per diem rate or discounted rate. Outpatient services rendered to Trigon subscribers are reimbursed at discounted rates or applicable fee schedule. The rates are not subject to retroactive adjustment. Medicare. Inpatient acute care services and defined capital costs rendered to Medicare program beneficiaries are paid at prospectively determined rates per discharge. These rates vary according to a patient classification system that is based on clinical, diagnostic, and