LUTHERAN SOCIAL SERVICES OF ILLINOIS AND SUBSIDIARY CORPORATIONS Des Plaines, Illinois. CONSOLIDATED FINANCIAL STATEMENTS June 30, 2007 and 2006

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1 Des Plaines, Illinois CONSOLIDATED FINANCIAL STATEMENTS

2 TABLE OF CONTENTS PAGE INDEPENDENT AUDITOR S REPORT...1 FINANCIAL STATEMENTS Consolidated Statements of Financial Position...2 Consolidated Statements of Activities...4 Consolidated Statements of Cash Flows...6 Consolidated Statements of Functional Expenses and Directly Related Program Services Revenue...8 Notes to Consolidated Financial Statements...12

3 A1 Board of Directors Lutheran Social Services of Illinois and Subsidiary Corporations Des Plaines, Illinois Independent Auditor's Report We have audited the accompanying consolidated statements of financial position of Lutheran Social Services of Illinois (an Illinois not-for-profit corporation) and Subsidiary Corporations as of June 30, 2007 and 2006, and the related consolidated statements of activities, cash flows, and functional expenses and directly related program services revenue for the years then ended. These consolidated financial statements are the responsibility of the Agency s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits 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 audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Lutheran Social Services of Illinois and Subsidiary Corporations as of, and the changes in net assets and cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 2 to the consolidated financial statements, the Agency adopted the recognition and disclosure provisions of Financial Accounting Standards Board (FASB) Statement No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R), as of June 30, In accordance with Government Auditing Standards, we have also issued a report dated October 19, 2007 on our consideration of Lutheran Social Services of Illinois and Subsidiary Corporations internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts and grants. The purpose of that report is to describe the scope of testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on the internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards and should be read in conjunction with this report in considering the results of our audit. a1 Oak Brook, Illinois October 19, 2007 Offices in 17 states and Washington, DC 1 h

4 CONSOLIDATED STATEMENTS OF FINANCIAL POSITION ASSETS CURRENT ASSETS Cash and cash equivalents $ 4,421,335 $ 6,329,364 Accounts receivable, net of allowance for doubtful accounts of $865,028 at June 30, 2007 and $977,502 at June 30, ,055,011 9,860,040 Current portion of unconditional promises to give net of allowance for doubtful promises of $100,000 at 1,042, ,200 Note receivable 74,195 - Prepaid expenses 921, ,542 Short-term investments 21,890,074 25,145,463 Other current assets 98,124 88,000 Total current assets 38,502,719 42,820,609 INVESTMENTS 7,114,060 8,441,795 LAND, BUILDINGS AND EQUIPMENT Land 3,849,728 3,727,178 Buildings and other improvements 112,920,209 95,644,107 Furniture and equipment 21,801,767 18,662,349 Construction in progress 2,285,465 11,931,409 Total land, buildings and equipment, at cost 140,857, ,965,043 Less allowance for depreciation 56,697,968 52,527,503 Land, buildings and equipment, net 84,159,201 77,437,540 OTHER ASSETS Unconditional promises to give, less current portion above 444, ,829 Interest in charitable annuity lead trust 44,334 56,979 Escrow deposit accounts 5,048,669 5,155,193 Security deposits 91,818 64,685 Unamortized prior service pension costs - 341,858 Prepaid advertising 316, ,281 Prepaid bond issuance and long-term debt refinancing costs, less accumulated amortization of $220,367 at June 30, 2007 and $167,535 at June 30, ,100,465 1,151,111 Total other assets 7,045,603 7,889,936 TOTAL ASSETS $ 136,821,583 $ 136,589,880 2

5 LIABILITIES AND NET ASSETS CURRENT LIABILITIES Line of credit $ 599,500 $ 419,000 Current maturities of long-term debt: Mortgages payable 289, ,304 Notes payable related to bond issues 805, ,000 Accounts payable and other accrued expenses 9,934,089 9,944,080 Cash advances for special purposes 322, ,471 Accrued interest payable 439, ,296 Accrued salaries and wages 4,779,201 4,503,320 Accrued and withheld payroll taxes 1,002, ,370 Security deposits 259, ,525 Total current liabilities 18,431,358 17,804,366 LONG-TERM LIABILITIES Residents' special deposits 217, ,614 Long-term debt, less current maturities above: Mortgages payable 9,191,241 9,480,424 Notes payable related to bond issues 26,380,000 27,185,000 Accrued interest payable 141, ,348 Refundable entrance fees 7,659,256 5,906,077 Deferred grant revenue from capital advance agreements 34,492,220 32,344,825 Deferred grant revenue from assisted living conversion agreement 5,362,614 3,645,699 Deferred revenue from advance fees 1,532,977 1,358,278 Liability for split interest gift arrangements 1,304,389 1,520,948 Funds held for unrelated charitable organizations 118, ,930 Residents' equity 238, ,400 Liability for pension benefits 8,187,830 9,060,931 Other long-term liabilities 63,385 65,306 Total long-term liabilities 94,889,387 91,325,780 Total liabilities 113,320, ,130,146 NET ASSETS Unrestricted 14,042,657 18,460,025 Temporarily restricted by donors 7,193,767 6,742,785 Permanently restricted by donors for endowment 2,264,414 2,256,924 Total net assets 23,500,838 27,459,734 TOTAL LIABILITIES AND NET ASSETS $ 136,821,583 $ 136,589,880 The accompanying notes are an integral part of the consolidated financial statements. 3

6 CONSOLIDATED STATEMENTS OF ACTIVITIES Years Ended SUPPORT AND REVENUES Public support: 2007 Temporarily Permanently Unrestricted Restricted Restricted Total Lutheran church support $ 741,539 $ - $ - $ 741,539 United Way 680, ,901-1,059,443 Contributions 2,420, ,146 6,670 2,778,305 Bequests 440,949 68,712 25, ,481 Total public support 4,283, ,759 32,490 5,114,768 Other revenue: Fees and grants from government agencies 69,096, ,096,146 Program service fees 23,286, ,286,898 Grant revenue from capital advance agreements 1,046, ,046,743 Public sales 117, ,835 Rents, investment return and gains and losses 4,012, ,921-4,671,579 Gain on disposal of fixed assets Miscellaneous 292, ,973 Total other revenue 97,853, ,921-98,512,591 Net assets released from restrictions 901,985 (876,985) (25,000) - Total support and revenues 103,039, ,695 7, ,627,359 EXPENSES Program services 94,956, ,956,916 Supporting services: Management and general 8,406, ,406,012 Fundraising 2,091, ,091,471 Total supporting services 10,497, ,497,483 Total expenses 105,454, ,454,399 INCOME (LOSS) (2,415,225) 580,695 7,490 (1,827,040) Actuarial loss on annuity obligations - (129,713) - (129,713) CHANGE IN NET ASSETS BEFORE OTHER ITEMS (2,415,225) 450,982 7,490 (1,956,753) Decrease in unrecognized pension cost 1,903, ,903,650 Effect of adoption of recognition provisions of FASB Statement No. 158 (3,905,793) - - (3,905,793) CHANGE IN NET ASSETS (4,417,368) 450,982 7,490 (3,958,896) NET ASSETS, BEGINNING OF YEAR 18,460,025 6,742,785 2,256,924 27,459,734 NET ASSETS, END OF YEAR $ 14,042,657 $ 7,193,767 $ 2,264,414 $ 23,500,838 4

7 SUPPORT AND REVENUES Public support: 2006 Temporarily Permanently Unrestricted Restricted Restricted Total Lutheran church support $ 667,329 $ 1,088 $ - $ 668,417 United Way 649, ,310 Contributions 2,125,339 1,519, ,847 3,758,225 Bequests 1,343, , ,574 1,987,692 Total public support 4,785,861 1,896, ,421 7,063,644 Other revenue: Fees and grants from government agencies 67,243, ,243,454 Program service fees 21,471, ,471,491 Grant revenue from capital advance agreements 893, ,892 Public sales 138, ,565 Rents, investment return and gains and losses 2,652, ,725-2,945,557 Gain on disposal of fixed assets 6, ,020 Miscellaneous 159, ,168 Total other revenue 92,565, ,725-92,858,147 Net assets released from restrictions 805,274 (815,274) 10,000 - Total support and revenues 98,156,557 1,373, ,421 99,921,791 EXPENSES Program services 90,195, ,195,458 Supporting services: Management and general 7,864, ,864,123 Fundraising 1,925, ,925,393 Total supporting services 9,789, ,789,516 Total expenses 99,984, ,984,974 INCOME (LOSS) (1,828,417) 1,373, ,421 (63,183) Actuarial loss on annuity obligations - (177,277) - (177,277) CHANGE IN NET ASSETS BEFORE OTHER ITEMS (1,828,417) 1,196, ,421 (240,460) Decrease in unrecognized pension costs 3,795, ,795,467 Write off of unamortized prepaid bond issuance costs (553,667) - - (553,667) CHANGE IN NET ASSETS 1,413,383 1,196, ,421 3,001,340 NET ASSETS, BEGINNING OF YEAR 17,046,642 5,546,249 1,865,503 24,458,394 NET ASSETS, END OF YEAR $ 18,460,025 $ 6,742,785 $ 2,256,924 $ 27,459,734 The accompanying notes are an integral part of the consolidated financial statements. 5

8 CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended CASH FLOWS FROM OPERATING ACTIVITIES Change in net assets $ (3,958,896) $ 3,001,340 Adjustments to reconcile change in net assets to net cash used in operating activities: Depreciation 4,734,164 4,058,829 Change in value of liability for split interest gift arrangements (including charitable annuity lead trust) 129, ,277 Amortization of deferred grant revenue from capital advance agreements (1,046,743) (893,892) Recognition of income on split interest gift arrangements (200,931) (674,649) Amortization of entrance fees (381,449) (354,880) Amortization of prepaid bond issuance and long-term debt refinancing costs 52,832 58,697 Write off of unamortized prepaid bond issuance costs - 553,667 Reduction in entrance fees to cover unpaid monthly resident fees (65,156) - Receipt of donated property - (88,000) Gain on sale and disposal of fixed assets (417) (6,020) Reinvestment of investment income (920,934) (920,275) Net realized and unrealized gains on investments (2,923,647) (1,288,324) Increase in cash surrender value of life insurance (10,756) (31,424) Decrease in unrecognized pension costs (1,903,650) (3,795,467) Effect of adoption of recognition provisions of FASB Statement No ,905,793 - Current pension cost 2,370,708 2,625,876 Contributions restricted for long-term investment (32,490) (381,421) Effects of changes in operating assets and liabilities: Accounts receivable (194,971) (1,194,297) Unconditional promises to give 167,871 (302,140) Other current assets (407,770) (127,675) Restricted deposit accounts (34,632) (97,224) Accounts payable and other accrued expenses (9,991) 568,181 Other current liabilities 313,485 1,328,533 Liability for pension benefits (4,904,094) (2,528,905) Other long-term liabilities (55,049) 75,616 Net cash used in operating activities (5,377,010) (236,577) CASH FLOWS FROM INVESTING ACTIVITIES Purchases of land, buildings and equipment (8,263,731) (11,645,983) Proceeds from sale of property and equipment 2,460 7,351 Purchase of investments (6,454,078) (16,747,331) Proceeds from sale of investments 14,346,447 17,400,544 Proceeds from surrendering life insurance policies - 10,949 Refunds to former residents - (180,880) Net withdrawals from (deposits into) residual receipts, replacement reserve, and minimum capital investment 114,023 (492,948) Net cash used in investing activities (254,879) (11,648,298) 6

9 CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from bond issuance - 20,000,000 Proceeds from split interest gift arrangements 20, ,410 Proceeds from charitable annuity lead trust 17,203 17,203 Proceeds from split interest agreements relinquished 557,384 2,030,999 Proceeds from contributions restricted for investment in endowment 55, ,500 Proceeds from entrance fees 3,018,065 1,229,257 Proceeds from capital advance and assisted living conversion agreements 1,716,916 3,437,835 Payments on termination of split interest gift arrangements - (27,098) Payments on split interest gift arrangements (170,880) (253,055) Payments of refundable entrance fees (717,777) (953,967) Repayment of bonds (685,000) (14,325,000) Repayment of other debt (266,185) (244,949) Net borrowings under line of credit Payment of costs to refinance bonds 180,500 (2,186) 419,000 (647,038) Net cash provided by financing activities 3,723,860 11,101,097 NET DECREASE IN CASH AND CASH EQUIVALENTS (1,908,029) (783,778) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 6,329,364 7,113,142 CASH AND CASH EQUIVALENTS, END OF YEAR $ 4,421,335 $ 6,329,364 The accompanying notes are an integral part of the consolidated financial statements. 7

10 CONSOLIDATED STATEMENT OF FUNCTIONAL EXPENSES AND DIRECTLY RELATED PROGRAM SERVICES REVENUE Year Ended June 30, PROGRAM SERVICES PRISONER/ BEHAVIORAL CHILDREN'S FAMILY HEALTH COMMUNITY COMMUNITY HOUSING NURSING CARE OTHER MINISTRY SERVICES SERVICES SERVICES SERVICES SERVICES OPERATING MATINS, INC. (05) (13) (12) (40) (41) (42) (93) (91) FUNCTIONAL EXPENSES Salaries $ 526,741 $ 10,514,610 $ 17,085,481 $ 4,594,703 $ 3,915,897 $ 9,693,935 $ - $ - Employee health and retirement benefits, payroll taxes, etc. 86,324 2,188,910 3,636, , ,339 2,199, Total salaries and related expenses 613,065 12,703,520 20,721,950 5,565,953 4,840,236 11,893, Professional fees and contract service payments 18,774 1,525,171 8,839,753 26, ,790 2,960, Supplies 18, , , , ,646 2,116, Communications 24, , ,924 86, , , Occupancy 48,040 1,081,169 2,040, ,054 2,569,319 1,523,529-3,400 Advertising and printing 3,390 23,296 84,823 59, , , Local transportation 23, ,810 1,463, , ,933 33, Meetings, seminars and education 2,947 22,345 42,903 8,240 37,189 28, Specific assistance to individuals 99, , ,445 17,088 19, Elderly and congregate expenses , Equipment rental and maintenance , ,310 21, , , Miscellaneous and other operating ,564 91,097 19, , ,484 13, Interest expense - 100,885 37,831 25, , , Bond costs - 12,438 1,123 2,416 18,273 63,608 (128,396) - Total functional expenses 852,737 17,508,135 35,344,207 6,564,248 9,870,138 19,690,049 (114,501) 3,415 Depreciation 2, ,699 2,651 61,278 1,998, ,153-3,594 Total program and supporting service expenses $ 855,019 $ 17,746,834 $ 35,346,858 $ 6,625,526 $ 11,868,188 $ 20,655,202 $ (114,501) $ 7,009 DIRECTLY RELATED PROGRAM SERVICES REVENUE Fees and grants from governmental agencies $ 58,833 $ 15,831,141 $ 35,350,756 $ 5,332,296 $ 3,603,433 $ 8,919,687 $ - $ - Program service fees - 2,054, ,896 1,181,850 7,403,841 12,249, Grant revenue from capital advance agreements ,046, Public sales 19,596 13,250 50,803 2,673 30,093 1, Rents, investment return and gains and losses - 1,969 4, ,833-1,007,023 28,389 Gain (loss) on sale of fixed assets Miscellaneous 20 10,604 17,686-17,351 1, Total directly related program services revenue $ 78,449 $ 17,912,143 $ 35,820,191 $ 6,516,819 $ 12,400,294 $ 21,171,841 $ 1,007,023 $ 28,389 8

11 2007 PROGRAM SERVICES (cont'd) SUPPORTING SERVICES THE VESPER MGMT SUBTOTAL MANAGEMENT RESOURCE CORNERSTONE CORPORATION PROGRAM AND GENERAL DEVELOPMENT FOUNDATION, INC. SUBTOTAL TOTAL (90) SERVICES (70, 82) (80,83) (99) FUNDRAISING 2007 FUNCTIONAL EXPENSES Salaries Employee health and retirement benefits, payroll taxes, etc. Total salaries and related expenses Professional fees and contract service payments Supplies Communications Occupancy Advertising and printing Local transportation Meetings, seminars and education Specific assistance to individuals Elderly and congregate expenses Equipment rental and maintenance Miscellaneous and other operating Interest expense Bond costs Depreciation Total functional expenses Total program and supporting service expenses $ - $ 46,331,367 $ 4,723,227 $ 1,045,050 $ - $ 1,045,050 $ 52,099,644-10,006, , , ,173 11,132,805-56,337,810 5,681,416 1,213,223-1,213,223 63,232, ,584 13,949, , ,915 49, ,870 14,973,261 23,979 4,185, , ,737 1, ,695 4,436,457 1,608 1,191, ,609 26, ,311 1,393, ,240 8,213, ,437 16, ,228 8,555,768 2, , , , , ,117-2,142,080 96,529 38,082-38,082 2,276, , ,073 69, , ,518-1,261,981 2, ,264,061-68, , , ,365 5,730-5, , ,620 29,357 49,754 49,035 98, , ,475 1,737,655 97,886 7,644-7,644 1,843,185 55,422 24,884 22,595 1,150-1,150 48,629 1,155,771 90,874,199 7,819,312 1,924, ,930 2,026, ,720, ,010 4,082, ,700 64,747-64,747 4,734,164 $ 1,966,781 $ 94,956,916 $ 8,406,012 $ 1,989,541 $ 101,930 $ 2,091,471 $ 105,454,399 DIRECTLY RELATED PROGRAM SERVICES REVENUE Fees and grants from governmental agencies Program service fees Grant revenue from capital advance agreements Public sales Rents, investment return and gains and losses Gain (loss) on sale of fixed assets Miscellaneous Total directly related program services revenue $ - $ 69,096,146 $ - $ - $ - $ - $ 69,096,146-23,286, ,286,898-1,046, ,046, , , ,768 1,755, ,519-2,716,028 2,716,028 4,671,579 1,960 2,460 (2,043) ,934 50, , ,973 $ 420,662 $ 95,355,811 $ 440,752 $ - $ 2,716,028 $ 2,716,028 $ 98,512,591 The accompanying notes are an integral part of the consolidated financial statements. 9

12 CONSOLIDATED STATEMENT OF FUNCTIONAL EXPENSES AND DIRECTLY RELATED PROGRAM SERVICES REVENUE Year Ended June 30, PROGRAM SERVICES PRISONER/ BEHAVIORAL CHILDREN'S FAMILY HEALTH COMMUNITY COMMUNITY HOUSING NURSING CARE OTHER MINISTRY SERVICES SERVICES SERVICES SERVICES SERVICES OPERATING MATINS, INC. (05) (11, 13, 43) (12) (40) (41) (42) (93) (91) FUNCTIONAL EXPENSES Salaries $ 416,134 $ 10,281,294 $ 16,355,693 $ 4,189,471 $ 3,257,139 $ 9,284,664 $ - $ - Employee health and retirement benefits, payroll taxes, etc. 76,957 2,250,642 3,605,183 1,038, ,959 2,480, Total salaries and related expenses 493,091 12,531,936 19,960,876 5,227,938 4,097,098 11,764, Professional fees and contract service payments 22,437 1,425,197 8,218,081 1, ,374 3,366,474 5, Supplies 14, , , , ,909 2,007, Communications 23, , ,221 77, , , Occupancy 44,458 1,059,799 1,884, ,952 2,451,262 1,367,067-57,067 Advertising and printing 4,187 16,837 86,898 47,553 51, , Local transportation 20, ,698 1,401, ,327 93,350 33, Meetings, seminars and education ,166 39,475 6,468 13,813 16, Specific assistance to individuals 68, , ,047 2,741 5,529 1, Elderly and congregate expenses , Equipment rental and maintenance , ,103 24, , , Miscellaneous and other operating ,797 33,218 28, , ,706 (1,973) - Interest expense - 77,569 7,990 14, , ,750 12,197 - Bond costs - 13,542 1,395 2,473 17,193 63,974 (130,067) - Total functional expenses 692,316 16,957,297 33,562,303 6,069,137 8,622,083 19,682,936 (114,554) 57,856 Depreciation 1, ,476 30,280 46,596 1,750, ,523-3,594 Total program and supporting service expenses $ 694,049 $ 17,166,773 $ 33,592,583 $ 6,115,733 $ 10,372,483 $ 20,548,459 $ (114,554) $ 61,450 DIRECTLY RELATED PROGRAM SERVICES REVENUE Fees and grants from governmental agencies $ 6,000 $ 15,673,058 $ 33,949,718 $ 4,714,622 $ 3,425,209 $ 9,474,847 $ - $ - Program service fees - 1,974, , ,663 6,941,258 11,173, Grant revenue from capital advance agreements , Public sales - 31,223 12,778 2,345 37,485 11, Rents, investment return and gains and losses , , ,263 26,531 Gain (loss) on sale of fixed assets Miscellaneous - 8, , ,582 (883) - - Total directly related program services revenue $ 6,000 $ 17,688,168 $ 34,522,313 $ 5,682,123 $ 11,473,639 $ 20,658,662 $ 512,263 $ 26,531 10

13 2006 PROGRAM SERVICES (cont'd) SUPPORTING SERVICES THE VESPER MGMT SUBTOTAL MANAGEMENT RESOURCE CORNERSTONE CORPORATION PROGRAM AND GENERAL DEVELOPMENT FOUNDATION, INC. SUBTOTAL TOTAL (90) SERVICES (70, 82) (80,83) (99) FUNDRAISING 2006 FUNCTIONAL EXPENSES Salaries Employee health and retirement benefits, payroll taxes, etc. Total salaries and related expenses Professional fees and contract service payments Supplies Communications Occupancy Advertising and printing Local transportation Meetings, seminars and education Specific assistance to individuals Elderly and congregate expenses Equipment rental and maintenance Miscellaneous and other operating Interest expense Bond costs Depreciation Total functional expenses Total program and supporting service expenses $ - $ 43,784,395 $ 4,501,198 $ 1,095,158 $ - $ 1,095,158 $ 49,380,751-10,291, , , ,971 11,362,010-54,075,654 5,366,978 1,300,129-1,300,129 60,742, ,836 13,474, , ,856 31, ,585 14,357,829 23,433 3,841, , ,653 14, ,244 4,087,487 1,210 1,100, ,224 32,297-32,297 1,316, ,288 7,659, ,620 15,247-15,247 8,001,133 2, , ,210 69, , ,787-1,979,448 82,952 47,681-47,681 2,110,081-91, ,746 21,721-21, ,084-1,096,125 1, ,097,485-84, , , ,230 4,208-4, ,888 1, ,829 33,490 36,701 56,244 92, , ,899 1,592,019 95, ,688,172 60,399 28,909 23, ,010 1,030,943 86,560,317 7,484,445 1,778, ,725 1,881,383 95,926, ,539 3,635, ,678 44,010-44,010 4,058,829 $ 1,758,482 $ 90,195,458 $ 7,864,123 $ 1,822,668 $ 102,725 $ 1,925,393 $ 99,984,974 DIRECTLY RELATED PROGRAM SERVICES REVENUE Fees and grants from governmental agencies Program service fees Grant revenue from capital advance agreements Public sales Rents, investment return and gains and losses Gain (loss) on sale of fixed assets Miscellaneous Total directly related program services revenue $ - $ 67,243,454 $ - $ - $ - $ - $ 67,243,454-21,473,931 (2,440) ,471, , ,892-95,344-43,221-43, , ,556 1,132, ,208-1,599,178 1,599,178 2,945,557 4,117 6, ,020 12, ,884 (16,716) ,168 $ 450,997 $ 91,020,696 $ 195,052 $ 43,221 $ 1,599,178 $ 1,642,399 $ 92,858,147 The accompanying notes are an integral part of the consolidated financial statements. 11

14 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Lutheran Social Services of Illinois, including the subsidiary corporations included herein ( Agency ), is a multi-functional social service agency owned by the three Illinois Synods of the Evangelical Lutheran Church in America. It is a corporation organized under the laws of the State of Illinois pursuant to the provisions of the "General Not-For-Profit Corporation Act." It is exempt from income taxes under Section 501(c)(3) of the Internal Revenue Code. The Agency qualifies for the charitable contribution deduction under Section 170(b)(1)(A) and is not a private foundation under Section 509(a)(2). The Agency receives a significant portion of its operating funds from public support, fees and grants from government agencies and program service fees. The Agency s fiscal year ends on June 30. Significant accounting policies followed by the Agency are presented below. In accordance with Statement of Position 94-3, Reporting of Related Entities by Not-for-Profit Organizations, 20 affiliated corporations incorporated under the Illinois "General Not-For-Profit Corporation Act" are included as subsidiaries in the consolidated financial statements. These corporations are considered subsidiary corporations because Lutheran Social Services of Illinois has control over and an economic interest in these corporations. These subsidiary corporations are: Assisi Homes-Downer Place, Inc. Aurora Senior Housing, Inc. Batavia Council on Aging, Inc. The Cornerstone Foundation, Inc. Deer Creek Manor, Inc. Dekalb Housing for the Handicapped, Inc. Forsberg Christian Retirement Center, Inc. Freeport Senior Housing, Inc. Freeport Senior Housing II, Inc. Matins, Inc. Northwest Chicago Group Homes, Inc. Our Savior's Senior Housing, Inc. Peterson Meadows, Inc. Rochelle Senior Housing, Inc. Rolling Meadows Senior Living, Inc. Salem Village III, Inc. Spring Ridge Housing for Seniors, Inc. Tabor Lutheran Senior Housing, Inc. Vesper Management Corporation Victorian Woods Senior Living, Inc. 12

15 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Human services that the Agency provides include: Behavioral Health Services - a broad range of counseling, mental health and substance abuse services for both adults and adolescents; residential treatment for emotionally disturbed adolescents and assistance to children and adolescents with developmental disabilities. Community Child Care Services - comprehensive, developmentally-oriented, Child Care and Head Start programs in the Chicagoland area. Foster Care and Adoption Services - community-based child welfare services to children and their families. Senior Services - a wide spectrum of services for senior citizens including a broad range of community-based services to the older adult population including case/care management, homemaker services, adult day services, elder abuse intervention and escorted transportation; residential skilled nursing care services including subacute care, long-term care, dementia care, assisted living, outpatient services and geriatric assessment; and owned and managed housing facilities for the aged. Prisoner and Family Ministry - a variety of services for prisoners in Illinois prisons and jails and for their families, including transportation for visits by children of inmates, storybook readings by inmates for their children, community re-entry programs, pastoral care and, in cooperation with Habitat for Humanity, prisoner carpentry projects. Consolidated Financial Statement Presentation The accompanying consolidated financial statements include the accounts of Lutheran Social Services of Illinois and its subsidiary corporations ( Agency ). All significant transactions among these corporations have been eliminated. The Agency prepares its consolidated financial statements in accordance with Statement of Financial Accounting Standards (SFAS) No. 117, Financial Statements of Not-for-Profit Organizations. Under SFAS No. 117, the Agency is required to report information regarding its financial position and activities according to three classes of net assets: unrestricted net assets, temporarily restricted net assets and permanently restricted net assets. The consolidated financial statements contain estimates and assumptions based on available information that affect both the reported amounts of assets, liabilities, revenues, expenses and other changes in net assets and the related disclosures. Subsequently available information could cause the actual amounts to differ from the estimates used. 13

16 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Basis of Accounting The consolidated financial statements have been prepared using the accrual basis of accounting. Support and Revenues Revenue is presented on the Consolidated Statements of Activities net of provisions for doubtful accounts and billing adjustments. The Agency receives a significant portion of its operating funds from grants and awards. These funds are reported as unrestricted support as the grants reimburse the Agency for services provided. The Agency records contributions in accordance with SFAS No. 116, Accounting for Contributions Received and Contributions Made. The Agency receives contributions through pledges, bequests, life insurance premium payments, split interest gift arrangements and outright cash gifts. Contributions are classified as unrestricted, temporarily restricted or permanently restricted based on donor directions. Split interest gift arrangement contributions are classified partially as temporarily restricted and partially as a liability for the present value of the obligation. Upon the death of the annuitants or income beneficiaries, the remaining amount is classified as unrestricted or temporarily restricted based on donor directions. Investment income and realized and unrealized gains restricted by a donor are reported as increases in unrestricted net assets if the restrictions are met in the reporting period in which the investment income and realized and unrealized gains are recognized. Contributions that are restricted by the donor are reported as an increase in unrestricted net assets if the restriction expires in the reporting period in which the contribution is recognized. All other donor restricted contributions are reported as an increase in temporarily restricted or permanently restricted net assets, as appropriate. When a restriction expires, the temporarily restricted net assets are reclassified to unrestricted net assets. Investment income and realized and unrealized gains and losses resulting from contributions are reported as unrestricted or temporarily restricted net assets, as directed by the donor. 14

17 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Donated Services, Materials and Property The Agency has volunteers who contribute their time and materials to provide services to the various programs. The fair value of these services was not readily determinable and, therefore, has not been recognized in the consolidated financial statements. Donations of property and equipment are recorded as support at their estimated fair value at the date of donation. Such donations are reported as unrestricted support unless the donor has restricted the donated asset to a specific purpose. Assets donated with explicit restrictions regarding their use and contributions of cash that must be used to acquire property and equipment are reported as restricted support. Absent donor stipulations regarding how long those donated assets must be maintained, the Agency reports expirations of donor restrictions when the donated or acquired assets are placed in service as instructed by the donor. Functional Allocation of Costs Certain supporting service and program costs have been allocated to the programs which benefit from these costs. Cash Equivalents The Agency considers all liquid investments with a maturity of three months or less when purchased to be cash equivalents. However, all investments held in trust for Illinois Finance Authority (IFA) and Illinois Health Facilities Authority (IHFA) Bond Issues and all investments held for refundable entrance fees are considered long-term investments. Investments The Agency accounts for investments in accordance with SFAS No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations. SFAS No. 124 requires that investments in equity securities with readily determinable fair values and investments in debt securities be reported at fair value with gains and losses included in the Consolidated Statements of Activities. The Agency considers all investments unrelated to debt service with original maturities from three months to one year to be short-term investments. Donated securities are recorded at market value on the date received or at nominal value when the market value is not readily available. 15

18 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Receivables Accounts receivable are uncollateralized funding source obligations, which generally are payable within 30 days from the invoice or billing date. Accounts receivable are stated at the invoice amount. The note receivable is stated at principal and is unsecured. Payments of accounts receivable are applied to the specific invoices identified on the funding source s remittance advice or, if unspecified, to the earliest unpaid invoices. The carrying amount of accounts receivable and the note receivable are reduced by a valuation allowance that reflects management s best estimate of amounts that will not be collected. The allowance for doubtful accounts is based on management s assessment of the collectibility of specific funding source accounts and the aging of accounts receivable. If actual defaults are higher than the historical experience, management s estimates of the recoverability of amounts due the Agency could be adversely affected. All accounts or portions thereof deemed to be uncollectible or to require an excessive collection cost are written off to the allowance for doubtful accounts. No provision has been made for the uncollectibility of the note receivable as of June 30, Promises to Give Unconditional promises to give are recognized as revenue or gains in the period received and as assets, decreases in liabilities, or expenses depending on the form of the benefits received. Conditional promises to give are recognized only when the conditions on which they depend are substantially met and the promises become unconditional. There were no conditional promises to give as of. The carrying amount of unconditional promises to give is reduced by a valuation allowance that reflects management s best estimate of amounts that will not be collected. The allowance for uncollectible amounts is based on management s assessment of the collectibility of specific promises to give. If actual defaults are higher than the historical experience, management s estimates of the recoverability of amounts due the Agency could be adversely affected. All accounts or portions thereof deemed to be uncollectible or to require an excessive collection cost are written off to the allowance for uncollectible promises to give. Depreciation Provision has been made for depreciation in accordance with generally accepted accounting principles. Depreciation is distributed as an expense to the individual programs and has been provided on the straight-line method over the estimated useful lives of the assets as follows: Buildings Other improvements Furniture and equipment years 5-25 years 3-7 years 16

19 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Impairment of Long-Lived Assets The Agency reviews long-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of carrying amount or the fair value less costs to sell. Prepaid Advertising Prepaid advertising costs include advertising costs incurred in connection with acquiring the initial continuing care contracts for the residential units, currently under construction. Such costs will be expensed on a straight-line basis over the average expected remaining lives of the residents under the contract or the contract term, if shorter. For the years ended, the total advertising expenses incurred were $441,323 and $293,390, respectively. Capital Advance and Assisted Living Conversion Grant Agreements The deferred grant revenue from the capital advance and assisted living conversion grant agreements with the U.S. Department of Housing and Urban Development (HUD) are being amortized over the terms of the agreements using the straight-line method. Refundable Entrance Fees and Advance Fees In accordance with the AICPA Audit and Accounting Guide for Health Care Organizations, fees paid by a resident upon entering a continuing care contract, net of the portion thereof that is refundable to the resident, are recorded as deferred revenue and are amortized to revenue using the straight-line method over the estimated remaining life expectancy of the resident, which is updated annually for each resident. The refundable portion, which is refundable only if another resident reoccupies the contract holder s unit, is also recorded as deferred revenue and is amortized to revenue using the straight-line method over the estimated remaining life of the unit, which is consistent with the estimated useful lives used for depreciation. 17

20 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Residents Equity The liability for residents equity represents the residents' equity interest in their respective residences at one of the Agency's retirement centers. Prior to the year ended June 30, 2001, at the time of purchase, the Agency charged each resident a non-refundable founder s gift equal to 20% of the original purchase price. This gift is recognized as revenue by the Agency over a period of four years. At the end of this period, the equity is reduced to 80% of the original price. Beginning in 2001, the Agency stopped charging the 20% non-refundable founder s gift as a provision of new residency agreements and began charging advance fees, which are discussed above. As of July 1, 2003, the Agency no longer charges advance fees. Instead, new residents must enter into rental agreements with the Agency. NOTE 2 - RECENT ACCOUNTING PRONOUNCEMENT In September 2006, the Financial Accounting Standards Board ( FASB ) issued FASB Statement No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R) ( Statement 158 ). Statement 158 requires plan sponsors of defined benefit pension and other postretirement benefit plans (collectively, postretirement benefit plans ) to recognize the funded status of their postretirement benefit plans in the statement of financial position, measure the fair value of plan assets and benefit obligations as of the date of the fiscal year-end statement of financial position, and provide additional disclosures. On June 30, 2007, the Agency adopted the recognition and disclosure provisions of Statement 158. The effect of adopting Statement 158 on the Agency s financial condition at June 30, 2007 has been included in the accompanying consolidated financial statements. Statement 158 did not have an effect on the Agency s consolidated financial condition at June 30, 2006 or Statement 158 s provisions regarding the change in the measurement date of postretirement benefit plans are not applicable to the Agency until the year ended June 30, See Note 12 for further discussion of the effect of adopting Statement 158 on the Agency s consolidated financial statements. NOTE 3 - SHORT-TERM INVESTMENTS Short-term investments consist of U.S. obligations, money market index account deposits, certificates of deposit and mutual funds valued at $21,890,074 and $25,145,463 at June 30, 2007 and 2006, respectively. At, the investments have a cost of $19,952,921 and $23,770,770, respectively. 18

21 NOTE 4 - INVESTMENTS Long-term investments are stated at fair value. Fair values and unrealized appreciation (depreciation) at June 30 are summarized as follows: Investments Held in Trust for Illinois Finance Authority (IFA) and Illinois Health Facilities Authority (IHFA) Bond Issues: 2007 Unrealized Fair Appreciation Cost Value (Depreciation) IFA Revenue Bonds, Series 2006, Lutheran Social Services of Illinois Project Fixed income bond $ 1,398,168 $ 1,398,168 $ - Money market and cash 685, ,758 - IHFA Revenue Refunding bonds, Series 1999, Peterson Meadows, Inc. Money market and cash 882, ,983 - Total 2,966,909 2,966,909 - Cornerstone Foundation, Inc. Investments restricted under life annuity contracts Charitable equities 1,220,668 1,812, ,468 Fixed income charitable bond 931, ,966 (7,346) Short-term money market 117, ,969 - Total 2,269,949 2,854, ,122 19

22 NOTE 4 - INVESTMENTS (continued) 2007 Unrealized Fair Appreciation Cost Value (Depreciation) Andrew E. Seaver Trust Fund Common stock 27,135 39,425 12,290 Corporate bonds 53,492 53,109 (383) Real estate 4,650 4,393 (257) Cash 12,388 12,388 - Total 97, ,315 11,650 Peterson Meadows, Inc. Scudder Investments - U.S. Government Securities Fund 597, ,532 (28,164) Unrestricted investments Certificates of deposit 252, ,408 - Cash surrender value of life insurance 361, ,825 - Total 614, ,233 - Total investments $6,546,452 $7,114,060 $ 567,608 20

23 NOTE 4 - INVESTMENTS (continued) Investments Held in Trust for Illinois Finance Authority (IFA) and Illinois Health Facilities Authority (IHFA) Bond Issues: 2006 Unrealized Fair Appreciation Cost Value (Depreciation) IFA Revenue Bonds, Series 2006, Lutheran Social Services of Illinois Project Fixed income bond $ 1,398,168 $ 1,398,168 $ - Money market and cash 843, ,106 - IHFA Revenue Refunding bonds, Series 1999, Peterson Meadows, Inc. Money market and cash 871, ,069 - Total 3,112,343 3,112,343 - Cornerstone Foundation, Inc. Investments restricted under life annuity contracts Charitable equities 1,430,232 1,922, ,358 Fixed income charitable bond 1,065,256 1,040,359 (24,897) Short-term money market 164, ,316 - Total 2,659,804 3,127, ,461 21

24 NOTE 4 - INVESTMENTS (continued) 2006 Unrealized Fair Appreciation Cost Value (Depreciation) Andrew E. Seaver Trust Fund Common stock 27,754 40,124 12,370 Corporate bonds 39,849 38,857 (992) Cash 25,409 25,409 - Total 93, ,390 11,378 Peterson Meadows, Inc. Scudder Investments - U.S. Government Securities Fund 1,574,200 1,491,363 (82,837) Forsberg Christian Retirement Center, Inc. Investments held for future Forsberg projects Certificates of deposit 14,000 14,000 - Unrestricted investments Certificates of deposit 241, ,365 - Cash surrender value of life insurance 351, ,069 - Total 592, ,434 - Total investments $8,045,793 $8,441,795 $ 396,002 22

25 NOTE 4 - INVESTMENTS (continued) The following schedules summarize the investment return, which includes interest on cash and cash equivalents, notes receivable and short-term and long-term investments, and its classification in the Consolidated Statements of Activities: 2007 Temporarily Unrestricted Restricted Total Interest and dividend income $ 1,023,526 $ 92,121 $ 1,115,647 Net realized and unrealized gains 2,356, ,800 2,923,646 Total investment return $ 3,380,372 $ 658,921 $ 4,039, Temporarily Unrestricted Restricted Total Interest and dividend income $ 1,005,482 $ 70,666 $ 1,076,148 Net realized and unrealized gains 1,066, ,059 1,288,324 Total investment return $ 2,071,747 $ 292,725 $ 2,364,472 23

26 NOTE 5 - UNCONDITIONAL PROMISES TO GIVE The unconditional promises to give are discounted based upon payment terms using discount factors ranging from 4% to 7%. Unconditional promises to give at June 30 consist of the following: Receivable in less than one year $1,142,773 $ 861,200 Receivable in one to five years 473, ,660 Receivable in six to ten years 20,000 40,000 Total unconditional promises to give 1,635,838 1,848,860 Less allowance for doubtful promises (100,000) (100,000) Less unamortized discount (49,010) (70,831) Net unconditional promises to give $1,486,828 $1,678,029 Current portion $1,042,773 $ 761,200 Long-term portion 444, ,829 Net unconditional promises to give $1,486,828 $1,678,029 NOTE 6 - NOTE RECEIVABLE The note receivable is an unsecured client obligation which bears interest at 9% per year and is dated and due as follows: Dated Due August 1, 2006 February 1, 2007 $ 74,195 $ - Accrued interest on this note of $6,121 is included in accounts receivable on the Statement of Financial Position at June 30,

27 NOTE 7 - LINE OF CREDIT The Agency has a line of credit agreement with J.P. Morgan Chase Bank, N.A., which has been renewed annually each February 28. The agreement provides for borrowing of up to $3,000,000. The outstanding balance was $599,500 and $419,000 at, respectively. The agreement also provides for monthly interest at the bank s prime rate. The prime rate of interest was 8.25% at both, respectively. The line of credit agreement expires on February 28, 2008 and is secured by certain assets held at J.P. Morgan Chase Bank, N.A., a first mortgage on certain real estate and assignment of rents and leases on that same real estate. The agreement contains various covenants which, among other things, require minimum unrestricted cash and investments balances, issuance of consolidated financial statements and maintenance of books and records. As of June 30, 2007 and 2006, and for the fiscal years then ended, the Agency was in compliance with all of these covenants. NOTE 8 - LONG-TERM DEBT Long-term debt at June 30 consists of the following: Mortgages payable Wells Fargo Multifamily Capital (formerly with Reilly Mortgage Associates, L.P.), due in monthly installments of $51,135, including principal and interest at 9%, FHA interest subsidy reduces interest to an approximate effective rate of 1% to July 1, 2019, secured by land and building (Salem Village III, Inc.) $ 4,510,716 $ 4,708,604 Ziegler Financing Corporation, due in monthly installments of $21,254, including principal and interest at 6.00%, to April 1, 2034, secured by land and building (Batavia Council on Aging, Inc.) 3,414,564 3,463,146 U.S. Department of Housing and Urban Development, due July 1, 2019, with interest at the rate of 1% per annum which will not be compounded, payable at maturity, secured by restricted deposits, land and building (Salem Village III, Inc.) 1,028,977 1,028,977 U.S. Department of Housing and Urban Development, due in monthly installments of $5,056, including principal and interest at 7.63%, to October 1, 2021, secured by land and building (Dekalb Housing for the Handicapped, Inc.) 526, ,001 Total mortgages payable 9,480,543 9,746,728 Less current maturities 289, ,304 Long-term portion of mortgages payable $ 9,191,241 $ 9,480,424 25

28 NOTE 8 - LONG-TERM DEBT (continued) Notes payable related to bond issues Tax exempt bonds issued through the Illinois Finance Authority, Series 2006, Revenue Bonds (Lutheran Social Services of Illinois), serial and term maturity dates through 2028, interest rates ranging from 4.125% to 5.25%, secured by the property of the corporations which constitute the Obligated Group (Lutheran Social Services of Illinois and Vesper Management Corporation). $19,630,000 $20,000,000 Tax exempt bonds issued through the Illinois Health Facilities Authority, Series 1999, Revenue Refunding Bonds (Peterson Meadows Project), serial and term maturity dates through 2022, interest rates ranging from 4.50% to 5.90%, secured by a first mortgage on the real estate. 7,555,000 7,870,000 Total notes payable related to bond issues 27,185,000 27,870,000 Less current maturities 805, ,000 Long-term portion of notes payable related to bond issues $26,380,000 $27,185,000 Total long-term debt $35,571,241 $37,616,728 The loan agreement related to the Illinois Finance Authority, Series 2006, Revenue Bonds (Lutheran Social Services of Illinois) contains covenants that include requirements to maintain certain financial ratios such as historical debt service coverage ratio. Additional covenants include requirements and/or restrictions related to the use and operations of the facilities, the issuance of consolidated financial statements, the issuance of new debt, transfer of assets, and disposition of property. As of, and for the fiscal years then ended, the Agency was in compliance with all of these covenants. During the year ended June 30, 2006, Series 2006, Revenue Bonds (Lutheran Social Services of Illinois) were issued through the Illinois Finance Authority. The aggregate principal amount of the bonds issued was $20,000,000. The proceeds were used to refund Illinois Health Facilities Authority, Series 1993, Revenue Refunding Bonds, to fund debt service and project funds and to pay certain costs related to issuing the Series 2006 bonds and the refunding of the Series 1993 bonds. 26

29 NOTE 8 - LONG-TERM DEBT (continued) The loan agreement and master trust indenture related to the Illinois Health Facilities Authority, Series 1999, Revenue Refunding Bonds (Peterson Meadows Project) contains covenants that include requirements to maintain and calculate certain financial ratios as defined in the loan agreements. Additional covenants include requirements and/or restrictions related to use and operations of the facilities, the issuance of financial statements, the issuance of new debt, transfer of assets, disposition of property, and repayment of long-term loans from the Agency. As of, and for the fiscal years then ended, the Agency was in compliance with all of these covenants. Effective January 1, 2004, the Illinois Health Facilities Authority and other bonding agencies of the State of Illinois were consolidated into the Illinois Finance Authority. This change has no effect on the financial results or covenant requirements of the Agency. Scheduled annual principal maturities of the above mortgages and notes for the next five years are as follows: Year Ended June 30, 2008 $ 1,094, ,159, ,231, ,306, ,384,189 Later years 30,489,017 Total $ 36,665,543 NOTE 9 - CAPITAL ADVANCE AGREEMENTS The Agency has funded the construction of various housing projects through Capital Advance Agreements with HUD, which provided for borrowings not to exceed $48,436,038. These agreements require no principal or interest payments and are secured by the related land and buildings. If the housing projects are used for approved purposes over the terms of the agreements, which expire in years ranging from 2033 to 2047, the loans will be deemed to be paid and discharged. The amounts drawn to date are $42,260,036. Grant revenue from the capital advance agreements is being recognized over the terms of the agreements on a straightline basis. During the years ended, the Agency recognized revenue of $1,046,743 and $893,892, respectively, on these agreements. 27