Increased compensation, space and occupancy costs continued to drive up expenses for fiscal year 2004, the University announced yesterday in its annual report.

The report on Harvard’s fiscal year ending June 30, 2004, presented to the Board of Overseers by Vice President for Finance Ann E. Berman and Treasurer James F. Rothenberg, was approved on Sunday by the Board.

The University’s revenues and expenses both rose about 5 percent to $2.6 billion, yielding an operating surplus of $37 million. The previous year’s expenses increased 8 percent over fiscal year 2002.

Compensation expenses ballooned 6 percent to $1.3 billion, reflecting rising salary and wage costs, which increased 5 percent to reach over $1 billion for the first time. The report said the rise in salary costs resulted from raises and changes in pay, the addition of new personnel to carry out sponsored research and faculty hiring initiatives.

The University also attributed the compensation rise to increased benefits expenses, up 11 percent as the result of higher pension, health care and post-retirement welfare costs.

Compensation costs comprised 52 percent of the University’s expenses—the same share as the previous year, when benefits expenses shot up 36 percent resulting from similar costs.

Space and occupancy expenses rose by 9 percent to $262.6 million due to increased utility costs stemming from higher consumption and energy prices. The University also cited improvement and maintenance costs for new facilities, increased security spending, and temporary relocations during facility renovation.

The University also expanded its physical plant to 21.6 million square feet as it spent $410 million on 356 construction and renovation projects. While capital spending was down from last year’s $526 million total, Harvard moved forward in its efforts to establish an Allston campus by expanding its holdings there. In the last fiscal year Harvard acquired 104,000 square feet of land in Allston comprising five properties located among the University’s existing holdings.

Other capital projects included expansions of graduate student and affiliate housing; renovations to Loker Commons and the Malkin Athletic Center; construction of a new research building at the Longwood Medical Area; and a Science Center addition.

The report cited concerns about declining federal funding for research—last year’s annual report had anticipated “significantly lower” increases in government budgets for research grants.

But federally sponsored research support increased 14 percent, an even higher increase than that of the previous year. Government sponsors like the National Science Foundation, NASA, and the National Institutes of Health (NIH) all boosted their funding of Harvard research, even though the NIH did not see an increase in appropriations.

Non-federal research sponsorship, however, dropped 13 percent, in many cases due to declining investment performance.

Total gifts to the University for current use accounted for almost $239 million, down from $251 million in fiscal 2003; total gifts for capital jumped to $353 million from $311 million. The latter rise partly resulted from a dramatic increase in gifts from life income funds, a newly-approved investment arrangement where donors invest in Harvard’s endowment, receive a payout each year, and give their entire stake to Harvard upon their death.

Gifts to the Faculty of Arts and Sciences (FAS) for current use dropped 10 percent to $59.6 million from last year’s total of $66.4 million. FAS fundraising fell almost $20 million short of its projections at the end of February 2004, The Crimson reported in April.

The annual report anticipated the University’s concerns for fiscal year 2005 as growing retirement and health benefit costs, government research sponsorship, and the increasing necessity of financial aid.

Berman and Rothenberg were not available for comment.