CENTRAL ADMINISTRATIVE OFFICE OF THE ROMAN CATHOLIC DIOCESE OF SAN JOSE JUNE 30, 2011 AND 2010

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2 TABLE OF CONTENTS Page REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS 1 FINANCIAL STATEMENTS Statements of Financial Position 2011 and Statement of Activities Statement of Activities Statements of Cash Flows 2011 and Notes to Financial Statements SUPPLEMENTARY INFORMATION Independent Auditor s Report on Supplementary Information 41 ALL FUNDS Statement of Financial Position Statement of Financial Position Statement of Activities Statement of Activities SERVICE FUNDS Statement of Financial Position 2010 and Statement of Activities 2010 and PRIEST RETIREMENT FUNDS Statement of Financial Position 2011 and Statement of Activities 2011 and FUNDRAISING FUNDS Statement of Financial Position 2011 and Statement of Activities 2011 and DEPOSIT AND LOAN FUNDS Statement of Financial Position 2011 and Statement of Activities 2011 and

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4 STATEMENTS OF FINANCIAL POSITION AS OF June 30, 2011 and 2010 ASSETS Cash and cash equivalents $ 33,858,654 $ 32,971,977 Marketable securities 20,881,446 16,551,676 Receivables Receivables from parishes and institutions (net of allowance for doubtful accounts of $20,100 in 2011 and $47,648 in 2010) 321, ,340 Pledges (net of allowance for doubtful accounts and valuation reserves of $59,202 in 2011 and $59,202 in 2010) 1,615,120 1,631,557 Other (net of allowance for doubtful accounts and valuation reserves of $769,282 in 2011 and $1,003,756 in 2010) 5,396,101 4,932,964 Deposits and prepaid expenses 308, ,216 Inventory 8,661,961 8,719,122 Loans receivable from parishes and institutions in Deposit and Loan Fund (net of allowance for doubtful accounts and valuation reserves of $2,846,111 in 2011 and $3,125,309 in 2010) 20,996,385 22,839,566 Debenture issuance costs (net of accumulated amortization of $6,772 in 2011 and $74,143 in 2010) 399, ,130 Marketable securities held for long-term purposes 3,974,249 3,860,455 Investment in real estate 232, ,072 Assets held in trust for others 3,137,742 2,920,893 Land, buildings and equipment (net of accumulated depreciation of $19,158,258 in 2011 and $17,465,442 in 2010) 52,435,120 53,111,320 Total Assets $ 152,218,503 $ 148,817,288 LIABILITIES & NET ASSETS Liabilities Accounts Payable $ 2,338,345 $ 2,831,411 Pledges Payable to Parishes 1,640, ,623 Accrued Liabilites 26,183,121 26,498,050 Deposits Payable - Parishes 26,461,528 29,396,493 Debentures Payable 22,582,465 23,036,486 Notes Payable 809,310 1,503,911 Assets Held in trust for others 3,137,742 2,920,893 Held for Parishes/Institutions 9,233,479 7,256,782 Deferred Revenue 16,752,742 16,212,771 Total Liabilities 109,139, ,648,420 Net Assets Unrestricted Undesignated 9,775,030 9,212,472 Designated 10,482,502 8,537,928 Designated - Cemetery Long-Term Care 7,772,013 7,165,096 Total unrestricted assets 28,029,544 24,915,495 Temporarily restricted 11,075,130 9,320,605 Permanently restricted 3,974,249 3,932,768 Total net assets 43,078,923 38,168,868 Total liabilities and net assets $ 152,218,503 $ 148,817,288 The Accompanying Notes are an Integral Part of these Financial Statements - 2 -

5 STATEMENTS OF ACTIVITIES YEAR ENDED June 30, 2011 Unrestricted Temporarily Restricted Permanently Restricted Total Revenues Gifts, Bequests, and Collections $ 2,761,964 $ 6,358,302 $ 41,480 $ 9,161,746 Fees and Expense Reimbursement 2,799, ,799,116 Diocesan Assessment 2,976, ,976,132 Education Income 4,584, ,584,369 Rental Income 445, ,526 Investment Income 2,123, ,977-3,085,075 Interest Income from Loans 598, ,471 Cemetery Revenues 5,165, ,165,526 Insurance Premium Income 19,301, ,301,233 Newspaper Income 398, ,962 Other Income 444, ,772 Subtotal Revenues from Operations 41,599,169 7,320,279 41,480 48,960,928 Net assets released from restrictions 5,565,753 (5,565,753) - - Total revenues 47,164,923 1,754,525 41,480 48,960,928 Expenses Pastoral 4,334, ,334,997 Religious and personnel development 2,619, ,619,779 Education 4,115, ,115,270 Pension, priest retirement 1,363, ,363,796 Administration 2,526, ,526,265 Depreciation expense 1,723, ,723,793 Interest expense 2,246, ,246,913 Insurance premiums and benefits 17,976, ,976,957 Newspaper expenses 390, ,970 Cemetery expenses 4,247, ,247,584 Fundraising expenses 919, ,118 Total expenses 42,465, ,465,443 Increase (decrease) in net assets from operations 4,699,480 1,754,525 41,480 6,495,486 Change in fair value of rate swap (527,165) - - (527,165) Change in obligations for post-retirement benefits (1,058,266) - - (1,058,266) Increase (decrease) in net assets 3,114,049 1,754,525 41,480 4,910,055 Net assets at the beginning of the year 24,915,495 9,320,605 3,932,768 38,168,868 Net assets at the end of the year $ 28,029,544 $ 11,075,130 $ 3,974,249 $ 43,078,923 The Accompanying Notes are an Integral Part of these Financial Statements - 3 -

6 STATEMENTS OF ACTIVITIES YEAR ENDED June 30, 2010 Unrestricted Temporarily Restricted Permanently Restricted Total Revenues Gifts, Bequests, and Collections $ 2,782,733 $ 5,704,622 $ 135,640 $ 8,622,995 Fees and Expense Reimbursement 2,931, ,931,805 Diocesan Assessment 3,088, ,088,788 Education Income 4,479, ,479,094 Rental Income 490, ,536 Investment Income 1,513, ,790-1,834,468 Interest Income from Loans 666, ,746 Cemetery Revenues 5,735, ,735,580 Insurance Premium Income 19,604, ,604,565 Newspaper Income 355, ,383 Other Income 413, ,492 Subtotal Revenues from Operations 42,062,400 6,025, ,640 48,223,452 Net assets released from restrictions 5,600,361 (5,600,361) - - Total revenues 47,662, , ,640 48,223,452 Expenses Pastoral 4,300, ,300,352 Religious and personnel development 3,250, ,250,610 Education 5,395, ,395,056 Pension, priest retirement 2,300, ,300,628 Administration 2,978, ,978,531 Depreciation expense 1,589, ,589,881 Interest expense 2,502, ,502,752 Insurance premiums and benefits 16,943, ,943,896 Newspaper expenses 398, ,655 Cemetery expenses 4,948, ,948,645 Fundraising expenses 1,066, ,066,493 Total expenses 45,675, ,675,499 Increase (decrease) in net assets from operations 1,987, , ,640 2,547,953 Change in fair value of rate swap (569,113) - - (569,113) Change in obligations for post-retirement benefits (644,563) - - (644,563) Increase (decrease) in net assets 773, , ,640 1,334,277 Net assets at the beginning of the year 24,141,909 8,895,554 3,797,128 36,834,591 Net assets at the end of the year $ 24,915,495 $ 9,320,605 $ 3,932,768 $ 38,168,868 The Accompanying Notes are an Integral Part of these Financial Statements - 4 -

7 STATEMENTS OF CASH FLOWS YEARS ENDED June 30, 2011 and June 30, Cash flows from operating activities: Change in net assets after effect of change in accounting principle $ 4,910,055 $ 1,334,277 Change in fair value of rate swap 527, ,113 Change in obligations for post-retirement benefits 1,058, ,563 Change in net assets from operations 6,495,486 2,547,953 Adjustment to reconcile change in net assets to net cash provided by operating activities: Depreciation 1,723,793 1,589,881 Provision for losses on loans and receivables (541,220) (593,387) Amortization of bond issuance costs (5,426) 15,609 Investment (gains)/ losses (2,750,869) (1,863,793) Accrued cost unfunded pension liability (832,966) 3,620,346 Changes in operating assets and liabilities: Receivables (82,179) 590,129 Inventories 57, ,211 Deposits and prepaid expenses (81,040) (11,890) Trust assets held for parish (216,850) (123,635) Accounts payable and pledges payable 156, ,950 Accrued liabilities (540,229) (1,352,674) Assets held in trust 216, ,635 Held for parishes and institutions 1,976, ,104 Deferred revenue 539, ,271 Contributions restricted for investment in permanent endowments (41,480) (135,640) Net cash provided by operating activities 6,073,856 6,455,071 Cash flows from investing activities: Purchase of land, buildings and equipment (1,047,594) (1,905,202) Proceeds from repayment of loans receivable 2,090, ,223 Advances for loans/interest receivable 31,877 - Purchase of marketable securities and distributions (2,747,552) (669,901) Proceeds from sale of marketable securities and receipt of funds for investment 1,054, ,675 Net cash used in investing activities (617,909) (1,239,205) Cash flows from financing activities: Deposits payable (2,934,965) (292,365) Payments on notes and bonds payable (1,675,786) (2,131,754) Contributions restricted for investment in permanent endowments 41, ,640 Net cash used in financing activities (4,569,271) (2,288,479) NET INCREASE IN CASH AND CASH EQUIVALENTS 886,676 2,927,387 Cash and cash equivalents at beginning of period 32,971,977 30,044,590 Cash and cash equivalents at end of period $ 33,858,654 $ 32,971,977 SUPPLEMENTAL DISCLOSURE FOR CASH PAID FOR: Interest $ 2,536,017 $ 2,935,332 Taxes $ 18 $ - The Accompanying Notes are an Integral Part of these Financial Statements - 5 -

8 NOTE 1 - ORGANIZATION The Roman Catholic Bishop of San Jose, a California Corporation Sole, was incorporated on March 19, 1981 and commenced financial operations on July 1, 1981 as the Roman Catholic Diocese of San Jose ( the Diocese ). The financial statements include only those funds for which the Central Administrative Office ( CAO ) maintains direct operational control. All significant inter-organizational and inter-fund balances and transactions have been eliminated. Those entities not included in these statements are the parish churches, certain elementary and secondary schools, The Roman Catholic Welfare Corporation, The Catholic Foundation of Santa Clara County, Catholic Charities of Santa Clara County, The Roman Catholic Seminary Corporation of San Jose ( Seminary ), The Roman Catholic Bishop of San Jose Master Irrevocable Trust, Santee Catholic Mission, a corporation sole, the Cathedral Foundation, Jeanne d Arc Manor, Giovanni Center, Charities Housing Development Corporation of Santa Clara County, San Tomas/Charities Housing Corporation, Sierra Vista/Charities Housing Corporation, Sunset Housing Corporation, Stoney Pine and Roman Catholic Communications Corporation of the Bay Area/Catholic Telemedia Network. The primary sources of revenue for the CAO are donations through the Annual Appeal, assessment on parish offertory revenue, cemetery plot sales, tuition, reimbursements, premiums and fees. Following is a description of the fund groups included in net assets: Unrestricted Net Assets This net asset class is not subject to donor-imposed stipulations. The following funds have unrestricted net assets: Current Funds Operating Fund This fund contains the unrestricted resources available for the support of the CAO and resources held for parishes and institutions. This includes the land, buildings and equipment held for use by the CAO, St. Joseph s Cathedral and sites held for sale and for future parishes and institutions. The operating fund also holds funds raised and spent for acquisition of a site for a future parish. A portion of unrestricted net assets of the Operating Fund has been designated for certain initiatives. The CAO does not imply a time restriction on gifts of long-lived assets. Since 2009 the operations of the Newspaper are included in the Operating Fund. Service Funds Payroll Fund This fund contains resources held by the CAO to operate a central payroll system for parishes and institutions. They are billed for their respective shares of the periodic payrolls and the system s costs. Benefit Fund This fund collects and disburses monies for employee benefit programs. - Comprehensive Insurance Fund This fund collects and disburses monies for liability, general property and workers' compensation insurance. The net assets are designated for potential claims. 6

9 NOTE 1 - ORGANIZATION (Continued) Cemetery Fund The activities of the Roman Catholic Cemeteries of San Jose are maintained in this fund. Amounts set aside for perpetual cemetery care are designated as funds functioning as long-term care in the unrestricted net asset category. Employee Loan Fund This fund has been established for loans to employees and priests of the Diocese. At June 30, 2011 and 2010, the interest rate on loans was 5.0%. Since May 31, 2009 no new loans were being made from this fund pending revision of the loan approval and collection policies and procedures. Endowment Fund The unrestricted portion of this fund may be used for any purpose. The majority of the fund is currently used for scholarships for high school and elementary school students in Catholic schools in the Diocese and for priest retirement and seminarian education. Priest Retirement Fund These funds have been established to provide support for retired priests. Specific assets have been designated for this purpose from the Annual Diocese Appeal and parish payments. Deposit and Loan Fund This fund contains deposits held by the CAO for parishes and institutions which are held for investment and/or loaned to other parishes and institutions. At June 30, 2011 and 2010 the effective rate was 0.75% to 1.75%, depending on the term of the deposit. The interest rates applied to loans range from 2.25% to 5.0% as of June 30, 2011 and 2010, with some loans on non-accrual of interest. The Deposit and Loan Fund had $26,461,528 and $29,396,493 of deposits from parishes and schools as of June 30, 2011 and 2010, respectively. The source and term of deposits is shown in the following tables: As of June 30, 2011 By Term <1 Year 1-2 Years 6 Years Total Parishes $ 12,804,142 $ 3,131,102 $ 3,476,778 $ 19,412,022 Schools 5,204, ,637 1,698,012 7,049,506 $ 18,008,999 $ 3,277,739 $ 5,174,790 $ 26,461,528 Percent of total 68% 12% 20% 100% 7

10 NOTE 1 - ORGANIZATION (Continued) As of June 30, 2010 By Term <1 Year 1-2 Years 6 Years Total Parishes $ 13,250,112 $ 3,440,142 $ 3,327,681 $ 20,017,935 Schools 6,928, ,104 2,197,679 9,378,558 $ 20,178,887 $ 3,692,246 $ 5,525,360 $ 29,396,493 Percent 69% 12% 19% 100% Fundraising Fund This fund has been established for general fundraising activities for the support of Diocesan general operations. Holy Spirit School Holy Spirit School, a Diocesan elementary school, is contained in this fund. The CAO has a substantial investment in the school and has an active oversight in monitoring the operations of the school. Because of this significantly closer affiliation with Holy Spirit School which became effective July 1, 2002, the financial statements of the School have been combined with those of the CAO. All significant inter-fund balances and transactions have been eliminated. Temporarily Restricted Net Assets - This net asset class includes gifts for which donor-imposed purpose restrictions or time restrictions have not been met. Operating Fund In addition to unrestricted net assets, this fund also includes uncollected donor bequests and trusts and other donor-restricted gifts which are classified as temporarily restricted net assets. Annual Appeal Fund This fund contains the operations of the Annual Diocesan Appeal. The annual appeal funds raised in February through June are treated as temporarily restricted revenues and are released from restriction in the following year, which is the period for which the funds are collected from the parishes and budgeted for use in operations. Associated fundraising costs are expensed as incurred. Endowment Fund In addition to unrestricted, designated and permanently restricted net assets, this fund also contains resources that are temporarily restricted in accordance with trust or other donor agreements. Holy Spirit School In addition to unrestricted and permanently restricted net assets, this fund also contains resources that are restricted for scholarships, as well as pledges receivable that are temporarily restricted by a time restriction until the cash is collected on these pledges. 8

11 NOTE 1 - ORGANIZATION (Continued) Permanently Restricted Net Assets - This net asset class consists of assets, the use of which has been restricted for investment in perpetuity. The income from these assets is available for either general operations or specific programs as specified by the donor. Endowment Fund This fund is currently used for scholarships for high school and elementary school students in Catholic schools in the Diocese and for priest retirement and seminarian education. Holy Spirit School In addition to unrestricted and temporarily restricted net assets, this fund also contains permanently restricted resources, the income from which is to be used for scholarships. Also included in the statement of financial position is the following fund: Pooled Investment Fund This fund contains investments of the CAO, as well as those investments held for parishes and institutions. Ownership by specific funds or entities is accounted for utilizing a pooling method based on market values. Revenues and expense of the pool are reflected as net asset changes in the fund or entity for which the assets are held. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting policies of the CAO conform to accounting principles generally accepted in the United States of America ( generally accepted accounting principles ) applicable to religious organizations. A summary of the significant accounting policies applied consistently in the preparation of the accompanying financial statements follows: Fund Accounting The accounts of the CAO are maintained in accordance with the principles of fund accounting. This is the procedure by which resources for various purposes are classified for accounting and reporting purposes into funds that are in accordance with specified activities or objectives. Accordingly, all financial transactions have been recorded by fund group. However, for the financial statements, transactions are reported by the net asset categories described in Note 1. Accrual Basis The financial statements of the CAO have been prepared on the accrual basis of accounting. Cash and Cash Equivalents All highly liquid debt instruments purchased with a maturity of three months or less are considered cash equivalents, and may include short-term commercial paper and repurchase agreements. 9

12 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Revenue Recognition The CAO records earned revenue on the accrual basis. Diocesan Assessments paid by parishes are based on parish collections for the second prior fiscal year. Diocesan Assessments, insurance and other fees are billed to the parishes and schools by the CAO on a monthly basis. Sales of developed cemetery property and at-need services and merchandise are recognized when the contracts are executed and the property and services are delivered. Revenues and costs associated with cemetery property sold on a pre-developed basis are deferred and recognized in accordance with the retail land sales provisions of generally accepted accounting principles. This method generally provides for the recognition of revenue in the period in which the customer's cumulative payments exceed 10% of the contract price related to the real estate. Contributions and Pledges Contributions are recognized as pledges receivable in the Statement of Financial Position at the time a donor makes a promise to give to the CAO that is, in substance, unconditional. Contributions are reported as temporarily restricted support if they are received with donor stipulations that limit the use of the donation. When the donor restriction expires, stipulated time restriction ends or purpose restriction is accomplished, temporarily restricted assets are reclassified to unrestricted assets and reported in the Statement of Activities as net assets released from restriction. Marketable Securities Marketable securities are presented in the financial statements at fair value based on quoted market prices provided by the investment brokers. Dividends and interest are accrued as earned and recorded as unrestricted revenue unless income is restricted by the donor. Any unrealized gains or losses for the current period are reported as investment income. Fair Value Measurements Generally accepted accounting principles define fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Generally accepted accounting principles establishes a hierarchy to prioritize the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest ranking to fair values determined using unadjusted quoted prices in active markets for identical assets (Level 1) and the lowest ranking to fair values determined using methodologies and models with unobservable inputs (Level 3). Observable inputs are inputs that reflect the assumptions market participants would use in pricing the asset based on market data obtained from sources independent of the Diocese. Unobservable inputs reflect the Diocese s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available under the circumstances. 10

13 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) The fair value hierarchy is categorized into three levels based on the inputs as follows: Level 1 Values are unadjusted quoted prices for identical assets and liabilities in active markets accessible at the measurement date. Level 2 Inputs include quoted prices for similar assets or liabilities in active markets, quoted prices from those willing to trade in markets that are not active, or other inputs that are observable or can be corroborated by market data for the term of the instrument. Such inputs include market interest rates and volatilities, spreads and yield curves. Level 3 Certain inputs are unobservable (supported by little or no market activity) and significant to the fair value measurement. Unobservable inputs reflect the Organization s best estimate of what hypothetical market participants would use to determine a transaction price for the asset or liability at the reporting date. Trade Receivables Trade receivables are principally generated from the operations of the Cemeteries and from billings from the CAO to the various parishes and schools within the Diocese for insurances, payroll, pension and other costs. The CAO provides for an allowance for doubtful accounts for those receivables in excess of 90 days past due and considers the financial position and payment history of the parish or school when estimating the allowance for doubtful accounts. Trade receivables are non-interest bearing and unsecured. Receivables are determined to be past due based on contractual terms. Loans Receivable Loans that management has the intent and ability to hold for the foreseeable future, until maturity, or pay-off, are reported at their outstanding principal, net of the allowance for present value discount and loan losses. Interest on loans is calculated by using the simple interest method on the balance of the outstanding principle and interest. These loans are unsecured. However, the CAO has the ability to collect all unpaid amounts from the proceeds of sale of parish or school property upon their disposal. A loan is identified as impaired when it is probable that interest and principle will not be collected according to the contracted terms of the loan agreement. The accrual of interest on impaired loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. Interest income is subsequently recognized only to the extent cash payments are received and where the future collection of principle is probable. 11

14 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Allowance for Loan Losses in Deposit and Loan Fund The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb losses inherent in existing loans and commitments to extend credit, based on evaluations of the collectability and prior loss experience of loans and commitments to extend credit. The evaluation takes into consideration such factors as changes in the nature and volume of the portfolio, the discounted value of loans for those loans on a zero interest rate, overall portfolio quality, loan concentrations, specific problem loans, commitments and current and anticipated economic conditions that may affect the borrowers' ability to pay. Inventories Cemetery inventories consist of real property, graves, crypts, cremains, niches, landscaping and irrigation surrounding the sites and site development. Inventories are valued at the lower of cost (based on average cost) or market. Land, Buildings and Equipment Land, buildings and equipment are recorded at cost, or, in the case of Cemetery properties acquired directly from the Archdiocese of San Francisco, at approximate market value at the time of transfer. Building and equipment depreciation expense is calculated principally on the straightline method over the estimated useful lives of the assets. Maintenance and repairs which neither materially add to the value of the property nor appreciably prolong its life are charged to expense as incurred. The CAO will capitalize fixed assets when the asset purchased, built, or leased has a useful life of one year or more, and the acquisition cost or manufactured cost of the asset is $5,000 or more. Multiple assets acquired in one transaction whose cost individually is less than $5,000 but in aggregate is greater than $25,000 are also capitalized. Deferred Revenue Deferred revenue consists principally of rental income, which is recognized on a straight-line basis over the term of the lease, and pre-need cemetery sales of future goods and services. Tax Exempt Status The Diocese has been granted tax exempt status by the Internal Revenue Service and the California Franchise Tax Board under code Sections 501(c) 3 and 23701(d), respectively. The Diocese qualifies for the charitable contribution deduction under Section 170(b) (1) (A) and has been classified as an organization other than a private foundation under Section 509(a) (1). However, it is subject to tax on unrelated business income resulting from building lease income and newspaper advertising income received. 12

15 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Accounting for Income Taxes Uncertain Tax Positions Generally accepted accounting principles provide accounting and disclosure guidance about positions taken by an organization in its tax returns that might be uncertain. Management has considered its tax positions and believes that all of the positions taken in its federal and state exempt organization returns are more-likely-than-not to be sustained upon examination. The Diocese s federal Exempt Organization Business Income Tax Return (Forms 990-T) for the years ended June 30, 2008 through 2010 are subject to examination by the Internal Revenue Service, generally for three years after they are filed. The Diocese s state returns (Form 109) for the years ended June 30, 2007 through 2010 are subject to examination by the California Franchise Tax Board, generally for four years after they are filed. Comparative Information Certain amounts reflected in the CAO's prior year financial statements have been reclassified in these financial statements to reflect current year presentation. Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: - Cash and Equivalents The carrying amount approximates fair value because of the short maturity of those instruments. The CAO maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. The CAO has not experienced any losses in such accounts. Management believes the Diocese is not exposed to any significant risk on cash accounts. - Receivables Receivables expected to be received in more than one year are reported at the present value of estimated cash flows, using rates commensurate with the risk involved at the date the receivable originates. - Marketable Securities The fair value of investments is based on quoted market prices for those or similar assets. The CAO holds various investments which may include mutual funds, equities, fixed income contracts and government securities. These securities are exposed to various risks such as interest rate, market and credit. Due to the level of risk associated with these securities and the level of uncertainty related to changes in value, it is a least reasonably possible that changes in the various risk factors will occur in the near term that could materially affect the value of these investments reported in the accompanying financial statements. 13

16 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) - Loans In the case of interest-bearing loans, interest is charged at variable market rates. For non-interestbearing loans, the fair value has been discounted, using rates for similar loans, to reflect the net present value of these loans. - Notes Payable The carrying value of notes payable approximates the fair value, as the carrying value is calculated using discounted cash flow analyses, based on the CAO's incremental borrowing rate. Fair Value Measurements The Fair Values of certain assets measured on a recurring basis at June 30, 2011 are: Total Level 1 Level 2 Level 3 Securities $ 24,855,695 $ 24,855,695 $ - $ - Non-Accrual Loans 20,316, ,316,272 Interest Rate Swap (3,942,465) - - (3,942,465) Charitable Remainder Trust 199, ,234 Land Charitable Remainder Trust 994, ,108 Beneficial Interests 694, , ,072 Total $ 43,117,635 $ 25,296,414 $ - $ 17,821,221 The Fair Values of certain assets measured on a recurring basis at June 30, 2010 are: Total Level 1 Level 2 Level 3 Securities $ 20,412,131 $ 20,412,131 $ - $ - Non-Accrual Loans 24,935, ,935,809 Interest Rate Swap (3,386,486) - - (3,386,486) Charitable Remainder Trust 173, ,665 Land Charitable Remainder Trust 923, ,482 Beneficial Interests 76, ,699 Total $ 43,135,300 $ 20,412,131 $ - $ 22,723,169 Use of Estimates In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as revenues and expenses during the reporting period. Actual results could differ from those estimates. 14

17 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) The CAO's allowances for present value adjustments and doubtful receivables, pledges and loans totaling $3,694,696 for 2011 and $4,235,915 for 2010 are particularly sensitive estimates. The determination of the balances in these accounts is based on an analysis of the receivables and loans and reflects amounts which in management's judgment, are adequate to provide for potential losses after giving consideration to the character of the receivables and loan portfolio, current economic conditions, past collection experience and such other factors that deserve current recognition in estimating losses. Assets Held for in Trust for Others The CAO has been named trustee for two unitrusts. The donor is the income beneficiary until death, at which time the property transfers to the designated beneficiary. The CAO is not the beneficiary (diocesan parishes or schools are) and, therefore, the CAO records an asset and a corresponding liability. Bond Issuance Costs Costs incurred in connection with the refinancing of previously issued debentures are being amortized over the remaining life of the refinanced instrument. Liquidity In fiscal 2011 liquid assets (Cash and Marketable Securities, excluding Marketable Securities held for long-term purposes) increased by $5,216,447. This growth was due to an increase in cash of $886,677 and in the value of Marketable Securities by $4,329,770. The Cash Flows Statement highlights the other contributing factors to the balance of the increase in Cash and Marketable Securities. At June 30, 2011, $2,167,000 of net construction commitments were outstanding, a decrease of $380,000 from $2,547,000 at June 30, The commitments are fully funded by Parishes and Schools with deposits in the Deposit and Loan fund. During fiscal year 2009, the CAO purchased 20 acres of land in southern Santa Clara County for the construction of a secondary school. The CAO also acquired an option to purchase an additional 20 acres for $3,600,000. As of June 30, 2011, the CAO paid $678,500 toward this option, all of which is applicable to the purchase price. The CAO is able to draw from the Bond Refinancing done in FY 2011 sufficient funds to pay for the balance owing on this property when the option comes due. In fiscal 2003, the CAO instituted a Diocesan Assessment from the parishes based on 10% of Offertory collected in the second prior fiscal year. In fiscal 2011, $2,976,132 and in fiscal 2010, $3,088,788 of revenue was raised from this Assessment. It is anticipated that this source of revenue will decrease in fiscal 2012, not due to a change in the assessment rate, but due to decreases in overall Offertory collections in the parishes by 0.5% in fiscal These funds are used to cover some of the fixed operating expenses of the CAO. 15

18 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) The Deposit and Loan Fund continues to be one source of existing and potential liquidity as well as significant liquidity problems for the CAO. At June 30, 2011, there was $43,490,839 in deposits in the fund (before elimination of $17,029,311 of intra-fund deposits) a decrease of $2,041,197 or 4% from June 30, The net decrease in deposits, after eliminations, was $2,934,965 or 11%, from June 30, As shown in the tables in Note 1, the amount of deposits committed for terms of 1 year or more increased only slightly from 31% of total deposits to approximately 32% of the total, providing slightly more stability to this funding source in the Deposit and Loan Fund. The CAO anticipates having adequate cash resources over and above restricted cash to meet its obligations. In the event that the CAO does not obtain sufficient cash from these aforementioned sources and strategies, additional cash could be obtained through the sales of unrestricted marketable securities. As of June 30, 2011 over $9,665,977 of the outstanding loans of $23,842,496 were on the equivalent of non-accrual of interest and another $3,989,290 of the outstanding loans had a special amortization and loan rate different from standard loans because of the inability of the parishes to pay in accordance with the original terms and this is down slightly from the 2010 balances of 9,707,400 of the outstanding loans of $25,964,875 that were on the equivalent of non-accrual of interest and another $4,128,100 of the outstanding loans that had a special amortization and loan rate different from standard loans because of the inability of the parishes to pay in accordance with the original terms. The CAO does not expect any principal losses on these loans that were made for the seismic retrofit of a parish church, the construction of a parish church and of a parish hall, but the delay in payment will decrease the available cash in the Deposit and Loan Fund that can be used for bond payments and withdrawals by depositors. NOTE 3 - MARKETABLE SECURITIES Marketable securities at June 30 consisted of the following: Mutual Funds $ 24,817,464 $ 20,363,249 Other 38,231 48,882 Total $ 24,855,695 $ 20,412,131 Marketable securities were classified on the Statement of Assets, Liabilities and Net Assets as follows: Marketable Securities $ 20,881,446 $ 16,551,676 Marketable Securities held for long-term purposes 3,974,249 3,860,455 Total $ 24,855,695 $ 20,412,131 16

19 NOTE 3 - MARKETABLE SECURITIES (continued) Investment income for the years ended June 30, consisted of the following: Interest and dividends $ 426,502 $ 494,577 Realized gains (losses), net 8,966 48,119 Unrealized gains (losses), net 3,700,136 1,863,793 Total income 4,135,604 2,406,488 Less: Portfolio manager and custodian fees (32,861) (32,035) Net income from investment pool activities 4,102,743 2,374,453 Investment income cash management and other 32,042 44,925 Total income from investment activities 4,134,785 2,419,379 Less income attributed to custodian and similar funds: Interest and dividends (net of manager fees of $8,589 in 2010 and $6,181 in 2009) 103, ,582 Realized gains (losses) 2,269 11,812 Unrealized gains (losses) 944, ,517 Total earnings from investment activities 1,049, ,911 excluding custodian and similar funds $ 3,085,075 $ 1,834,468 NOTE 4 - PLEDGES RECEIVABLE AND PAYABLE Pledges receivable and payable are as follows at June 30, 2011: Holy Annual Spirit Appeal School Total Due within one year $ 1,655,588 $ 18,734 $ 1,674,322 Due in one to five years ,655,588 18,734 1,674,322 Less discount for present value - (1,727) (1,727) 1,655,588 17,007 1,672,595 Less allowance for doubtful accounts (54,895) (2,580) (57,475) Net pledges receivable $ 1,600,693 $ 14,427 $ 1,615,120 Annual campaign pledges payable from CAO to parishes as of June 30, 2011 $ 1,640,846 $ - $ 1,640,846 17

20 NOTE 4 - PLEDGES RECEIVABLE AND PAYABLE (continued) Pledges receivable and payable are as follows at June 30, 2010: Holy Annual Spirit Appeal School Total Due within one year $ 1,665,194 $ 25,565 $ 1,690,759 Due in one to five years ,665,194 25,565 1,690,759 Less discount for present value - (1,727) (1,727) 1,665,194 23,838 1,689,032 Less allowance for doubtful accounts (54,895) (2,580) (57,475) Net pledges receivable $ 1,610,299 $ 21,258 $ 1,631,557 Annual campaign pledges payable from CAO to parishes as of June 30, 2010 $ 991,623 $ - $ 991,623 Pledges receivable are recorded after discounting the future cash flows to present value using discount rates ranging from 5.9% - 6.2%. Pledges Payable will be paid within one year. NOTE 5 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (DEPOSIT AND LOAN FUND) Collections of loans receivable are scheduled as follows: $ 1,080, $ 1,234, , ,274, , ,108, , , , ,508 Thereafter 19,642,377 Thereafter 20,670,401 Subtotal 23,842,496 25,964,875 Less allowance for loan losses and valuation reserves (2,846,111) (3,125,309) Total $ 20,996,385 $ 22,839,566 The CAO advances funds for construction projects to parishes and schools but does not set terms of repayment until these projects are complete. As of June 30, 2011 and 2010, there were no construction loans outstanding. 18

21 NOTE 5 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (DEPOSIT AND LOAN FUND) (continued) Allowances for loan losses are as follows: Balance, beginning of the year $ 3,125,309 $ 3,694,889 Present Value adjustment (239,184) (548,796) Provisions for loan losses (40,014) (20,784) Balance, end of year $ 2,846,111 $ 3,125,309 Impaired loans (those loans on non-interest accrual or a special rate) were $13,655,266 and $13,835,514 at June 30, 2011 and 2010, respectively. The average recorded investment in impaired loans during 2011 was $13,745,390 and during 2010 was $13,940,161. The allowance for loan losses and the present value discount related to these loans was $2,351,083 in 2011 and $2,590,267 in NOTE 6 - LAND, BUILDINGS AND EQUIPMENT Land, building and equipment consisted of the following at June 30, 2011: Priest Operating Cemetery Retirement Holy Spirit Funds Fund Fund School Total Buildings and Improvements $ 32,851,116 $ 5,173,142 $ - $ 11,644,814 $ 49,679,072 Leasehold improvements , ,388 Furniture and fixtures 679, ,982-1,499,177 2,595,946 Vehicles 34, , ,144 Equipment 177, , ,095 Other improvements 364, , ,690 34,107,553 7,453, ,388 13,143,991 55,112,335 Less accumulated depreciation (9,189,010) (4,645,292) (407,388) (4,916,548) (19,158,238) 24,918,543 2,808,111-8,227,443 35,954,097 Land Sites for future parishes and institutions 7,663, ,663,956 Land under operating leases (see Note 12) 613, ,588 Operating properties 5,168,858 2,758,592-52,684 7,980,134 13,446,402 2,758,592-52,684 16,257,678 Construction in progress 201,168 22, ,345 Total land, buildings and equipment $ 38,566,113 $ 5,588,880 $ - $ 8,280,127 $ 52,435,120 19

22 NOTE 6 - LAND, BUILDINGS AND EQUIPMENT (Continued) Land, building and equipment consisted of the following at June 30, 2010: Priest Operating Cemetery Retirement Holy Spirit Fund Fund Fund School Total Buildings and Improvements $ 32,452,377 $ 5,173,142 $ - $ 11,644,814 $ 49,270,333 Leasehold Improvement , ,388 Furniture and fixtures 679, ,982-1,352,974 2,499,742 Vehicles 32, , ,136 Equipment 177, , ,095 Other improvements 364, , ,690 33,706,662 7,445, ,388 12,997,788 54,557,384 Less accumulated depreciation (8,272,800) (4,378,700) (406,776) (4,407,165) (17,465,442) 25,433,862 3,066, ,590,623 37,091,943 Land Sites for future and institutions 7,335, ,335,480 Land under leases (see Note 613, ,588 Operating 5,168,858 2,456,068-52,684 7,677,610 13,117,926 2, 456, ,626,678 Construction in progress 392, ,699 Total land, buildings equipment $ 38,944,487 $ 5,522,913 $ 612 $ 8,643,307 $ 53,111,320 NOTE 7 - SECURED LETTER OF CREDIT FACILITY AND UNSECURED DEBENTURES On December 1, 1999, the CAO concluded the sale of unsecured debentures with proceeds totaling $19,240,000 and issuance costs of $995,590. Proceeds from the sale of the unsecured debentures were used to build Holy Spirit Elementary School, to finance earthquake retrofit improvements at various parish and school facilities, for general corporate purposes and to pay costs of issuance. Principal and interest on the unsecured debentures are being paid from contributions. 20

23 NOTE 7 - SECURED LETTER OF CREDIT FACILITY AND UNSECURED DEBENTURES (continued) To facilitate a refinancing of the debenture in September 2005, the CAO entered into an agreement with a bank that provides for a letter of credit to be issued that backs the credit of the CAO enabling the CAO to refinance the bond debt in the open market. The letter of credit agreement requires the CAO to provide a deed of trust in certain of its property and to maintain specific ratios and timely submission of audited financial statements. This process also allowed the CAO to borrow an additional $5,500,000 that enabled it to purchase a fully leased investment office property that it now uses for its own offices and for offices leased to unrelated parties. Covenants The CAO of the Roman Catholic Diocese of San Jose must comply with covenants including maintenance of specific ratios and timely submission of audited financial statements. The CAO was in compliance with these requirements at June 30, 2011 and Aggregate maturities of the unsecured debentures are as follows: 2012 $ 490, , , , ,000 Thereafter 16,040,000 Subtotal 18,640,000 Valuation of SWAP 3,942,465 Total debentures payable $ 22,582,465 In June of 2006, the CAO entered into an interest rate SWAP (derivative) agreement for $20,000,000 of the outstanding $23,905,000 of bond indebtedness, exchanging a weekly floating London Interbank Offered Rate (LIBOR) for a fixed rate. While the differential was at par in 2006, the decrease in the LIBOR based rate at June 30, 2011 versus the fixed rate of 5.34% for the SWAP created a difference in value that needs to be recognized in these financial statements. The fair value (i.e., gain or loss) of the derivative agreement would be recorded as either an asset or liability in the statement of financial position and the change in fair value recognized in the statement of activities. The derivative agreement is recognized on the CAO's financial statements as of June 30, 2011 because of the $3,942,465 differential in values. In March, 2007, the CAO entered into an interest rate SWAP agreement for $1,740,000 with Wells Fargo Bank, holder of the note for the construction of the mausoleum at the Cemetery. This agreement runs through the maturity date of that loan in This derivative agreement is recognized on the CAO's financial statements as of June 30, 2011 in the amount of $0 and as of June 30, 2010 in the amount of $28,814. The loan and related derivative were repaid in full as of June 30,

24 NOTE 8 - NOTES PAYABLE AND LINES OF CREDIT Notes payable consisted of the following at June 30: Term loan from Wells Fargo Bank, due March 1, Interest fixed at Libor %, or 5.25% at April 1, Principal of $29,000 per month. Loan repaid June, $ - $ 609,000 Plus amount representing imputed interest on SWAP liability on Wells Fargo Bank Note - 28,814 Non-interest bearing obligation to The Archdiocese of San Francisco, payable in annual installments of $100,000 through 2020 and the balance due in The value of this note has been determined based on an imputed interest rate of 5.6% 809, ,097 Total $ 809,310 $ 1,503,911 Aggregate maturities of notes payable as of June 30, 2011 are as follows: 2012 $ 100, , , , ,000 Thereafter 431, ,960 Less amount representing imputed interest included above (122,650) $ 809,310 22

25 NOTE 9 - RESTRICTED NET ASSETS Temporarily restricted net assets are available for the following as of June 30: Current Funds: Operating (time and purpose restrictions) $ 1,738,747 $ 1,051,316 Fundraising Funds: Annual appeal programs and general operations (time restriction) 5,657,587 5,619,069 Holy Spirit School: Endowments for scholarships (time and purpose restrictions) 305, ,764 Programs (time and purpose restricted) 179, ,582 Endowment Fund-cumulative earnings: Trust agreements and scholarships (purpose restrictions) 3,193,851 2,231,874 $ 11,075,130 $ 9,320,605 Permanently restricted net assets are restricted to investment in perpetuity, the income from which is expendable to support the following as of June 30: Priest retirement and seminarian education $ 811,190 $ 811,190 Scholarships 3,163,059 3,121,578 $ 3,974,249 $ 3,932,768 NOTE 10 - NET ASSETS RELEASED FROM RESTRICTIONS Net assets were released from donor restrictions by incurring expenses satisfying the restricted purposes or by occurrence of other events specified by donors. Net assets released from restrictions during 2011 and 2010 consisted of the following: Purpose restrictions accomplished $ 16,398 $ 29,927 Time restrictions expired 5,549,355 5,570,434 Total restrictions released $ 5,565,753 $ 5,600,361 23

26 NOTE 11 ENDOWMENTS The endowments of the CAO consist of seven funds established for scholarships for children in the primary and secondary Catholic School in the Diocese of San Jose and for seminarian education and priest retirement. As required by generally accepted accounting principles, net assets associated with endowment funds are classified and reported based on the existence or absence of donor-imposed restrictions. Interpretation of Relevant Law The CAO has interpreted the California Version of the Uniform Prudent Management of Institutional Funds Act (UPMIFA) as requiring the preservation of the fair value of the original gift as of the gift date of the donor-restricted endowment funds absent explicit donor stipulations to the contrary. As a result of this interpretation, the Diocese classifies as permanently restricted net assets (a) the original value of gifts donated to the permanent endowment, (b) the original value of subsequent gifts to the permanent endowment, and (c) accumulations to the permanent endowment made in accordance with the direction of the applicable donor gift instrument at the time the accumulation is added to the fund. The remaining portion of the donor-restricted endowment fund that is not classified in permanently restricted net assets is classified as temporarily restricted net assets until those amounts are appropriated for the expenditure by the Diocese in a manner consistent with the standard of prudence prescribed by the California version of UPMIFA. In accordance with the California version of UPMIFA, the Diocese considers the following factors in making a determination to appropriate or accumulate donor-restricted funds: 1) Duration and preservation of the fund 2) The purposes of the organization and the donor-restricted endowment fund 3) General economic conditions 4) The possible effect of inflation and deflation 5) The expected total return from income and the appreciation of investments 6) Other resources of the organization 7) The investment policies of the organization. Endowment Net Asset Composition by Type of Fund as of June 30, 2011: Unrestricted Temporarily Restricted Permanently Restricted Total Board-Designated $ 2,027,691 $ - $ - $ 2,027,691 Donor-Restricted - 3,504,102 3,974,248 7,478,350 Total Funds $ 2,027,691 $ 3,504,102 $ 3,974,248 $ 9,506,041 Changes in Endowment Net Assets for the year ended June 30, 2011: Temporarily Unrestricted Restricted Permanently Restricted Total Endowment Net Assets, Beginning of the Year $ 1,948,387 $ 2,460,639 $ 3,932,768 $ 8,341,794 Investment Income/Expense - 139, ,173 Investment Appreciation 79,304 1,336,553-1,415,857 Contributions ,480 41,480 Appropriations for expenditure - (432,263) - (432,263) Endowment Net Assets, End of Year $ 2,027,691 $ 3,504,102 $ 3,974,248 $ 9,506,041 24

27 NOTE 11 ENDOWMENTS (Continued) Funds with Deficiencies From time to time, the fair value of assets associated with individual donor-restricted endowment funds may fall below the level that the donor or California version of UPMIFA requires the Diocese to retain as a fund of permanent duration. In accordance with generally accepted accounting principles, the deficiencies of this nature are reported in unrestricted net assets. As of June 30, 2011 and 2010 those amounts were $0 and $79,304, respectively. These deficiencies resulted from unfavorable fluctuations in the underlying value of the funds held for these accounts. Return Objectives and Risk Parameters The Diocese has adopted investment and spending policies for endowment assets that attempt to provide a predictable stream of funding to programs supported by its endowment while seeking to maintain the purchasing power of the endowment assets. Strategies Employed for Achieving Objectives To satisfy its long-term and rate-of-return objectives, the Diocese relies on a total return strategy in which investment returns are achieved through both capital appreciation (realized and unrealized) and current yield (interest and dividends). The Diocese targets a diversified asset allocation and instructs its fund managers to follow the Socially Responsible Investment Guidelines as promulgated by the United States Council of Catholic Bishops. Spending Policy and How the Investment Objectives Relate to Spending Policy The Diocese has a policy of appropriating for distribution each year up to 5 percent of the endowment funds average fair value over the prior year. In establishing this policy the Diocese considered the longterm expected return on its endowment. This policy is subject to periodic review and revision by the Diocesan Finance Council. NOTE 12 - FUTURE MINIMUM RENTAL INCOME In October 1987, the CAO entered into an 85-year lease which allowed the lessee to build and operate a continuing care retirement home on land owned by the CAO. First year base rent of $480,000 was paid in October Base rent of $600,000 was paid in October 1988, for the second year. Lease payments of $7,180,000 were received during Lease payments of $1,000,000 were received each October 1, from 1995 through The payments received in 1990 and later years are being recognized as income ratably (approximately $142,800 annually) over the remaining term of the lease. Amounts to be recognized in future periods are recorded as deferred revenue. Deferred revenue associated with the lease was $8,745,794 and $8,888,584 at June 30, 2011 and 2010, respectively. 25

28 NOTE 12 - FUTURE MINIMUM RENTAL INCOME (continued) The CAO is the lessor of certain other rental properties. Future minimum rental income from long-term non-cancelable operating leases as of June 30, 2011 is as follows: Year Ending June $ 264, , , , ,788 Thereafter 8,031,852 $ 9,044,298 Rental income recognized for 2011 and 2010 was $445,526 and $490,536, respectively. NOTE 13 - COMMITMENTS AND CONTINGENCIES The CAO conducts its operations in leased facilities under operating leases, including the facilities used by Christ the King Parish, the Records and Archives Center, ILM, the Clergy Retirement House, and some of the Seminarians. In addition to the minimum rental payments, the CAO must pay a proportionate share of the operating expenses of the facilities. Rent expense for the years ended June 30, 2011 and 2010 was $223,250 and $366,031, respectively. Future minimum rental payments are as follows (excluding operating expenses) Year Ending June $ 134, , , , ,000 Thereafter 176,667 $ 787,349 The accompanying statement of activities reflects rent expense on a straight-line basis over the term of the lease obligation with a difference between rent expense and rent paid of $2,228 for 2011 and $1,595 for

29 NOTE 13 - COMMITMENTS AND CONTINGENCIES (continued) The CAO has entered into several construction agreements on behalf of various parishes and schools. At June 30, 2011, total commitments are $2,390,822. The total amount expended as of June 30, 2011 on these commitments was $781,490. All expenditures incurred with respect to these construction agreements are expenditures of the various parishes and schools. The CAO is party to various other litigation matters in the normal course of business. Management believes that the resolution of these matters will not have a material adverse effect on the financial condition of the CAO. NOTE 14 - POSTRETIREMENT BENEFITS OTHER THAN PENSIONS The CAO sponsors a postretirement Medicare supplemental plan for retired priests who are eligible to receive Medicare. The plan pays medical costs not covered by Parts A and B of Medicare. The plan assumes that the priest has full Medicare coverage. In addition, the plan pays 90% of prescription drug costs. The maximum annual payout is $7,500. The plan also pays 90% of reasonable and customary charges for dental benefits, with a $35 deductible, and maximum benefits of $2,000 per year. The plan also pays vision benefits, with a $25 deductible on eye exams. An actuary performs an analysis of per capita claims costs and premiums on a calendar year basis. Since plan experience with regard to claims costs is limited due to the small size of the group, the actuary uses retiree premiums as the basis for estimating future claim costs. The CAO uses the accrual method of accounting for postretirement benefits based on actuarially determined costs to be recognized over the period the employee provides service to the CAO. Generally accepted accounting principles require entities to accrue for expected medical and other postretirement benefits over the years that the employees render the necessary service. Additionally, the CAO follows the disclosure provisions of generally accepted accounting principles that require additional employer disclosures about pension and other postretirement benefit plans. Contributions of $593,000 and $325,000 were made to the plan in the years ended June 30, 2011 and 2010 respectively. Benefit payments of $0 and $116,000 were made from the plan during the years ended June 30, 2011 and 2010, respectively. The Diocese expects to contribute $519,000 to the plan during the fiscal year ending June 30, Funded Status The following table sets forth the plan's funded status at June 30: Ended June 30, 2011 Ended June 30, 2010 Accumulated postretirement benefit obligation for service rendered to date $ (6,621,000) $ (6,006,000) Plan assets at fair value 3,392,000 2,307,000 Funded status as of end of year (3,229,000) (3,699,000) Liability for postretirement benefits $ (3,229,000) $ (3,699,000) 27

30 NOTE 14 - POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (Continued) Amounts recognized in the statement of financial position consisted of Ended June 30, 2011 Ended June 30, 2010 Noncurrent assets $ - $ - Current liabilities - - Noncurrent liabilities (3,229,000) (3,699,000) $ (3,229,000) $ (3,699,000) Amounts recognized in unrestricted net assets consisted of Ended June 30, 2011 Ended June 30, 2010 Net loss (gain) $ 2,501,000 $ 2,916,000 Net transition obligation (asset) - - $ 2,501,000 $ 2,916,000 Net Periodic Postretirement Benefit Cost The following items are the components of the net periodic postretirement benefit cost for the plan as a whole for the year ended June 30: Ended June 30, 2011 Ended June 30, 2010 Service cost-benefits earned during the period $ 218,000 $ 149,000 Interest cost on projected benefit obligation 320, ,000 Actual return on plan assets (507,000) (189,000) Net amortization and deferral 507, ,000 Net periodic postretirement benefit cost $ 538,000 $ 496,000 28

31 NOTE 14 - POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (Continued) Other changes in plan assets and benefit obligations recognized in unrestricted net assets: Ended June 30, 2011 Ended June 30, 2010 Net loss (gain) $ (270,000) $ 786,000 Prior service cost (credit) - - Amortization of loss (gain) (145,000) (118,000) Amortization of prior service cost (credit) - - Amortization of transition obligation - (44,000) Total recognized in unrestricted net assets $ (415,000) $ 624,000 Assumptions Total recognized in net periodic benefit cost and unrestricted net assets $ 123,000 $ 1,120,000 Assumptions Used to Determine Net Postretirement Benefit Cost Ended June 30, 2011 Ended June 30, 2010 Discount rate 5.60% 6.43% Expected long-term rate of return on assets 6.00% 6.00% Future Health Cost Inflation Rate 5.50% 5.50% Assumption Used to Determine Benefit Obligations at Year-End Ended June 30, 2011 Ended June 30, 2010 Discount rate 5.60% 5.43% Future Health Cost Inflation Rate 5.50% 5.50% 29

32 NOTE 14 - POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (Continued) Cash Flows Estimated Future Benefit Payments The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid from the Medicare supplement plan: Ending June 30 Annual 2012 $ 250, , , , , ,882,000 NOTE 15 PENSION PLANS The CAO uses the accrual method of accounting for pension benefits based on actuarially determined costs to be recognized over the period the employee provides service to the CAO. SFAS No. 87, Employer s Accounting for Pensions, requires entities to accrue for expected pension over the years that the employees render the necessary service. Additionally, the CAO follows the disclosure provisions of generally accepted accounting principles that require additional employer disclosures about pension and other postretirement benefit plans. 1. LAY EMPLOYEES The CAO participates in a defined benefit pension plan operated by the Diocese. All full-time lay employees are eligible. For employees hired before January 1, 2007, the plan provides benefits based on the highest final average salary and all years and months of service, counting partial months as whole months. For employees hired after January 1, 2007, the plan provides benefits based on an account balance that accumulates each year with pay credits and interest credits. Although the Diocese is exempt from the funding requirements of ERISA, it has been the Diocese s practice to make contributions annually to the plan that are not less than the pre-erisa minimum funding requirement as applicable to churches, and not in excess of the amount that could be deducted for federal income tax purposes, assuming the Diocese was not exempt from taxation. In general, it has been the policy of the Diocese to fund any unfunded past service liability over no more than 30 years. The CAO administers the plan and assesses each of the participating entities its portion of estimated annual pension cost. Contributions of $9,434,000 and $9,825,000 were made to the plan during the years ended June 30, 2011 and June 30, 2010, respectively. Benefit payments of $5,581,000 and $5,111,000 were made from the plan during the years ended June 30, 2011 and June 30, 2010, respectively. The Diocese expects to contribute $9,009,000 to the pension plan during the fiscal year ending June 30,

33 NOTE 15 PENSION PLANS (Continued) The fair values of the Diocesan Lay Pension Plan assets as of June 30, 2011 by asset category are as follows: Fair Value Measurements Asset Category Total Fair Value Quoted Prices (Level 1) Significant Observation Inputs (Level 2) Significant Unobservable Inputs (Level 3) Cash $ 447,860 $ 447,860 $ - $ - Cash Equivalents 3,299,976 3,299, Equity Securities US Large Cap 58,349,323 58,349, International Large Cap 1,080,590 1,080, Mutual Funds 9,413,821 9,413, Fixed Income Securities US Treasuries/Agencies 19,744,974 19,744, Corporate Bonds 2,674,195 2,674, Fixed Income 4,222,248 4,222, Accrued Income 339, , Total $ 99,572,717 $ 99,572,717 $ - $ - No one security in the plan represents more than 5% of total assets other than US Treasury Securities and the Fixed Income Security which is an exchange traded fund. 31

34 NOTE 15 PENSION PLANS (Continued) The amounts allocated to the CAO, Cemeteries and Holy Spirit School as of June 30, 2011 and June 30, 2010 are: Ended June 30, 2011 Ended June 30, 2010 Net amount of pension liability recognized at year-end CAO $ (4,247,000) $ (4,629,000) Cemeteries (1,900,000) (2,057,000) Holy Spirit School (2,328,000) (2,622,000) Net Periodic Pension Cost CAO (382,000) 977,000 Cemeteries (157,000) 428,000 Holy Spirit School (294,000) 754,000 Plan Contributions CAO 449, ,000 Cemeteries 191, ,000 Holy Spirit School 318, ,000 Plan Asset Investment Strategy and Allocation The asset allocation for the pension plan as of June 30, 2011 and June 30, 2010 and the target allocation, by asset category, are: Policy Policy Asset Benchmark Asset Actual Percentage of Plan Assets at June 30 Asset Category Allocation Range Allocation Equities Fixed Income Cash Equivalents 25-65% 25-50% 0-50% 60% 30% 10% 61% 35% 4% 56% 41% 3% 32

35 NOTE 15 PENSION PLANS (Continued) The Diocese has adopted an official Statement of Investment Policy for this plan. Pension plan assets are invested by an independent professional investment manager, with the objective of achieving long-term growth in assets with reasonable risk as compared to established benchmarks. The investment policy requires high quality investments and adequate diversification. Prohibited investments include options, short sale contracts and limited partnerships. The Diocese regularly monitors the investment manager s performance relative to short-term and long-term objectives as set forth in the official policy. A compliance audit of the managers adherence to policy guidelines is conducted as a component of each performance evaluation. The Statement of Investment Policy includes consideration for social responsibility and Roman Catholic social teaching. The Diocese employs a methodical process to determine the estimates of expected long-term rate of return on assets. These estimates are primarily driven by actual historical asset-class returns and advice from external actuarial and investment consulting firms while incorporating specific asset-class risk factors. For the fiscal years ending June 30, 2011 and June 30, 2010, the expected long-term rate of return used in determining net periodic pension cost was 7.75%. The assumptions used to determine the net periodic pension cost and benefit obligations for the fiscal years ending June 30, 2011 and June 30, 2010 are: Lay Retirement Plans Ending June 30, 2011 Ending June 30, 2010 For Net Periodic Pension Cost: Discount Rate Expected long-term rate of return on assets Salary scale For Benefit Obligation At Year End: Discount Rate Salary Scale 5.50% 7.75% 5.00% 5.65% 5.00% 6.55% 7.75% 5.00% 5.50% 5.00% 2. PRIESTS A. Retirement Plan The CAO also sponsors a defined benefit pension plan for all Diocesan priests who are ordained for or incardinated in the Diocese and in good standing and not on probation. The plan provides benefits based on a flat benefit prorated for years and months of service less than 35 years. Since the CAO is exempt from the funding requirements of ERISA, it has been the CAO s practice to make contributions annually to the plan based on actuarial principles. In general, it has been the CAO s policy to fund any unfunded past service liability over 30 years. 33

36 NOTE 15 PENSION PLANS (Continued) Contributions of $1,076,000 and $850,000 were made to the plan in the years ended June 30, 2011 and 2010 respectively, by the parishes, schools or other units to which the participating clergy were assigned. Benefit payments of $692,000 and $637,000 were made from the plan during the years ended June 30, 2011 and 2010, respectively. The Diocese expects to contribute $681,000 to the pension plan during the fiscal year ending June 30, The fair values of the Diocesan Clergy Pension Plan assets as of June 30, 2011 by asset category are as follows: Quoted Prices Significant Observable Inputs Significant Unobservable Inputs Asset Category Total Fair Value (Level 1) (Level 2) (Level 3) Cash $ 77,374 $ 77,374 $ - $ - Cash Equivalents 995, , Equity Securities US Large Cap 4,904,706 4,904, Mutual Funds 941, , Fixed Income Securities US Treasuries/Agencies 938, , Fixed Income 888, , Total $ 8,746,063 $ 8,746,063 $ - $ - No one security in the plan represents more than 5% of total assets other than US Treasury Securities and the Fixed Income Security which is an exchange traded fund. Plan Asset Investment Strategy and Allocation The asset allocation for the pension plan as of June 30, 2011 and June 30, 2010 and the target allocation, by asset category, are: Policy Policy Asset Benchmark Asset Actual Percentage of Plan Assets at June 30 Asset Category Allocation Range Allocation Equities Fixed Income Cash Equivalents 25-65% 25-60% 0-50% 60% 30% 10% 58% 30% 12% 57% 41% 2% 34

37 NOTE 15 PENSION PLANS (Continued) The Diocese has adopted an official Statement of Investment Policy for this plan. Pension plan assets are invested by an independent professional investment manager, with the objective of achieving long*term growth in assets with reasonable risk as compared to established benchmarks. The investment policy requires high quality investments and adequate diversification. Prohibited investments include options, short sale contracts and limited partnerships. The Diocese regularly monitors the investment manager s performance relative to short-term and long-term objectives as set forth in the official policy. A compliance audit of the managers adherence to policy guidelines is conducted as a component of each performance evaluation. The Statement of Investment Policy includes consideration for social responsibility and Roman Catholic social teaching. The Diocese employs a methodical process to determine the estimates of expected long-term rate of return on assets. These estimates are primarily driven by actual historical asset-class returns and advice from external actuarial and investment consulting firms while incorporating specific asset-class risk factors. For the fiscal years ending June 30, 2011 and June 30, 2010, the expected long-term rate of return used in determining net periodic pension cost was 7.5%. B. Supplemental Plan The CAO sponsors a nonqualified supplemental defined benefit pension plan for certain priests listed in the Appendix A and B of the plan document. Benefits for priests in Appendix A are based on the excess of their benefit calculated under the regular retirement plan with additional years of service over their actual retirement plan benefit. Benefits for priests in Appendix B are based on the excess of their benefit calculated according to the formula defined in Appendix B over their actual regular retirement plan benefit. Since the plan is exempt from the funding requirements of ERISA, it has been the CAO s practice to make contributions annually to the plan not less than that required to pay benefits for that year. Contributions of $181,000 and $825,000 were made to the plan in the years ended June 30, 2011 and 2010, respectively, by the parishes, schools or other units to which the participating clergy were assigned. Benefit payments of $224,000 and $206,000 were made from the plan during the years ended June 30, 2011 and 2010, respectively. The Diocese expects to contribute $0 to the pension plan during the fiscal year ending June 30, Plan Asset Investment Strategy and Allocation Plan assets for the supplemental plan are insufficient to necessitate an independent investment policy. As of June 30, 2011, 58% of plan assets were invested in equities, 27% in fixed income, 12% in cash and cash equivalents, and the balance in mutual funds. As of June 30, 2010, 1% of plan assets were invested in a balanced mutual fund and the balance in cash equivalents. 35

38 NOTE 15 PENSION PLANS (Continued) TABLE 1 FUNDED STATUS The funded status of the plans and the net amount recognized in the statement of financial position at June 30, 2011 and 2010 are as follows: Priests Retirement Plan Ending June 30, 2011 Ending June 30, 2010 Priests Supplemental Plan Ending Ending June 30, 2011 June 30, 2010 Vested benefit obligation $ (11,213,000) $ (10,312,000) $ (2,540,000) $ (1,989,000) Accumulated benefit obligation (11,559,000) (10,580,000) (2,564,000) (2,001,000) Projected benefit obligation $ (14,541,000) (13,281,000) (3,099,000) (2,361,000) Plan assets at fair value 6, ,005,000 2,462,000 2, Funding status of the Plan $ (8,257,000) $ (8,276,000) (637,000) $ 75,000 Net amount recognized $ (8,257,000) $ (8,276,000) $ (637,000 ) $ 75,000 Under generally accepted accounting principles, the funded status is recognized in the statement of financial position. Unrecognized prior service costs and unrecognized actuarial losses are recognized in unrestricted net assets. TABLE 2 AMOUNTS RECOGNIZED IN STATEMENT OF FINANCIAL POSITION The amounts recognized in the statement of financial position at June 30, 2011 and 2010 consist of: Priests Retirement Plan Ending June 30, 2011 Ending June 30, 2010 Priests Supplemental Plan Ending Ending June 30, 2011 June 30, 2010 Noncurrent Assets $ - $ - $ - $ 75,000 Noncurrent Liabilities (8,257,000) (8,276,000) (637,000 ) - Total $ (8,257,000) $ (8,276,000) $ (637,000 ) $ 75,000 36

39 NOTE 15 PENSION PLANS (Continued) TABLE 3 AMOUNTS RECOGNIZED IN UNRESTRICTED NET ASSETS The amounts recognized in unrestricted net assets at June 30, 2011 and 2010 consist of: Priests Retirement Plan Ending June 30, 2011 Ending June 30, 2010 Priests Supplemental Plan Ending Ending June 30, 2011 June 30, 2010 Net loss (gain) $ 2,388,000 $ 2,099,000 $ 2,222,000 $ 1,391,000 Net transition obligation (asset) Prior service cost (credit) 1,176,000 1,325, , ,000 Total $ 3,564,000 $ 3,424,000 $ 2,397,000 $ 1,589,000 TABLE 4 NET PERIODIC PENSION COST The following items are the components of the net periodic pension cost for the plan year ended June 30: Priests Retirement Plan Ending June 30, 2011 Ending June 30, 2010 Priests Supplemental Plan Ending Ending June 30, 2011 June 30, 2010 Service cost-benefits earned during the period $ 394,000 $ 308,000 $ - $ - Interest cost on projected benefit obligation 702, ,00 123, ,000 Actual return on plan assets (1,007,000) (468,000) (82,000 ) (23,000) Net amortization and deferral 828, ,000 44,000 22,000 Net periodic pension cost $ 917,000 $ 1,099,000 $ 85,000 $ 143,000 37

40 NOTE 15 PENSION PLANS (Continued) TABLE 5 OTHER CHANGES IN PLAN ASSETS AND BENEFIT OBLIGATIONS RECOGNIZED IN UNRESTRICTED NET ASSETS The amounts recognized in unrestricted net assets at June 30, 2011 and 2010 consisted of: Priests Retirement Plan Ending June 30, 2011 Ending June 30, 2010 Priests Supplemental Plan Ending Ending June 30, 2011 June 30, 2010 Net loss (gain) $ 334,000 $ 629,000 $ 913,000 $ 207,000 Prior service cost (credit) Amortization of loss (gain) (45,000) (16,000) (82,000) (73,000) Amortization of prior service cost (credit) (149,000) (149,000) (23,000) (36,000) Amortization of transition obligation - (182,000) - - Total recognized in unrestricted net assets $ 140,000 $ 282,000 $ 808,000 $ 98,000 Total recognized in net periodic benefit cost and unrestricted net assets $ 1,057,000 $ 1,381,000 $ 893,000 $ 241,000 TABLE 6 PRIEST PLAN ASSUMPTIONS Priests Retirement Plan Ending June 30, 2011 Ending June 30, 2010 Priests Supplemental Plan Ending Ending June 30, 2011 June 30, 2010 For Net Periodic Pension Cost: Discount Rate 5.43% 6.51% 5.43% 6.51% Expected long-term rate on return on assets 7.50% 7.50% 6.00% 6.00% Salary scale N/A N/A N/A N/A Future Benefit Increases 2.00% 2.00% 2.00% 2.00% For Benefit Obligation at Year End: Discount Rate 5.60% 5.43% 5.60% 5.43% Salary Scale N/A N/A N/A N/A Future Benefit Increases 2.00% 2.00% 2.00% 2.00% 38

41 NOTE 15 PENSION PLANS (Continued) TABLE 7 ESTIMATED FUTURE BENEFIT PAYMENTS Ending June Priests Retirement Plan (annual benefits) $816, , , , ,000 4,505,000 Priests Supplemental Plan (annual benefits) $238, , , , ,000 1,049,000 NOTE 16 - RELATED PARTY TRANSACTIONS The CAO performs various administrative services, including payroll processing, for various parishes and schools. Fees received for these services were $834,120 for the year ending June 30, 2011 and $821,071 for the year ending June 30, The CAO paid $190,256 in the fiscal year 2011 and $184,184 in the fiscal year 2010, net of restricted receipts from the rental of a piece of property, for the benefit of St. Joseph's Cathedral parish to support the operations of the Cathedral. The CAO, through the Deposit and Loan Funds, makes loans to eligible employees for amounts not exceeding $10,000 payable by automatic withdrawal over a term of 4 years. The loans are only for purposes indicated in the Employee Loan Policy. In FY 2009 the Diocese stopped making Employee Loans pending revision of the collections policy. The net amounts outstanding at June 30, 2011 were $110,405 and at June 30, 2010 were $206,105. The loan rates are the same as those charged for loans to parishes and schools. The CAO collects fees from schools and pays them to the Roman Catholic Communications Corporation of the Bay Area/Catholic Telemedia Network, a corporation of which the Diocese of San Jose is a member. Fees paid to CTN were $85,480 for the year ending June 30, 2011 and $85,438 for the year ending June 30, NOTE 17 - SELF-INSURED RISK As of July 1, 2006, the Diocese is self-insured with respect to its general liability coverage for the first $50,000 per case with an aggregate maximum exposure per year, coverage in excess of $50,000 is reinsured with non-affiliated insurers. For sexual abuse coverage, the Diocese has a larger per case deductible of $250,000 and has additional insurance through a risk retention group of which the Diocese is a minority owner. As of July 1, 2009 the Diocese is self-insured through a $25,000 deductible with respect to Crime and Fiduciary Liability coverage. As of July 1, 2006, the Diocese is self-insured through a $100,000 deductible per case with respect to its property all-risk coverage (excluding earthquake and flood). The Diocese is self-insured through a deductible of 5% per claim with a minimum of $100,000 with respect to its earthquake and catastrophic flood insurance coverage through its participation with three other California dioceses in a pooled agreement. 39

42 NOTE 17 - SELF-INSURED RISK (continued) Since January 1, 2006, the Diocese insures for worker's compensation through a fixed premium agreement with an unaffiliated insurer. The Diocese is also self-insured with respect to retired priest's medical costs. For all but the earthquake deductibles, monetary reserves are maintained to cover the probable self-insured exposure for the various insurance coverages. NOTE 18 SUBSEQUENT EVENTS Management of the Diocese has evaluated events and transactions subsequent to June 30, 2011 for potential recognition or disclosure in the financial statements. The Diocese did not have subsequent events that required recognition or disclosure in the financial statements for the year ended June 30, Subsequent events have been evaluated through the date the financial statements became available to be issued, October 27, The entity has not evaluated subsequent events after October 27,

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57 IN THE DIOCESE THE VALLEY CATHOLIC December 13, Diocese of San Jose financial report for fiscal year ending June 30, 2011 By Robert Serventi Chief Financial Officer The financial statements for the Central Administrative Offices (CAO) of the Diocese of San Jose measure the operating results for varied activities managed by the Diocesan Chancery and do not include results of operation of the parishes, of most schools nor of other entities in the Diocese. The financial statements of the CAO are audited and have received an unqualified opinion from the auditors Berger Lewis of San Jose. A complete copy of the audited financial statements for the fiscal year ended June 30, 2010 and additional schedules referred to in this report are available at financial-reports. Summary The $4,910,000 increase in net assets was a significant improvement from the $1,334,000 increase in the prior year. The cash flow statement shows a positive cash flow of $886,000, all from operations in the Chancery, Cemeteries and Holy Spirit School. While cash flow from operations increased over $6,073,000, $619,000 of that was used to purchase additional property for the Calvary Cemetery operations and increase securities. Another $1,675,000 was used to reduce notes and bonds payable and $2,934,000 to cover deposit withdrawals from the Deposit and Loan fund. These withdrawals funded projects in the parishes and schools. Total revenues for the year ended June 30, 2011 were $48,960,000, a nominal increase from the $48,223,000 of fiscal year All of the increase in gross revenues can be attributed to over $800,000 of non-recurring restricted donations received during the year. Total expenses for the year decreased $3,210,000 to $42,645,000 from $45,675,000. There were decreases in all expense categories with the most significant reduction of $1,275,000 in education costs due to a non-cash adjustment for lay pension fund liabilities of over $300,000 and other operational reductions at Holy Spirit School. Non-operational cost adjustments due to changes in the valuation of the SWAP liability and the accrued clergy THANKS FOR OPENING YOUR HEARTS TO OUR NEWEST PARISH, - OUR LADY OF REFUGE - YOU CAN STILL MAKE A DIFFERENCE AND DONATE TODAY. A complete copy of the audited financial statements for the fiscal year ended June 30, 2010 and additional schedules referred to in this report are available at pension fund liability combined for a $1,585,000 reduction in the net change in assets. The consolidated balance sheet of the CAO remains relatively strong with increases of over $4,000,000 in securities principally due to market valuation changes in those assets. While loans receivable from parishes and schools decreased $1,843,000, deposits payable to parishes and schools decreased $2,935,000 due to building projects in those locations funded from these deposits. All but $563,000 of the Change in Net Assets of $4,910,000 were for designated or restricted purposes. Looking Forward Fiscal year 2012 continues to be another difficult financial year for the Diocese. The financial markets continue in turmoil with valuation of securities lower than the prior year and the general economy continues weak. Interest rates on deposit accounts continue low in an effort to curtail the deficit in the Deposit and Loan Fund and to reflect changes in the marketplace for deposits. Continuing efforts are being made to restructure this Fund and some of the underlying assets to help those parishes and schools with debts to return to paying principal and interest. Due to non-or nominalpayment of large loans by three parishes, the D&L Fund continues to be unable to offer loans to other parishes. This fund is under review by the Diocesan Finance Council. The results of operations of just those programs funded by the ADA and Cathedraticum will be discussed in an article in the next edition of this newspaper. These programs account for less than 25 percent of the revenues of the consolidated operations reported in the CAO audit. However, great effort is being made by all the clergy and parishioners of the Diocese to provide those revenues, and so we will report back separately on the use of those funds.