University of California Required Communications to The Regents Committee on Compliance and Audit

www.pwc.com University of California Required Communications to The Regents Committee on Compliance and Audit June 30, 2011

October 12, 20111 Members of The Regents Committee on Compliance and Audit of the University of California: Annually, as part of our responsibilities under generally accepted auditing standards, we are required to communicate to you certain matters regarding the resultss and scope of our audits, the work that we conduct relative to internal control over financial reporting, as well as issues related to the accounting policies used by the University of Californiaa (the University ). In addition, our Firm requires that we communicate certain items beyond those required by professional standards. This document covers these required communications relating to the 2011 financial statements and our audits; and sets forth a brief summary of each item, as well as its applicability to the University. We plan to cover these items at the November meeting and would be pleased to respond to any questions that you might have. The matters raised in this report are only those which have come to our attention arising from, or relevant to, audit procedures performed that we believe should be brought to the attention of The Regents Committee on Compliance and Audit. Since audits are not designed to identify all matters of possible interest from a governance standpoint, the items discussedd here do not constitute a comprehensive record of all matters arising from our audit. This report is intended solely for the use of The Regents Committee on Compliance and Audit and management of the University of California, and is not for distribution to other parties. We look forward to meeting with you to present this report, address your questions and discusss any other matters of interest to you. Please feel free to contact Joan Murphy, Engagement Partner, at (415) 498-7690 with any questions you may have. Very truly yours, PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP, Three Embarcadero Center, San Francisco, CA 94111-40044 T: (415) 498 5000, F: (415) 498 7100, www.pwc.com/us

University of California Required Communications to The Regents Committee on Compliance and Audit Contents Required Communications to The Regents Committee on Compliance and Audit... 1 Appendix A Management Representation Letter... 19 THIS REPORT AND THE INFORMATION THAT IT CONTAINS ARE SOLELY FOR THE BENEFIT AND RESTRICTED USE OF THE COMMITTEE ON COMPLIANCE AND AUDIT OF THE UNIVERSITY OF CALIFORNIA BOARD OF REGENTS AND ARE NOT INTENDED TO BE USED OR RELIED UPON BY ANY OTHER PARTY. PwC

University of California Required Communications to The Regents Committee on Compliance and Audit Required Communications to The Regents Committee on Compliance and Audit Matter to be communicated Auditor s responsibility under Generally Accepted Auditing Standards Auditor s response Our audit of the consolidated financial statements of the University, including the separate audits of the University s Defined Benefit Retirement Plans, Retirement Savings Program and Health and Welfare Benefit Program (including the Retiree Health Benefit Trust), and the medical centers, is conducted in accordance with auditing standards generally accepted in the United States of America. We are required to communicate to you the responsibility undertaken by us in connection with an audit performed in accordance with generally accepted auditing standards, as well as the additional requirements under Government Auditing Standards. The auditor is responsible for forming and expressing an opinion about whether the financial statements that have been prepared by management with the oversight of those charged with governance are presented fairly, in all material respects, in conformity with generally accepted accounting principles. The auditor is responsible for conducting the audit in accordance with generally accepted auditing standards. Those standards require that the auditor obtain reasonable rather than absolute assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. Accordingly, a material misstatement may remain undetected. Also, an audit is not designed to detect error or fraud that is immaterial to the financial statements. An audit includes obtaining an understanding of internal control sufficient to plan the audit and to determine the nature, timing, and extent of audit procedures to be performed. Our audit is not designed to provide an expression of opinion on the University s internal control over financial reporting or to identify material weaknesses. The auditor is responsible for communicating significant matters related to the financial statement audit that are, in the auditor s professional judgment, relevant to the responsibilities of those charged with governance in overseeing the financial reporting process. We consider the University s internal control over financial reporting as a basis for designing our audit procedures for the limited purpose described above; our procedures may identify significant deficiencies or material weaknesses which we will report to you. Generally accepted auditing standards do not require the auditor to design procedures for the purpose of identifying other matters to communicate with those charged with governance. PwC 1

University of California Required Communications to The Regents Committee on Compliance and Audit Required Communications to The Regents Committee on Compliance and Audit Matter to be communicated Auditor s responsibility under Generally Accepted Auditing Standards Significant accounting policies, alternative treatments within generally accepted accounting principles, and the auditor s judgment about the quality of accounting policies Auditor s response Since the University is a recipient of federal funds, we also conduct our audit under Government Auditing Standards. Under those standards, we perform additional tests of the University s compliance with federal laws and regulations with the purpose of reporting on the University s compliance with and on internal controls related to federal programs. Although an audit under Government Auditing Standards involves additional tests of controls and transactions beyond that required under generally accepted auditing standards, it should not be assumed that this audit will meet the needs of all possible users of the financial statements. Additionally, when applicable, the auditor is also responsible for communicating particular matters required by laws or regulations, by agreement with the entity or by additional requirements applicable to the engagement. The auditor s responsibility under generally accepted auditing standards has also been communicated to management in our engagement letter dated March 25, 2011. We are responsible for providing our views about qualitative aspects of the University s significant accounting practices, including accounting policies, accounting estimates and financial statement disclosures. Generally accepted accounting principles provide for the University to make accounting estimates and judgments about accounting policies and financial statement disclosures. We have included discussion below in regards to: Any changes in significant accounting policies, including the application of new accounting pronouncements; The appropriateness of critical accounting policies to the particular circumstances of the entity. When acceptable alternative accounting policies exist, we have summarized the financial statement items that are affected by the choice of significant policies as well as information on accounting policies used by other entities; The effect of the timing of unusual or significant transactions; and The effect of new significant accounting policies to be adopted in future years. PwC 2

University of California Required Communications to The Regents Committee on Compliance and Audit Required Communications to The Regents Committee on Compliance and Audit Matter to be communicated Significant accounting policies, alternative treatments within generally accepted accounting principles, and the auditor s judgment about the quality of accounting policies Auditor s response Changes in Significant Accounting Policies During the year ended June 30, 2011, the University adopted Governmental Accounting Standards Board (GASB) Statement No. 59, Financial Instruments Omnibus, and GASB Statement No. 62, Codification of Accounting and Financial Reporting Guidance Contained in Pre-November 30, 1989 FASB and AICPA Pronouncements. Implementation of GASB No. 59, which updated existing standards regarding financial reporting and disclosure requirements of certain financial instruments and external investment pools, and No. 62, which formally incorporates certain pre November 1989 FASB standards as authoritative GASB guidance, had no effect on the University's net assets or changes in net assets for the years ended June 30, 2011 and 2010. In preparation of the 2011 financial statements management elected to make certain reclassifications to the 2010 financial statements to improve comparability. Management reclassified forward contracts on a to-be-announced basis held by the University and UCRS based upon recent GASB guidance. The reclassification was a decrease in investment derivatives and an increase in fixed or variable income securities in the notes to the financial statements for the University for $125 million and for UCRS for $870 million. In addition, management determined that certain cash flows for accounts receivable and doubtful accounts were being reported on a net basis. Management elected to revise the cash flows reported for changes in accounts receivable and allowance for doubtful accounts by $175 million to report the cash flows on a gross basis. There was no impact of this reclassification to cash used by operating activities. The effect on the prior period financial statements was not material for either of these reclassifications and they have been appropriately disclosed in the notes to the financial statements. There were no other significant changes in accounting policies or their application for the year ended June 30, 2011. Critical Accounting Policies The University s accounting policies are disclosed in the notes to the financial statements. Those which are most critical, sensitive or subject to judgment include: 1. The establishment of revenue, contractual and other reserves for the medical centers. PwC 3

University of California Required Communications to The Regents Committee on Compliance and Audit Required Communications to The Regents Committee on Compliance and Audit Matter to be communicated Significant accounting policies, alternative treatments within generally accepted accounting principles, and the auditor s judgment about the quality of accounting policies Auditor s response 2. The determination of charges to federal contracts, especially as they relate to indirect cost rates. 3. Estimation methods used to determine the fair value of nonreadily marketable securities. 4. Estimates used to determine the fair value of the OPEB obligation for retiree health benefits, obligation to the UCRP, the liability for workers compensation and other selfinsurance reserves. 5. Allowances established for uncollectible pledges or medical center receivables. 6. The determination of what entities are to be included as component units due to their significance and the nature of the University s relationship with the entity. 7. Treatment of related party transactions with the University, as applicable to the separately-issued financial statements of the foundations, medical centers, Retiree Health Benefit Trust, and UCRS. 8. Determination of capital vs. operating leases Generally accepted accounting principles require preparers of financial statements to determine the appropriate accounting treatment for all lease arrangements. The guidance for accounting for leases is complex. Where the University has leases that involve construction of facilities that serve its campuses, it must exercise significant judgment in making the determination of whether these leases are operating or capital. Capital leases require the asset and the related liability to be recorded on the University s statement of net assets. In considering our views on the quality of accounting policies selected, we should note that there are, in general, a few areas in which the University has a choice of alternatives. Some of the more significant areas in which there are alternatives include: 1. The order of charging restricted vs. unrestricted funds in this area, the University could use a specific order for applying charges to restricted vs. unrestricted funds, e.g., require that restricted funds be used first. The University does not currently dictate an order of use as it provides campuses with budgetary flexibility. Private universities subject to FASB standards are required to use restricted funds first and, as such, are more comparable with each other PwC 4

University of California Required Communications to The Regents Committee on Compliance and Audit Required Communications to The Regents Committee on Compliance and Audit Matter to be communicated Significant accounting policies, alternative treatments within generally accepted accounting principles, and the auditor s judgment about the quality of accounting policies Auditor s response than GASB universities. 2. Federal refundable loans GASB actually allows universities to present refundable loans as either liabilities or as part of net assets. The University presents refundable loans as liabilities, which we believe is preferable. 3. Perpetual trusts held by third parties there is diversity in practice as to the recording of irrevocable trusts held by third parties which provide that income is to be received by the University in perpetuity. The University records the estimated fair value of such trusts, which is preferable in our view; however, it should be noted that there is not a consistent view among preparers and the large accounting firms about whether these should be recorded. 4. Spending rate The University uses a spending rate that allows use of some appreciation from endowment investments. Use of a spending rate is consistent with the California Uniform Prudent Management of Institutional Funds Act (UPMIFA). Virtually all institutions in higher education use a spending rate. 5. Valuation of non-publicly traded investments The University reflects, where appropriate, non-publicly traded investments, such as private equities, absolute return funds and real estate, at estimated fair value. Depending on the type of non-readily marketable investment, the University determines fair value by using either March 31 or May 31 valuations, adjusted for cash receipts, cash disbursements and securities distributions through June 30. The University uses this valuation methodology since June 30 data is not available in order to prepare a timely closing. While a June cutoff date would be preferable, the University s treatment is very common in higher education and use of the June data would result in delays in the closing process. The University believes the carrying amount of these financial instruments is a reasonable estimate of fair value at June 30. Our audit did not identify any significant differences between June 30th values and those recorded in the financial statements. 6. Determination of what constitutes cash and cash equivalents for purposes of the cash flows statement The University has PwC 5

University of California Required Communications to The Regents Committee on Compliance and Audit Required Communications to The Regents Committee on Compliance and Audit Matter to be communicated Significant accounting policies, alternative treatments within generally accepted accounting principles, and the auditor s judgment about the quality of accounting policies Auditor s response defined cash as demand deposits, which is a conservative definition. An entity may include in its definition other instruments that have original maturities of less than 90 days. 7. University of California Retirement Plan (UCRP) benefits - The University s cost for the campus and medical centers, if any, is based upon the annual required pension cost to the UCRP, as actuarially determined. The annual required pension cost for the combined DOE laboratories is also actuarially determined, independently from the campuses and medical centers. Since the DOE has an ongoing financial responsibility for these costs, the University records a receivable from the DOE for any portion of the University s obligation to UCRP attributable to the DOE laboratories. 8. Retiree health benefits - The University s cost for the campus and medical centers is based upon the retiree health benefit cost, as actuarially determined. The retiree health benefit cost for LBNL is also actuarially determined, independently from the campuses and medical centers. As with UCRP benefits, since the DOE has an ongoing financial responsibility for these costs, the University records a receivable from the DOE for any portion of the University s obligation for retiree health benefits attributable to LBNL. We do not consider any of the accounting elections to be controversial or relating to emerging areas. All of these critical accounting policies are fully disclosed in the financial statements. Significant or Unusual Transactions State of California Assembly Bill (AB 1383) of 2009, as amended by AB 1653 on September 8, 2010, established a series of Medicaid supplemental payments funded through a Quality Assurance Fee and a Hospital Fee Program, which are imposed on certain California hospitals. The effective date of the Hospital Fee Program is April 1, 2009 through December 31, 2010 and is predicated, in part, on the enhanced Federal Medicaid Assistance Percentage (FMAP) contained in the American Reinvestment and Recovery Act (ARRA). The Hospital Fee Program makes supplemental payments to hospitals for various health care services and supports the state s effort to maintain PwC 6

University of California Required Communications to The Regents Committee on Compliance and Audit Required Communications to The Regents Committee on Compliance and Audit Matter to be communicated Significant accounting policies, alternative treatments within generally accepted accounting principles, and the auditor s judgment about the quality of accounting policies Auditor s response health care coverage for children. The University's Medical Centers, designated as public hospitals, are exempt from paying the Quality Assurance Fee; however, the Medical Centers received supplemental payments under the Hospital Fee Program. For the year ended June 30, 2011, the Medical Centers received $83 million, which has been reported as net patient service revenue included in the "Medical centers, net" financial statement line item and $143 million as a state grant which has been reported as non-operating revenue in the "State hospital fee grants" line item in the financial statements. In July 2011, the University issued General Revenue Bonds totaling $1.2 billion, including $550 million taxable fixed rate notes, $500 million taxable floating rate notes, and $150 million taxable variable rate demand bonds, in order to finance pension contributions to the UCRP, operating costs (on an interim basis), and issuance costs. This has been appropriately disclosed as a subsequent event in the notes to the financial statements. In September 2011, the University executed an agreement with the state to deposit $1 billion into the State Agency Investment Fund (SAIF). SAIF was created under California Government Code Section 16330. The deposit bears interest at 2% annually. The University is permitted to withdraw funds on the maturity date (April 25, 2013) or prior to the maturity date by giving ten days notice. This has been appropriately disclosed as a subsequent event in the notes to the financial statements. There were no other significant unusual transactions during the year ended June 30, 2011 related to financial reporting matters. New Accounting Pronouncements There were no new accounting pronouncements that were determined by management that significantly affected the University s 2011 financial statements. While several new pronouncements were adopted, none had a significant impact. These are discussed in the notes to the financial statements. Management judgments and accounting estimates As with any financial statements, the financial statements of the University contain judgments and estimates. We are required to communicate to you the process used by the University in PwC 7

University of California Required Communications to The Regents Committee on Compliance and Audit Required Communications to The Regents Committee on Compliance and Audit Matter to be communicated Management judgments and accounting estimates Auditor s response developing particularly sensitive accounting estimates, as well as our views thereon. In preparing its financial statements, University management makes judgments and estimates regarding provisions for, among other items, medical revenue, contractual allowances and uncollectible accounts, the fair value of contributions, the fair value of certain investments, provisions for self-insurance, provisions for UCRP and retiree health benefit obligations, depreciable lives for fixed assets and employee related costs. Estimates used by the University are based either on historical data, independent actuaries or, in the case of significant gifts, upon the University s independent estimate or internal analysis of fair value, together with consultations with appraisal firms, if considered necessary. We have reviewed the processes the University uses in developing these estimates and believe the processes are reasonable. Any estimates, however carefully developed, may differ materially from actual results. Moreover, certain of the estimates, such as medical center payer reserves, are subject to agreements with various third-party payers that have provisions for retroactive settlements and dispute resolution related to matters such as allowable costs, utilization and charge structure. Provisions have been made in the financial statements for prior and current years estimated settlements with the various third-party payers. Some of the more significant estimates inherent in the financial statements, together with their related amounts at June 30, 2011, include: Self-insurance reserves (workers compensation, professional liability, employee health and dental) $589 million Reserves for bad debts (applicable to all receivable balances, including pledges and notes and mortgages receivable) $353 million Reserves for medical center third party payer settlement liabilities - $155 million. These reserves represent amounts due principally to Medicare and Medi-Cal Fair values of certain non-readily marketable investments, such as $531 million and $3.1 billion in private equity partnerships held by the University and UCRS, respectively; and $1.6 billion and $2.8 billion in absolute return partnerships held by the University and UCRS, respectively PwC 8

University of California Required Communications to The Regents Committee on Compliance and Audit Required Communications to The Regents Committee on Compliance and Audit Matter to be communicated Management judgments and accounting estimates Audit adjustments Auditor s response Fair value of mortgage loans - $705 million held by the University Obligations to UCRP for pension benefits $1.7 billion for the University Obligations for retiree health benefits - $5.3 billion for the University During any reporting period, adjustments of these estimates, while likely not to be significant to the net assets of the University, may be significant to the change in net assets for the fiscal year. In connection with our audits, we are required to report to you any adjustments that we have proposed to the University which 1) have been recorded in the preparation of the financial statements and 2) have not been recorded but evaluated by us for materiality. In the course of our audits, we tracked adjustments in excess of the following amounts for each respective audit: University - $12 million (overall materiality is $242 million) UCRP - $21 million (overall materiality is $419 million) University of California PERS-VERIP - $34 thousand (overall materiality is $675 thousand) UCRSP, including the Defined Contribution Plan (the DC Plan), the Supplemental Defined Contribution Plan, the Tax-Deferred 403(b) Plan, and the 457(b) Deferred Compensation Plan - $8 million (overall materiality is $163 million) UCRHBT - $35 thousand (overall materiality is $698 thousand) UC Health and Welfare Department - $4 million (overall materiality is $74 million) Medical centers - ranges from $460 thousand to $1.4 million (overall materiality ranges from $9 million to $28 million) Items below these levels were not accumulated. There were no uncorrected misstatements in excess of any of the above levels for 2011. PwC 9

University of California Required Communications to The Regents Committee on Compliance and Audit Required Communications to The Regents Committee on Compliance and Audit Matter to be communicated Audit adjustments Auditor s response We proposed and University management recorded an audit adjustment related to the University's obligation for retiree health benefits. Effective in 2018, an excise tax on "Cadillac Plans" will apply as a result of the Patient Protection and Affordable Care Act. Healthcare insurers who offer plans with a higher cost than the excise threshold will be charged a 40% tax on the costs exceeding the threshold. It is assumed that these insurers will pass this additional cost onto the plan sponsors through an increase in the premiums. This assumption change increased the actuarial accrued liability for the UCRHBT by $440 million and increased the University's obligation for retiree health benefits by $50 million. A number of out-of-period and reclassification adjustments were identified by management. Refer to the summary of adjustments included as an attachment to the management representation letter included in the appendix to this report. The adjustments neither individually, nor in aggregate, are considered material to the financial statements requiring restatement of the 2010 financial statements. Potential effect on the financial statements of any significant risks, exposures and material uncertainties We are required to report to you significant risks and uncertainties related to the financial statements as well as material uncertainties, especially related to going concern matters. The items discussed below are focused on current issues that affect the financial statements and are not intended to represent all risks that apply to the University. The items below are disclosed in the financial statements, although we have added some additional discussion beyond what is contained in the financial statements to place these items in context. There are significant uncertainties and risks related to certain areas in which the University operates. As an operator of five academic medical centers, the University is subject to risks due to complex reimbursement regulations with varying interpretations. Amounts received by these hospitals are subject to audit and review by fiscal intermediaries and significant contingencies often result. As a recipient of federal awards, the University s revenue under grants and contracts is subject to annual audit under OMB Circular A-133, as well as reviews by its funding agencies. Moreover, due to the judgments necessary to charge amounts to PwC 10

University of California Required Communications to The Regents Committee on Compliance and Audit Required Communications to The Regents Committee on Compliance and Audit Matter to be communicated Potential effect on the financial statements of any significant risks, exposures and material uncertainties Control deficiencies Auditor s response federal awards, as well as the decentralized environment in which the University operates, it is reasonably possible that mischarges could occur. As an operator of LBNL, the University is subject to oversight by the DOE related to its charges and its management responsibilities in general. The University maintains a large investment portfolio and invests in both publicly traded and private investments. Declines in the market value of such investments could significantly impact the University and UCRS s financial position. The financial markets, both domestically and internationally, have been volatile in recent times and have affected the valuation of investments. The Regents utilizes asset allocation strategies that are intended to optimize investment returns over time in accordance with investment objectives and at levels of risk acceptable to The Regents. The University receives considerable support for its operations from both state and federal sources. Such support includes both direct state support for certain of its operations and facilities, financing through the State Public Works Board, federal student assistance and sponsored research. Changes in the amounts of such support, which may be out of the control of the University, could affect its ability to continue its programs at the same levels. Lastly, the University is subject to various other claims and contracts, some of which are currently in litigation. In those circumstances where management believes recording an accrual is appropriate and in accordance with generally accepted accounting principles, they have done so. We are required to report to you weaknesses in internal control which are either significant deficiencies or material weaknesses, both of which represent deficiencies in the design or operation of the internal control structure. The purpose of our audit was to express an opinion on the financial statements, but not to express an opinion on the effectiveness of the internal control over financial reporting; accordingly, we are not expressing such an opinion. Moreover, our audit did not include an audit of internal control over financial reporting similar to that required for public companies. PwC 11

University of California Required Communications to The Regents Committee on Compliance and Audit Required Communications to The Regents Committee on Compliance and Audit Matter to be communicated Control deficiencies Auditor s response A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct misstatements on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance. A material weakness is a deficiency, or a combination of deficiencies, in internal control such that there is a reasonable possibility that a material misstatement of the financial statements will not be prevented, or detected and corrected on a timely basis. We have completed our evaluation on whether any identified audit adjustments or deficiencies, individually or in aggregate, are to be classified as either significant deficiencies or material weaknesses. Our comments with respect to internal control are contained in management letters issued to the campuses, medical centers, foundations, retirement plans, health and welfare program and LBNL, as applicable. We have considered the individual deficiencies identified as well as in aggregation, and included these deficiencies in our Report to The Regents Committee on Compliance and Audit as warranted. We noted no material weaknesses as a result of our audits and the items contained therein are considered control deficiencies only. Other information in documents containing audited/reviewed financial information Our responsibility with respect to other information in documents containing audited financial statements is to consider whether its content or manner of presentation is materially inconsistent with the financial information covered by our report or whether it contains a material misstatement of fact. The University includes its financial statements in its Annual Financial Report and also in bond offering documents. The University also includes the financial statements for each of the medical centers in certain bond offerings. We read the University s Annual Financial Report and bond offering PwC 12

University of California Required Communications to The Regents Committee on Compliance and Audit Required Communications to The Regents Committee on Compliance and Audit Matter to be communicated Other information in documents containing audited/reviewed financial information Disagreements with management Consultation with other accountants Significant issues discussed, or subject to correspondence, with management prior to retention Auditor s response documents to ensure there are no material inconsistencies between the audited financial statements and the other information in the Annual Financial Report and the bond offering documents. In addition, the University prepares management s discussion and analysis (MD&A) and required supplemental information (RSI) surrounding the University s pension and retiree health plans. The MD&A and RSI are both supplemental information required by GASB. We read this information to make certain it is not inconsistent with the financial statements; however, this information is not audited. In cases where supplemental information, such as management s discussion and analysis, is included in financial statements submitted by the auditor, we are also required to include a reference in our opinion describing the supplemental information and our responsibility thereon. As such, each of the medical center separately-issued financial statements and the University of California Health & Welfare Program financial statements include a reference to required supplemental information and the fact we issue no opinion thereon. We are required to inform you of any instances of disagreement with management, whether or not satisfactorily resolved, about matters that are significant to the financial statements or the auditors report. There were no such instances of disagreement. If we become aware that the University has consulted with other accountants on significant accounting and auditing matters, disclosure or other items related to the financial statements, we would inform you of any such consultations. We are not aware of any such consultations with other accountants. No such issues were discussed with management. PwC 13

University of California Required Communications to The Regents Committee on Compliance and Audit Required Communications to The Regents Committee on Compliance and Audit Matter to be communicated Significant difficulties encountered during the audit Fraud and illegal acts Auditor s response No difficulties were encountered while performing our audit that require the attention of The Regents Committee on Compliance and Audit. We are required to ensure that you are informed of any instances of fraud we become aware of in the course of our audit, unless those matters are clearly inconsequential. We also are required to ensure that you are informed of any instances of illegal acts that come to our attention as part of our audit. Errors identified in connection with our audit are addressed in connection with recorded adjustments. The University has established policies and processes governing the reporting of all allegations and instances of misuse of University resources. The policies provide guidance and criteria for determination of matters to be reported in an annual report on compliance to the Office of the President. Any matters of significance are required to be reported to The Regents Committee on Compliance and Audit. There are also additional matters investigated by internal audit which are reported to The Regents, if significant. We have a responsibility to plan and perform our audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. In order to fulfill that responsibility, we performed the following procedures to address fraud: Conducted interviews with the Chair of the Regents Committee on Compliance and Audit, senior management, management, internal audit and other employees regarding the University s fraud risks and their knowledge of any fraudulent activity. Considered the fraud risk factors present for the board, senior management, management and employees to commit fraud, including key incentives, pressures and opportunities. Evaluated whether the University s programs and controls that address identified risks of misstatement due to fraud have been suitably designed and placed in operation. Incorporated unpredictability in the selection of the nature, timing and extent of audit procedures performed. Identified and selected journal entries and other adjustments for testing. PwC 14

University of California Required Communications to The Regents Committee on Compliance and Audit Required Communications to The Regents Committee on Compliance and Audit Matter to be communicated Fraud and illegal acts Other material written communications Other matters Auditor s response Performed disaggregated analytics, primarily over revenue. No irregularities, frauds or illegal acts involving neither senior management nor that would cause a material misstatement to the financial statements, came to our attention as a result of our audit procedures. In accordance with our engagement letter, we are obligated to provide The Regents Committee on Compliance and Audit with copies of all material written communications between us and the University. Those communications include summaries of waived and recorded adjustments, management representation letters, significant internal control recommendations, engagement letters, and any other substantive written communications. Attached to this document are discussions of out-of-period adjustments and the principal management representation letter. Please note that we receive multiple letters of representation for each of the campuses, medical centers, campus foundations, health and welfare program, retirement plans, etc. We have not provided you with copies of all of those letters, but we would be pleased to do so if desired. For the year ended June 30, 2011, we issued five Letters to Chancellors reporting local internal control recommendations. These are available upon request to The Regents Committee on Compliance and Audit. Independence We hereby re-confirm to The Regents that we are independent of the University under Rule 101 of the Code of Professional Conduct of the American Institute of Certified Public Accountants (AICPA) and the Government Accountability Office (GAO). From time to time, we may perform additional services for the University, which are subject to compliance with the rules set forth by The Regents, as well as the independence requirements of the AICPA and GAO. For the past fiscal year, those services have included the following: Performance of agreed upon procedures related to the University s reporting for NCAA rules, 415(m) plans and Mortgage Origination Program and Supplemental Home Loan Program. PwC 15

University of California Required Communications to The Regents Committee on Compliance and Audit Required Communications to The Regents Committee on Compliance and Audit Matter to be communicated Other matters Auditor s response Reviews in connection with bond offerings throughout the year. Report on the special purpose statement of income and expenses of the Revenue Bonds. Filing of applications with the India tax authority, and advising on specific tax and regulatory issues. All of these services are permissible services under The Regents standards for audit and non-audit services by The Regents external accounting firm and professional standards. Transparency in Reporting Transparency can be evaluated based upon, among other items, the clearness of disclosures, the adherence to the spirit of required disclosures, rather than meeting the minimum required, as well as the structuring of transactions, or lack thereof, to achieve particular accounting results. Although there are no objective standards by which transparency may be evaluated, we believe that the University has made appropriate disclosures in its financial statements, consistent with materiality standards, and that these disclosures are clear. Related party transactions We are required to report to you management s process for identifying related party transactions and discuss related party transaction disclosures. Management s process includes circulating the names of potentially related parties to the campuses and also reviewing disclosures in the financial statements for transactions with the State of California and affiliated entities, such as the campus foundations. The financial statements include disclosures of transactions with the state and also disclose that the University is a component unit of the state. The financials also disclose transactions with the campus foundations and the retirement system which are presented as separate elements of the basic financial statements. The separate financial statements of the medical centers, the campus foundations, the Health and Welfare Program and UCRS PwC 16

University of California Required Communications to The Regents Committee on Compliance and Audit Required Communications to The Regents Committee on Compliance and Audit Matter to be communicated Other matters Auditor s response all disclose transactions with the University as a related party. Certain transactions are not disclosed separately due to materiality. These include transactions with affiliates such as Hastings College of the Law and transactions with companies for which certain of The Regents may also be on the board. Scope of Services Reports Prepared as Part of Letter of Arrangement Opinions on the basic consolidated and fiduciary fund financial statements Opinions on the University of California Retirement System and Health and Welfare Program financial statements Opinions on the individual medical centers' financial statements Issuance of management letters to the individual Campuses and the Office of the President (as applicable) Required Communications with The Regents Committee on Compliance and Audit Issuance of the report on the special purpose statement of income and expenses of the Revenue Bonds Issuance of the NCAA agreed-upon procedures reports Issuance of all reports required under OMB Circular A- 133 Other Separate Recurring Audit Reports Agreed upon procedures related to sale of Mortgage Origination Program and Supplemental Home Loan Program loans Agreed upon procedures related to the 415(m) plans PwC 17

Appendix A Appendix A

Management Representation Letter PwC 19

Appendix A Summary of Out of Period Adjustments and 2010 Financial Statement Reclassifications In Thousands ($'000) Out of Period Adjustments UC Office of the President had a $55 million receivable from the State of California related to prior years. Since the early 1990s, the State has deferred payment until August of this amount, and the University has been improperly reporting a receivable from the State when the funds were not appropriated until the next fiscal year. This amount was reversed in 2011. UC Office of the President - Hastings College of the Law employees participate in UCRP and the University's retiree health program. The financial statement liabilities for these post-retirement benefits did not include the portion related to Hastings. Since the University has fiduciary responsibility for these plans, the obligations related to the Hastings employees was recorded in 2011. UCRP and retiree health obligations of $5 million and $7.1 million, respectively were recorded. UC Berkeley had previously underreported pledges receivable and corresponding revenue for pledges that were either unconditional in nature or the condition had already been met. In addition, deferred revenue was overstated for approximately $19 million. In 2011 the campus recorded $48 million in pledges receivable and revenue to correct this and reduced deferred revenue and recognized revenue for $19 million. UC Los Angeles campus had not properly recorded capital assets funded by the UCLA Medical Center. These errors occurred over several fiscal years and cumulatively, capital assets were understated by $50.4 million and accumulated depreciation was understated by $18.5 million, for a net effect of $33.6 million. The campus corrected these errors in 2011. UC Office of the President reclassified $126.2 million and $870.9 million of forward contracts on a to-be-announced basis held by the University and UCRS, respectively, to fixed or variable income securities from their 2010 financial statement presentation as investment derivatives. The revision impacted the notes to the financial statements only. UC Office of the President determined that certain cash flows for accounts receivable and doubtful accounts were being reported in the statement of cash flows on a net basis. In order to provide consistency in the 2011 and 2010 financial statements, management elected to revise the 2010 cash flows reported for changes in accounts receivable and the allowance for doubtful accounts by $174.7 million to report this cash flow activity on a gross basis. This revision had no impact on cash used by operating activities as the change was a reclassification within operating cash flows only. UC San Francisco campus inadvertently recorded the sale of a building in 2010 when a sale did not occur. The original cost of the building was $18.5 million; accumulated depreciation was $13.8 million, for a loss of $4.7 million. The recording of this transaction was reversed in 2011. UC Irvine campus combines the accounts of the Irvine Campus Housing Authority in their financial information. The entries to record this combination had not been recorded correctly by the campus for several years. The cumulative effect of recording the correcting entries in 2011 was to record an additional $19.4 million of revenues. ANR - As the University is the land grant organization for the State of California for the State's 4-H clubs, the 4-H clubs' financial activities should be combined in the University's financial statements. Accordingly, revenues of $5.5 million were recorded in the 2011 financial statements as a cumulative adjustment to prior years. All locations - Arts and collections assets totalling $7 million, which were not depreciated and are below the University's current capitalization thresholds, were written off in 2011. The UC Berkeley Foundation auditors identified adjustments to increase pledges recorded for $9.6 million and to decrease the fair value of investments for $2.1 million.

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