Notes to Financial Statements BlackRock Index Equity Portfolio 1. Significant Accounting Policies: BlackRock Index Equity Portfolio (the “Portfolio”) is part of BlackRock Funds SM (the “Fund”).The Fund is registered under the Investment Company Act of 1940, as amended, as an open-end management investment company. Effective June 4, 2007, the Portfolio invests all of its assets in Master S&P 500 Index Series (the “Series”) of the Quantitative Master Series LLC, which has the same investment objective and strategies as the Portfolio. Prior to June 4, 2007, the Portfolio invested all of its assets in The U.S. Large Company Series (the “Master”) of The DFA Investment Trust Company, which had a similar investment objective and strategies as the Series.The value of the Portfolio’s investment in the Series reflects the Portfolio’s proportionate interest in the net assets of the Series.The performance of the Portfolio is directly affected by the performance of the Series.The financial statements of the Series as of December 31, 2006, including the Schedule of Investments, are included elsewhere in this report, as well as the unaudited Statement of Assets and Liabilities and Schedule of Investments as of September 30, 2007, and should be read in conjunction with the Portfolio’s financial statements.The Portfolio’s financial statements are prepared in conformity with U.S. generally accepted accounting principles, which may require the use of management accruals and estimates. Actual results may differ from these estimates.The percentage of the Series owned by the Portfolio at September 30, 2007 was 25.7%. The Portfolio offers multiple classes of shares. Institutional and Service Shares are sold only to certain eligible investors. Investor A Shares are sold with a front-end sales charge. Shares of Investor B and Investor C Shares may be subject to a contingent deferred sales charge. All classes of shares have identical voting, dividend, liquidation and other rights and the same terms and conditions, except that Service, Investor A, Investor B and Investor C Shares bear certain expenses related to the shareholder servicing of such shares, and Investor B and Investor C Shares also bear certain expenses related to the distribution of such shares. Each class has exclusive voting rights with respect to matters relating to its shareholder servicing and distribution expenditures (except that Investor B shareholders may vote on certain changes to the Investor A distribution plan). Income, expenses (other than expenses attributable to a specific class) and realized and unrealized gains and losses are allocated daily to each class based on its relative net assets. The following is a summary of significant accounting policies followed by the Portfolio. (a) Valuation of investments — The Portfolio records its investment in the Series at fair value. Valuation of securities held by the Series is discussed in Note 1(a) of the Series’ Notes to Financial Statements, which are included elsewhere in this report. (b) Investment income and expenses — The Portfolio records daily its proportionate share of the Series’, and previously the Master’s, income, expenses and realized and unrealized gains and losses. In addition, the Portfolio accrues its own expenses. Other operating expenses incurred by the Fund are prorated to the Portfolio on the basis of relative net assets. (c) Investment transactions — Investment transactions in the Series are accounted for on a trade date basis. (d) Income taxes — It is the Portfolio’s policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute substantially all of its taxable income to shareholders. Therefore, no federal income tax provision is required. (e) Recent accounting pronouncements — In July 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109.” FIN 48 prescribes the minimum recognition threshold a tax position must meet in connection with accounting for uncertainties in income tax positions taken or expected to be taken by an entity, including mutual funds, before being measured and recognized in the financial statements. Adoption of FIN 48 is required for the last net asset value calculation in the first required financial statement reporting period for fiscal years beginning after December 15, 2006. The impact on the Portfolio’s financial statements, if any, is currently being assessed. In September 2006, Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“FAS 157”), was issued and is effective for fiscal years beginning after November 15, 2007. FAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. At this time, management is evaluating the implications of FAS 157 and its impact on the Portfolio’s financial statements, if any, has not been determined. In addition, in February 2007, FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“FAS 159”), which is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of FAS 157. FAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. FAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. At this time, management is evaluating the implications of FAS 159 and its impact on the Portfolio’s financial statements, if any, has not been determined. BLACKROCK INDEX EQUITY PORTFOLIO SEPTEMBER 30, 2007 13 Notes to Financial Statements (continued) BlackRock Index Equity Portfolio 2. Transactions with Affiliates: For the period October 1, 2006 to June 3, 2007, the Portfolio entered into an Administration Agreement with PFPC Inc. (“PFPC”), an indirect, wholly owned subsidiary of The PNC Financial Services Group, Inc. (“PNC”), and BlackRock Advisors, LLC (“BlackRock”) (collectively, the “Administrator”), an indirect, wholly owned subsidiary of BlackRock, Inc. Effective June 4, 2007, the Portfolio entered into an Administration Agreement with BlackRock and State Street Bank and Trust Company (“State Street”). The Portfolio pays a monthly fee based upon the average daily value of net assets for the performance of administrative services (other than investment advice and related portfolio activities) necessary to the operation of the Portfolio. For such services, the Portfolio pays a monthly fee based upon the average daily net assets at the following annual rates: .075% of the first $500 million of average daily net assets; .065% of average daily net assets in excess of $500 million but not exceeding $1 billion; and .055% of average daily net assets in excess of $1 billion. In addition, each of the share classes is charged an administration fee based upon the average daily net assets of each respective class at the following rates: .025% of the first $500 million, .015% of the next $500 million and .005% of assets in excess of $1 billion. BlackRock contractually agreed to waive or reimburse fees or expenses until February 1, 2008 in order to limit expenses. This agreement is reviewed annually by the Portfolio’s Board of Trustees. The current expense limitation as a percentage of net assets are as follows: .18% for Institutional; .615% for Service; .785% for Investor A, and 1.24% for Investor B and Investor C. Merrill Lynch & Co., Inc. (“Merrill Lynch”) and PNC are principal owners of BlackRock, Inc. If in the following two years the operating expenses of a share class that previously received a waiver or reimbursement from BlackRock and the Fund are less than the expense limit for that share class, the share class is required to repay BlackRock and the Fund up to the amount of fees waived or expenses reimbursed under the agreement if: (1) the Portfolio of which the share class is a part has more than $50 million in assets, (2) BlackRock continues to be the Portfolio’s investment advisor and (3) the Board of the Fund approved the payments to BlackRock at the previous quarterly meeting. At September 30, 2007, the amounts subject to possible future reimbursement under the expense limitation agreement are as follows: Expiring Expiring Expiring Total Waivers January 31, January 31, January 31, Subject to 2008 2009 2010 Reimbursement $1,120,125 $ 131,162 $ 87,300 $ 1,338,587 Effective June 4, 2007, State Street became the custodian of the Portfolio. Previously, PFPC Trust Company (“PTC”), an indirect, wholly owned subsidiary of PNC, served as custodian for the Portfolio. For these services, each custodian received a custodian fee computed daily and paid monthly, based on a percentage of the average daily gross assets of the Portfolio. The fee was paid at the following rates: 0.0073% of the first $250 million of average gross assets, 0.006% of the next $250 million of average gross assets, 0.0056% of the next $250 million of average gross assets, 0.0048% of the next $250 million of average gross assets, and 0.004% of average gross assets in excess of $1 billion; plus per transaction charges and other miscellaneous fees incurred on behalf of the Portfolio. The Portfolio earned income on positive cash balances in demand deposit accounts that are maintained by PFPC on behalf of the Portfolio. The Portfolio earned income in the amount of $1,616 for the year ended September 30, 2007. The Portfolio has also entered into a Distribution Agreement and Distribution Plan with BlackRock Distributors, Inc. (“BDI”). BDI is an affiliate of BlackRock, Inc. Pursuant to the Distribution Plan adopted by the Portfolio in accordance with Rule 12b-1 under the Investment Company Act of 1940, the Portfolio pays the Distributor ongoing service and distribution fees. The fees are accrued daily and paid monthly at annual rates based upon the average daily net assets of the shares as follows: Service Distribution Fee Fee Service .15% — Investor A .15% — Investor B .15% .75% Investor C .15% .75% In addition, the Fund may pay brokers, dealers, financial institutions and industry professionals ( including PNC, Merrill Lynch and their affiliates) fees for the provision of personal services to shareholders. Pursuant to the written agreements, Merrill Lynch and Hilliard Lyons, an indirect, wholly owned subsidiary of PNC, provide the Portfolio with sub-accounting, recordkeeping, sub-transfer agency and other administrative services with respect to sub-accounts they service. For these services, each receives an annual fee per shareholder account which will vary depending on share class. For the year ended September 30, 2007, the Portfolio paid Merrill Lynch and Hilliard Lyons, $100,531 and $37,687, respectively, for these services. For the year ended September 30, 2007, BDI earned underwriting discounts and direct commissions and Merrill Lynch, Pierce, Fenner & Smith Incorporated, a wholly owned subsidiary of Merrill Lynch, and BDI earned dealer concessions on sales of the Portfolio’s Investor A Shares, which totaled $6,054. 14 BLACKROCK INDEX EQUITY PORTFOLIO SEPTEMBER 30, 2007 Notes to Financial Statements (continued) BlackRock Index Equity Portfolio For the year ended September 30, 2007, affiliates received contingent deferred sales charges of $530, $95,657 and $5,514 relating to transactions in Institutional, Investor B and Investor C Shares, respectively. BlackRock maintains a call center, which is responsible for providing certain shareholder services to the Portfolio, such as responding to shareholder inquiries and processing transactions based upon instructions from shareholders with respect to the subscription and redemption of Fund shares. During the year ended September 30, 2007, the following amounts have been accrued by the Portfolio to reimburse BlackRock for costs incurred running the call center, which are a component of the transfer agent fees in the accompanying Statement of Operations. Call Center Fees Institutional $ 4,235 Service $ 1,032 Investor A $ 15,768 Investor B $ 10,497 Investor C $ 13,302 PFPC is the Portfolio’s transfer agent. Certain officers and/or directors of the Fund are officers and/or directors of BlackRock, Inc. or its affiliates. 3. Capital Share Transactions: Net decrease in net assets derived from capital share transactions was $194,817,053 and $346,204,722 for the years ended September 30, 2007 and September 30, 2006, respectively. Transactions in capital shares for each class were as follows: Dollar Institutional Shares for the Year Ended September 30, 2007 Shares Amount Shares sold 15,182,132 $ 434,758,246 Shares issued to shareholders in reinvestment of dividends 56,212 1,568,893 Total issued 15,238,344 436,327,139 Shares redeemed (17,107,084) (488,875,217) Net decrease (1,868,740) $ (52,548,078) Dollar Institutional Shares for the Year Ended September 30, 2006 Shares Amount Shares sold 955,902 $ 23,257,157 Shares issued to shareholders in reinvestment of dividends 165,070 4,064,328 Total issued 1,120,972 27,321,485 Shares redeemed (7,830,961) (192,573,329) Net decrease (6,709,989) $(165,251,844) Dollar Service Shares for the Year Ended September 30, 2007 Shares Amount Shares sold 689,177 $ 19,281,423 Shares issued to shareholders in reinvestment of dividends 12,156 337,537 Total issued 701,333 19,618,960 Shares redeemed (1,238,485) (34,417,910) Net decrease (537,152) $ (14,798,950) Dollar Service Shares for the Year Ended September 30, 2006 Shares Amount Shares sold 845,168 $ 20,432,914 Shares issued to shareholders in reinvestment of dividends 43,124 1,052,554 Total issued 888,292 21,485,468 Shares redeemed (2,058,224) (49,352,600) Net decrease (1,169,932) $ (27,867,132) Dollar Investor A Shares for the Year Ended September 30, 2007 Shares Amount Shares sold 2,241,287 $ 62,047,128 Shares issued to shareholders in reinvestment of dividends 93,212 2,586,033 Total issued 2,334,499 64,633,161 Shares redeemed (3,888,674) (108,477,810) Net decrease (1,554,175) $ (43,844,649) Dollar Investor A Shares for the Year Ended September 30, 2006 Shares Amount Shares sold 2,091,839 $ 50,941,404 Shares issued to shareholders in reinvestment of dividends 174,089 4,268,174 Total issued 2,265,928 55,209,578 Shares redeemed (3,635,017) (88,267,151) Net decrease (1,369,089) $ (33,057,573) Dollar Investor B Shares for the Year Ended September 30, 2007 Shares Amount Shares sold 28,652 $ 761,184 Shares issued to shareholders in reinvestment of dividends 7,531 206,387 Total issued 36,183 967,571 Shares redeemed (1,724,332) (46,833,109) Net decrease (1,688,149) $ (45,865,538) Dollar Investor B Shares for the Year Ended September 30, 2006 Shares Amount Shares sold 84,414 $ 1,998,703 Shares issued to shareholders in reinvestment of dividends 21,081 506,521 Total issued 105,495 2,505,224 Shares redeemed (2,386,436) (56,934,677) Net decrease (2,280,941) $ (54,429,453) 15 BLACKROCK INDEX EQUITY PORTFOLIO SEPTEMBER 30, 2007 Notes to Financial Statements (concluded) BlackRock Index Equity Portfolio Dollar Investor C Shares for the Year Ended September 30, 2007 Shares Amount Shares sold $ 414,223 15,122 Shares issued to shareholders in reinvestment of dividends 420,558 15,356 Total issued 30,478 834,781 Shares redeemed (1,425,591) (38,594,619) Net decrease (1,395,113) $(37,759,838) Dollar Investor C Shares for the Year Ended September 30, 2006 Shares Amount Shares sold $ 714,172 29,731 Shares issued to shareholders in reinvestment of dividends 642,657 26,704 Total issued 56,435 1,356,829 Shares redeemed (2,813,536) (66,955,549) Net decrease (2,757,101) $(65,598,720) The Portfolio charges a 2% redemption fee on the proceeds (calculated at market value) of a redemption (either by sale or exchange) of Portfolio shares made within 30 days of purchase. The redemption fee is paid to the Portfolio and is intended to offset the trading costs, market impact and other costs associated with short-term trading into and out of the Portfolio. 4. Distributions to Shareholders: The tax character of distributions paid during the fiscal years ended September 30, 2007 and September 30, 2006 was as follows: 9/30/2007 9/30/2006 Distributions paid from: Ordinary income $9,424,997 $ 17,551,033 Total taxable distributions $9,424,997 $ 17,551,033 As of September 30, 2007, the components of accumulated earnings on a tax basis were as follows: Undistributed ordinary income — net $ 1,712,014 Undistributed long-term capital gains — net — Total undistributed earnings — net 1,712,014 Cumulative losses — net (193,983,076)* Unrealized gains — net 619,186,124** Total accumulated earnings — net $ 426,915,062 * As of the tax year end of November 30, 2006, the Portfolio had a net capital loss carryforward of $195,749,939, of which $78,150,703 expires in 2010, $117,169,455 expires in 2011 and $429,781 expires in 2013. This amount will be available to offset like amounts of any future taxable gains. ** The difference between book-basis and tax-basis net unrealized gains is attributable primarily to the tax deferral of income from the Master partnership and book/tax differences on contributed securities. 5. Short-Term Borrowings: The Portfolio, along with certain other funds managed by the Administrator and its affiliates, is a party to a $500,000,000 credit agreement with a group of lenders, which expires November 2007. The Portfolio may borrow under the credit agreement to fund shareholder redemptions and for other lawful purposes other than for leverage. The Portfolio may borrow up to the maximum amount allowable under the Portfolio’s current prospectus and statement of additional information, subject to various other legal, regulatory or contractual limits. The Portfolio pays a commitment fee of .06% per annum based on the Portfolio’s pro rata share of the unused portion of the credit agreement. Amounts borrowed under the credit agreement bear interest at a rate equal to, at each fund’s election, the federal funds rate plus .35% or a base rate as defined in the credit agreement. The Portfolio did not borrow under the credit agreement during the year ended September 30, 2007. 6. Subsequent Event: On November 14, 2007, the Board of Trustees approved a change in the Portfolio’s fiscal year end from September 30 to December 31. 16 BLACKROCK INDEX EQUITY PORTFOLIO SEPTEMBER 30, 2007 Report of Independent Registered Public Accounting Firm BlackRock Index Equity Portfolio To the Board of Trustees and Shareholders of BlackRock Funds SM : We have audited the accompanying statement of assets and liabilities of BlackRock Index Equity Portfolio (the “Portfolio”), one of the portfolios constituting BlackRock Funds SM (the “Fund”), as of September 30, 2007, and the related statement of operations for the year then ended, the statements of changes in net assets for each of the two years in the period then ended, and the financial highlights for each of the four years in the period then ended. These financial statements and financial highlights are the responsibility of the Fund’s management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. The financial highlights of the Portfolio for the year ended September 30, 2003 were audited by other auditors whose report, dated November 26, 2003, expressed an unqualified opinion on those financial highlights. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. The Fund is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Fund’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of BlackRock Index Equity Portfolio of BlackRock Funds SM as of September 30, 2007, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the four years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. Deloitte & Touche LLP Princeton, New Jersey November 29, 2007 Important Tax Information (Unaudited) All of the ordinary income distributions paid by BlackRock Index Equity Portfolio during the fiscal year ended September 30, 2007 qualify for the dividends received deduction for corporations and consist entirely of qualified dividend income for individuals.
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