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NOTE A - SUMMARY OF ACCOUNTING POLICIES
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Dec. 31, 2011
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| Significant Accounting Policies [Text Block] |
NOTE
A – SUMMARY OF ACCOUNTING POLICIES
A
summary of the significant accounting policies applied in the
preparation of the accompanying consolidated financial
statements follows.
Business
and Basis of Presentation
Telkonet,
Inc., (the “Company”) formed in 1999 and
incorporated under the laws of the state of Utah, has evolved
into a Clean Technology company that develops, manufactures
and sells proprietary energy efficiency and SmartGrid
networking technology. Prior to January 1, 2007, the Company
was primarily engaged in the business of developing,
producing and marketing proprietary equipment enabling the
transmission of voice and data communications over a
building’s internal electrical wiring.
In
March 2007, the Company acquired substantially all of the
assets of Smart Systems International (“SSI”), a
leading provider of energy management products and solutions
to customers in the United States and Canada.
In
March 2007, the Company acquired 100% of the outstanding
membership units of EthoStream, LLC, a network solutions
integration company that offers installation, sales and
service to the hospitality industry. The EthoStream
acquisition enabled Telkonet to provide installation and
support for Power Line Carrier (PLC) products and third party
applications to customers across North America.
In
March 2011, the Company sold all its Series 5 PLC product
line assets to Wisconsin-based Dynamic Ratings, Inc.
(“Dynamic Ratings”) under an Asset Purchase
Agreement.
The
consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries, Telkonet
Communications, Inc., and EthoStream, LLC. All significant
intercompany transactions have been eliminated in
consolidation.
Going
Concern
The accompanying consolidated
financial statements have been prepared in conformity with
accounting principles generally accepted in the United States
of America, which contemplate continuation of the Company as
a going concern. The Company reported a net loss of
$1,902,239 for the year ended December 31, 2011, an
accumulated deficit of $118,344,196 and total current
liabilities in excess of current assets of $774,915 as of
December 31, 2011.
We
continue to experience net operating losses and deficits in
cash flows from operations. Our ability to
continue as a going concern is subject to our ability to
generate a profit and/or obtain necessary funding from
outside sources, including by the sale of our securities or
assets, or obtaining loans from financial institutions, where
possible. Our continued net operating losses and
the uncertainty regarding contingent liabilities cast doubt
on our ability to meet such goals and the Company cannot make
any representations for fiscal 2012 and beyond. The
accompanying consolidated financial statements do not include
any adjustments that might result from the outcome of these
uncertainties.
The
Company believes that anticipated revenues from operations
will be insufficient to satisfy its ongoing capital
requirements for at least the next 12 months. If
the Company’s financial resources from operations are
insufficient, the Company will require financing in addition
to the funds received from the sale of the Series 5 product
line in order to execute its operating plan and continue as a
going concern. The Company cannot predict whether this
additional financing will be in the form of equity or debt,
or be in another form. The Company may not be able to obtain
the necessary additional capital on a timely basis, on
acceptable terms, or at all. In any of these
events, the Company may be unable to implement its current
plans for expansion, repay its debt obligations as they
become due, or respond to competitive pressures, any of which
circumstances would have a material adverse effect on its
business, prospects, financial condition and results of
operations.
Management intends
to review the options for raising capital including, but not
limited to, through asset-based financing, private
placements, and/or disposition. Management
believes that with this financing, the Company will be able
to generate additional revenues that will allow the Company
to continue as a going concern. There can be no
assurance that the Company will be successful in obtaining
additional funding.
Concentrations
of Credit Risk
Financial
instruments and related items, which potentially subject the
Company to concentrations of credit risk, consist primarily
of cash, cash equivalents and trade receivables. The Company
places its cash and temporary cash investments with credit
quality institutions. At times, such investments may be in
excess of the FDIC insurance limit.
Cash and Cash Equivalents
For
purposes of the Statements of Cash Flows, the Company
considers all highly liquid debt instruments purchased with
an original maturity date of three months or less to be cash
equivalents.
Restricted
Cash on Deposit
During
the third quarter of 2011, the Company was awarded a contract
that contained a bonding requirement. The Company
satisfied this requirement with cash collateral supported by
an irrevocable standby letter of credit in the amount of
$91,000, which expires September 30, 2012. The
amount is presented as restricted cash on deposit on the
consolidated balance sheets.
Accounts
Receivable
The
Company records allowances for doubtful accounts based on
customer-specific analysis and general matters such as
current assessment of past due balances and economic
conditions. The Company writes off accounts
receivable when they become uncollectible. The
allowance for doubtful accounts was $115,400 and $175,000 at
December 31, 2011 and 2010, respectively. Management
identifies a delinquent customer based upon the delinquent
payment status of an outstanding invoice, generally greater
than 30 days past due date. The delinquent account
designation does not trigger an accounting transaction until
such time the account is deemed uncollectible. The allowance
for doubtful accounts is determined by examining the reserve
history and any outstanding invoices that are over 30 days
past due as of the end of the reporting
period. Accounts are deemed uncollectible on a
case-by-case basis, at management’s discretion based
upon an examination of the communication with the delinquent
customer and payment history. Typically, accounts
are only escalated to “uncollectible” status
after multiple attempts have been made to communicate with
the customer.
Property
and Equipment
In
accordance with ASC 360, property and equipment is stated at
cost and is depreciated using the straight-line method over
the estimated useful lives of the assets. The estimated
useful life ranges from 2 to 10 years.
Fair
Value of Financial Instruments
The
Company accounts for the fair value of financial instruments
in accordance with Accounting Standards Codification (ASC)
820, which defines fair value for accounting purposes,
established a framework for measuring fair value and expanded
disclosure requirements regarding fair value
measurements. Fair value is defined as an exit
price, which is the price that would be received upon sale of
an asset or paid upon transfer of a liability in an orderly
transaction between market participants at the measurement
date. The degree of judgment utilized in measuring
the fair value of assets and liabilities generally correlates
to the level of pricing observability. Financial
assets and liabilities with readily available, actively
quoted prices or for which fair value can be measured from
actively quoted prices in active markets generally have more
pricing observability and require less judgment in measuring
fair value. Conversely, financial assets and
liabilities that are rarely traded or not quoted have less
price observability and are generally measured at fair value
using valuation models that require more
judgment. These valuation techniques involve some
level of management estimation and judgment, the degree of
which is dependent on the price transparency of the asset,
liability or market and the nature of the asset or
liability. We have categorized our financial
assets and liabilities that are recurring, at fair value into
a three-level hierarchy in accordance with these
provisions.
The
following method and assumptions were used to estimate the
fair value of each class of financial instruments:
“Accounts
receivable, accounts payable and current portion of long-term
debt.” The carrying amount of these
items approximate
fair value.
“Long-term
debt.” The fair value of long-term debt is
determined by a comparison of current rates for similar debt
with the
same remaining maturities. The Company also considers credit
worthiness in determining the fair value of its
long-term
debt.
Goodwill
and Other Intangibles
In
accordance with the accounting guidance on goodwill and other
intangible assets, we perform an annual impairment test of
goodwill at our reporting unit level and other intangible
assets at our unit of account level, or more frequently if
events or circumstances change that would more likely than
not reduce the fair value of our reporting units below their
carrying value. Amortization is recorded for other
intangible assets with determinable lives using the straight
line method over the 12 year estimated useful life. Goodwill
is subject to a periodic impairment assessment by applying a
fair value test based upon a two-step method. The
first step of the process compares the fair value of the
reporting unit with the carrying value of the reporting unit,
including any goodwill. We utilize a discounted
cash flow valuation methodology to determine the fair value
of the reporting unit. This approach is developed
from management’s forecasted cash flow
data. If the fair value of the reporting unit
exceeds the carrying amount of the reporting unit, goodwill
is deemed not to be impaired. If the carrying
amount exceeds fair value, we calculate an impairment
loss. Any impairment loss is measured by comparing
the implied fair value of goodwill to the carrying amount of
goodwill at the reporting unit, with the excess of the
carrying amount over the fair value recognized as an
impairment loss.
Long-Lived
Assets
We
review long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of
an asset may not be recoverable in accordance with ASC
360-10. Recoverability is measured by comparison of the
carrying amount to the future net cash flows which the assets
are expected to generate. If such assets are
considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the
assets exceeds the projected future cash flows arising from
the asset determined by management to be commensurate with
the risk inherent to our current business model.
Inventories
Inventories
consist of routers, switches and access points for
Ethostream’s internet access solution and thermostats,
sensors and controllers for Telkonet’s EcoSmart product
suite. Inventories are stated at the lower of cost
or market determined by the first in, first out (FIFO)
method.
Deferred
Financing Costs
Deferred
financing costs were amortized under the straight-line method
over the term of the related indebtedness and included in
interest expense in the accompanying consolidated statements
of operations.
Income
(Loss) per Common Share
The
Company computes earnings per share under ASC 260-10,
Earnings Per Share. Basic net loss per common share is
computed by dividing net loss by the weighted average number
of shares outstanding of common stock. Diluted loss per
share is computed using the weighted average number of common
and common stock equivalent shares outstanding during the
period. There is no effect on diluted loss per share
since the common stock equivalents are
anti-dilutive. Dilutive common stock equivalents consist
of shares issuable upon the exercise of the Company's
outstanding stock options and warrants.
Use of
Estimates
The
preparation of financial statements in conformity with
generally accepted accounting principles requires management
to make estimates and assumptions that affect certain
reported amounts and disclosures. Accordingly,
actual results could differ from those estimates.
Income
Taxes
The
Company accounts for income taxes in accordance with ASC
740-10 “Income Taxes.” Under this method,
deferred income taxes (when required) are provided based on
the difference between the financial reporting and income tax
bases of assets and liabilities and net operating losses at
the statutory rates enacted for future periods. The Company
has a policy of establishing a valuation allowance when it is
more likely than not that the Company will not realize the
benefits of its deferred income tax assets in the
future.
The
Company adopted ASC 740-10-25, which prescribes a recognition
threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. ASC 740-10-25 also
provides guidance on derecognition, classification, treatment
of interest and penalties, and disclosure of such
positions.
The
Company also accounts for the uncertainty in income taxes
related to the recognition and measurement of a tax position
taken or expected to be taken in an income tax return. The
Company follows the applicable pronouncement guidance on
derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition
related to the uncertainty in these income tax positions.
Revenue
Recognition
For
revenue from product sales, we recognize revenue in
accordance with ASC 605-10, and ASC Topic 13 guidelines that
require that four basic criteria must be met before revenue
can be recognized: (1) persuasive evidence of an arrangement
exists; (2) delivery has occurred; (3) the selling price is
fixed and determinable; and (4) collectability is reasonably
assured. Determination of criteria (3) and (4) are
based on management’s judgments regarding the fixed
nature of the selling prices of the products delivered and
the collectability of those amounts. Provisions
for discounts and rebates to customers, estimated returns and
allowances, and other adjustments are provided for in the
same period the related sales are recorded. We
defer any revenue for which the product has not been
delivered or is subject to refund until such time that we and
the customer jointly determine that the product has been
delivered or no refund will be required. The
guidelines also address the accounting for arrangements that
may involve the delivery or performance of multiple products,
services and/or rights to use assets.
We
provide call center support services to properties installed
by us and also to properties installed by other providers. In
addition, we provide the property with the portal to access
the Internet. We receive monthly service fees from such
properties for our services and Internet access. We recognize
the service fee ratably over the term of the contract. The
prices for these services are fixed and determinable prior to
delivery of the service. The fair value of these services is
known due to objective and reliable evidence from contracts
and standalone sales. We report such revenues as
recurring revenues.
Total
revenues do not include sales tax as we consider ourselves a
pass through conduit for collection and remitting sales
tax.
Guarantees
and Product Warranties
ASC
460-10, Guarantees, requires that upon issuance of a
guarantee, the guarantor must disclose and recognize a
liability for the fair value of the obligation it assumes
under that guarantee. The Company’s guarantees were
issued subject to the recognition and disclosure requirements
of ASC 460-10 as of December 31, 2011 and 2010.
The
Company records a liability for potential warranty claims in
cost of sales at the time of sale. The amount of the
liability is based on the trend in the historical ratio of
claims to sales, the historical length of time between the
sale and resulting warranty claim, new product introductions
and other factors. The products sold are generally covered by
a warranty for a period of one year. In the event the Company
determines that its current or future product repair and
replacement costs exceed its estimates, an adjustment to
these reserves would be charged to earnings in the period
such determination is made. For the years ended December 31,
2011 and 2010, the Company experienced returns of
approximately 2% to 8% material cost of sales. For the years
ended December 31, 2011 and 2010, the Company recorded
warranty liabilities in the amount of $104,423 and $100,293,
respectively, using this experience factor range.
Product
warranties for the years ended December 31 is as
follows:
Advertising
The
Company follows the policy of charging the costs of
advertising to expenses as incurred. The Company incurred
$9,577 and $15,257 in advertising costs during the years
ended December 31, 2011 and 2010, respectively.
Research
and Development
The
Company accounts for research and development costs in
accordance with the ASC 730-10, Research and Development.
Under ASC 730-10, all research and development costs must be
charged to expense as incurred. Accordingly, internal
research and development costs are expensed as incurred.
Third-party research and development costs are expensed when
the contracted work has been performed or as milestone
results have been achieved. Company-sponsored research and
development costs related to both present and future products
are expensed in the period incurred. Total expenditures on
research and product development for 2011 and 2010 were
$775,329 and $1,130,383, respectively.
Stock
Based Compensation
We
account for our stock based awards in accordance with ASC
718-10, Compensation, which requires a fair value measurement
and recognition of compensation expense for all share-based
payment awards made to our employees and directors, including
employee stock options and restricted stock awards. We
estimate the fair value of stock options granted using the
Black-Scholes valuation model. This model requires us to make
estimates and assumptions including, among other things,
estimates regarding the length of time an employee will hold
vested stock options before exercising them, the estimated
volatility of our common stock price and the number of
options that will be forfeited prior to vesting. The fair
value is then amortized on a straight-line basis over the
requisite service periods of the awards, which is generally
the vesting period. Changes in these estimates and
assumptions can materially affect the determination of the
fair value of stock-based compensation and consequently, the
related amount recognized in our consolidated statements of
operations.
The
expected term of the options represents the estimated period
of time until exercise and is based on historical experience
of similar awards, giving consideration to the contractual
terms, vesting schedules and expectations of future employee
behavior. For 2011 and prior years, expected stock price
volatility is based on the historical volatility of the
Company’s stock for the related vesting periods.
Stock-based compensation expense in
connection with options granted to employees for the twelve
months ended December 31, 2011 and 2010 was $26,887
and $132,386,
respectively.
Deferred
Lease Liability
Rent
expense is recorded on a straight-line basis over the term of
the lease. Rent escalations and rent abatement periods during
the term of the lease create a deferred lease liability which
represents the excess of cumulative rent expense recorded to
date over the actual rent paid to date.
Lease
Abandonment
On
July 15, 2011, the Company executed a sublease agreement for
approximately 12,000 square feet of commercial office space
in Germantown, Maryland. The subtenant has the option to
extend the sublease from January 31, 2013 to December 31,
2015. Because we no longer have access to this subleased
space, we have recorded a charge of $59,937 in accrued
liabilities and expenses related to this abandonment. The
remaining liability at December 31, 2011 is $46,825.
Reclassifications
Certain
amounts previously reported have been reclassified to conform
to the current year presentation.
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