Diocese of Tucson

1. Organization

The Roman Catholic Church of the Diocese of Tucson (the "Diocese of Tucson" or the "Diocese") is a hierarchical religious organization governed by the Code of Canon Law of the Roman Catholic Church. Each office of the Diocese of Tucson performs specific functions in support of the Bishop's pastoral ministries and in support of the parishes and schools in the territory of the Diocese of Tucson. The offices include:

Office of the Bishop Tribunal

Chancellor's Office Formation

Vocations Catechesis

Human Resources Evangelization

Fiscal Services Catholic Schools

Property and Insurance Services Catholic Social Mission

Community Relations

2. Reorganization and Petition for Relief under Chapter 11

Significant claims of sexual abuse by clergy and others associated with the Diocese of Tucson created a material adverse effect on the Diocese of Tucson's ability to carry out its financial affairs, ministry and mission. Accordingly, on September 20, 2004, the Diocese of Tucson filed a petition for relief under Chapter 11 of the federal bankruptcy law in the United States Bankruptcy Court for the District of Arizona. Under Chapter 11, certain claims against the Diocese in existence prior to filing of the petition for relief under the federal bankruptcy laws are stayed while the Diocese continues operations as Debtor-in-Possession. These claims are reflected in the accompanying balance sheet as "liabilities subject to compromise". Claims secured against the Diocese of Tucson's assets are also stayed, although the holders of such claims have the right to move the court for relief from the stay. Secured claims are secured by a first priority lien on the Regina Cleri property.

The Diocese of Tucson received approval from the bankruptcy court to pay or otherwise honor certain of its prepetition obligations, including employee wages and fringe benefits. The Diocese of Tucson has determined there is sufficient collateral to cover the interest portion of its secured debt and has therefore accrued interest on that obligation.

The Diocese of Tucson filed a Plan of Reorganization (the "Plan") with the Bankruptcy Court which was confirmed on July 11, 2005 and became effective on September 20, 2005. This confirmed Plan provides for payment of all prepetition liabilities and the establishment of a Settlement Trust to distribute funds to tort claimants. Management's reorganization plan provides sufficient cash flow to allow the Diocese of Tucson to continue as a going concern once it emerges from bankruptcy proceedings.

3. Significant Accounting Policies

Basis of Presentation

The financial statements of the Diocese of Tucson have been prepared on the accrual basis of accounting in accordance with the standards of accounting and financial reporting as promulgated by the American Institute of Certified Public Accountants for Non-Profit Organizations.

The Diocese of Tucson presents its financial statements in accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 117, Financial Statements of Not-for-Profit Organizations. SFAS No. 117 establishes standards for external financial reporting by not-for-profit organizations. Resources are reported for accounting purposes in separate classes of net assets based on the existence or absence of donor-imposed restrictions. In the accompanying financial statements, net assets that have similar characteristics have been combined into similar categories as follows:

Significant Accounting Policies (continued)

- Permanently Restricted – Net assets that are subject to donor-imposed stipulations such that assets must be maintained permanently by the Organization. The donors of these assets permit the Organization to use all of the investment return of these assets in support of the Diocese’s ministries and mission.

- Temporarily Restricted – Net assets whose use by the Organization is subject to donor-imposed stipulations that can be fulfilled by actions of the Organization pursuant to those stipulations or that expire through the passage of time. All contributions are considered to be available for unrestricted use unless specifically restricted by the donor. Amounts received that are designated for future periods or restricted by the donor for specific purposes are reported as temporarily restricted support. However, if a restriction is fulfilled in the same time period in which the contribution is received, the Diocese of Tucson reports the support as unrestricted.

- Unrestricted – Net assets that are not subject to donor-imposed stipulations. Unrestricted net assets may be designated for specific purposes by action of the Board of Directors or may otherwise be limited by contractual agreements with outside parties.

Since the Diocese of Tucson had not emerged from bankruptcy at June 30, 2005, the accompanying financial statement was prepared in accordance with standards contained in AICPA Statement of Position 90-7, Financial Reporting by Entities in Reorganization under the Bankruptcy Code.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates.

Cash and Cash Equivalents

Cash and cash equivalents include all cash balances and highly liquid investments with an original maturity of three months or less. Cash and cash equivalents include short-term certificates of deposit and money market accounts which are stated at market value, which approximates cost.

The Organization places its cash and cash equivalents with high credit quality institutions. At times, such investments may be in excess of the FDIC insurance limit; however, management does not believe it is exposed to any significant credit risk on cash and cash equivalents.

Cash in Escrow - Restricted

Represents amounts held in escrow pursuant to property and land sales that closed as of June 30, 2005 to be used to fund a portion of the Diocese tort claimant settlement.

Accounts Receivable

Accounts receivable consist principally of uncollateralized amounts due from parishes and schools in the territory of the Diocese of Tucson. Management determines the allowance for doubtful accounts on a specific identification basis. Trade receivables are written off when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when received.

Investments

The Organization carries investments in marketable securities with readily determinable fair values and all investments in debt securities at their fair market values. Donated investments are recorded at fair market value at the date of donation.

Significant Accounting Policies (continued)

Land, Buildings and Equipment

Purchased fixed assets in excess of $1,000 are capitalized at cost. Depreciation is provided on a straight-line basis over the estimated useful lives of the related assets, which range from 3 to 40 years.

Donated Property and Equipment

Donations of property and equipment are recorded at their estimated fair market value at the date of donation. Such donations are reported as unrestricted support unless the donor has restricted the donated asset to a specific purpose. Assets donated with explicit restrictions regarding their use and contributions of cash that must be used to acquire property and equipment are reported as restricted support. The Organization reports expirations of donor restrictions when the donated or acquired assets are placed in service or as instructed by the donor. The Organization reclassifies temporarily restricted net assets to unrestricted net assets at the time the assets are placed in service.

Income Taxes

The Organization is exempt from federal income taxes under Section 501(c)(3) of the Internal Revenue Code and is also exempt from state income taxes. Accordingly, no provision is made for income taxes in the accompanying financial statements. Management is not aware of any matters which would cause the Organization to lose its tax-exempt status.

4. Investments

Investments consist of the following as of June 30, 2005:

5. Notes Receivable

Notes receivable consist of the following as of June 30, 2005:

6. Land, Buildings and Equipment

Land, buildings and equipment consist of the following as of June 30, 2005:

7. Escrow Agent Secured Claim

Represents amount due to escrow agent pursuant to a $3,000,000 promissory note dated March 25, 2002, pertaining to the 2002 settlement obligation. The note will be paid in full, without interest on the due date of the promissory note, January 24, 2007. As of June 30, 2005, the note has been discounted at an imputed rate of 6.75% and the discounted amount outstanding is $2,706,208 at June 30, 2005. This promissory note is collateralized by a first deed of trust that totaled $2,400,000 at June 30, 2005 (see Note 5) and is collateralized by a restricted cash account totaling $600,000.

8. Liabilities Subject to Compromise

Accounts Payable – Prepetition

Represents amounts due to various vendors and suppliers of goods and services incurred in the normal course of business as of September 20, 2004 (date of bankruptcy filing). Total amounts outstanding totaled $43,255 as of June 30, 2005.

Parish Loan Claims

Represent parish claims in the amount of their unrestricted deposits that were being held and managed by the Diocese of Tucson and unsecured loans made to the Diocese for the 2002 settlement. The funds will bear interest from and after the effective date at a rate of 2.5% annually and will be repaid in monthly principal and interest payments of $44,738 until paid in full. The balance of the unrestricted deposits and unsecured loans payable to the parishes is $6,962,867 at June 30, 2005. Pursuant to a settlement agreement between the Diocese and the parishes and approved by the Bankruptcy Court, the parishes made an aggregate withdrawal of its unrestricted deposits in the amount of $2,217,131 subsequent to year-end and prior to the effective date of its plan of reorganization.

General Unsecured Claims

Represent amounts due to the Catholic Order of Foresters and Arthur J. Gallagher & Co. Notes will bear interest from and after the effective date of the Plan at a rate of 4.5% annually with monthly principal and interest payments based on a 15 year amortization. The amounts due to the Catholic Order of Foresters and Arthur J. Gallagher & Co. at June 30, 2005 are $2,017,883 and $43,572, respectively.

Liability for Contribution to Settlement of Tort Claims

Represent all claims, demands, suits, causes of action, proceedings or any other rights or asserted rights to payment for, among other things, acts of sexual abuse committed by clergy or others associated with the Diocese of Tucson. Prior to the effective date of the Plan, in full discharge of the Diocese for all tort claims, the Diocese will establish the Settlement Trust and Litigation Trust which provide for liquidation of tort claims and payments of claims as and when they become allowed claims as defined in the Plan. The Settlement Trust and the Litigation Trust serve as the mechanisms to implement the Plan's treatment of the Settling and Non-Settling Tort Claims. The Trusts are responsible for issuing payments and disbursing funds, and assumed all liabilities of the Diocese of Tucson and Participating Third Parties.

As of June 30, 2005, pursuant to the Plan, the Diocese of Tucson has agreements in principle with Participating Third Parties in the amount of $2,210,000, of which the parishes represented $2,000,000, and with Settling Insurance Companies in the amount of $14,800,000 that will be transferred to the Trusts upon receipt of payment. Additionally, the Diocese of Tucson will fund $5,583,147 to the Trusts from the sale of real property.

Pursuant to the Plan, there is a sharing arrangement between the Diocese and the Settlement Trust, based on the aggregate amounts ultimately funded into the Settlement Trust. Funds that are shared with the Diocese are to be used for special projects as specified in the Plan including dealing with identification of sexual abuse, training and education of employees of the Diocese and other related Catholic entities within the territory of the Diocese. As of June 30, 2005 total amounts receivable from the Settlement Trust were $224,116 and are reported as a component of accounts receivable in the accompanying balance sheet.

9. Letter of Credit

The Diocese of Tucson has entered into agreements with a financial institution for a $300,000 letter of credit, collateralized by certificates of deposits, issued in favor of the Industrial Commission of Arizona pursuant to its workers compensation self-insurance program (see Note 13). No amounts were outstanding as of June 30, 2005.

10. Retirement Plans

Lay Employees Pension Plan

The Diocese of Tucson participates in a non-contributory multi-employer defined benefit pension plan. The plan was established July 1, 1983 and covers all eligible lay employees of the Diocese of Tucson and affiliated organizations.

The Organization's policy is to fund accrued pension costs currently. The plan is currently under funded; however, information is not available from the plan to allow the Organization to determine its share of funded or unfunded vested benefits.

403(b) Plan

On March 1, 2003, the Diocese of Tucson adopted a 403(b) qualified defined contribution plan. Employees are eligible for plan participation on their date of hire and contribute to the plan through salary deferrals. Employees are eligible to receive employer contributions upon completion of two years of continuous service. Employer contributions are equal to 25% of the employee's contribution up to a maximum of $1,000 annually. Employees are 100% vested in employee and employer contributions at all times.

11. Temporarily Restricted Net Assets

Temporarily restricted net assets consist of the following as of June 30, 2005:

12. Permanently Restricted Net Assets

Permanently restricted net assets consist of the following as of June 30, 2005:

Permanently restricted net assets are included in cash and cash equivalents and investments in the accompanying balance sheet.

13. Commitments and Contingencies

At June 30, 2005, the Diocese of Tucson administrative offices were leased under an operating lease agreement that expires in June 2053. Monthly lease expense total $13,623 and have annual inflationary adjustment clauses. The lease requires the Diocese of Tucson to pay property taxes, insurance, and normal maintenance and repair costs.

The Diocese is self-insured for workers' compensation, property and crime claims. The self-insured retention is $50,000 for both property and crime and $75,000 for workers' compensation per claim. The Diocese has obtained insurance coverage for claims in excess of the individual claim retention limits and annual aggregates of $175,000, for workers compensation claims, and $450,000 for property and crime claims. A portion of the insurance coverage is provided by BPIC (Bishops Plan Insurance Corporation), a captive insurance company in which the Diocese had an interest, which totaled $80,850 at June 30, 2005.