Summary of Significant Accounting Policies

9 Months Ended

Sep. 30, 2011

Summary of Significant Accounting Policies

Note 2 Summary of Significant Accounting Policies

Use of estimates

The preparation of unaudited consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Such estimates and assumptions impact, among others, the following: allowance for doubtful accounts, inventory obsolescence reserve, the fair value of share-based payments, fair value of derivative liabilities, estimates of the probability and potential magnitude of contingent liabilities and the valuation allowance for deferred tax assets due to continuing operating losses.

Making estimates requires management to exercise significant judgment. It is at least reasonably possible that the estimate of the effect of a condition, situation or set of circumstances that existed at the date of the consolidated financial statements, which management considered in formulating its estimate, could change in the near term due to one or more future confirming events. Accordingly, the actual results could differ significantly from our estimates.

Risks and uncertainties

The Company operates in an industry that is subject to intense competition and change in consumer demand. The Company's operations are subject to significant risk and uncertainties including financial and operational risks including the potential risk of business failure.

Cash

The Company considers all highly liquid instruments purchased with a maturity of three months or less to be cash equivalents. There were no cash equivalents at September 30, 2011 and December 31, 2010, respectively.

The Company minimizes its credit risk associated with cash by periodically evaluating the credit quality of its primary financial institution. The United States Congress has temporarily increased the Federal Deposit Insurance Corporation (FDIC) deposit insurance from $100,000 to $250,000 per depositor. Cash balance at times may exceed federally insured limits.

Accounts receivable and allowance for doubtful accounts

Accounts receivable are stated at the amount management expects to collect from outstanding balances. The Company generally does not require collateral to support customer receivables. The Company provides an allowance for doubtful accounts based upon a review of the outstanding accounts receivable, historical collection information and existing economic conditions. The Company determines if receivables are past due based on days outstanding, and amounts are written off when determined to be uncollectible by management. The maximum accounting loss from the credit risk associated with accounts receivable is the amount of the receivable recorded, which is the face amount of the receivable net of the allowance for doubtful accounts.

Inventory

Inventory is stated at the lower of cost or market using the first-in, first-out (FIFO) valuation method. Provisions are made for the estimated effect of obsolete and slow-moving inventories.

	September 30, 2011			December 31, 2010
Finished goods	$	487,914		$	148,866
Less reserve for obsolescence and slow moving inventory		(69,992	)		(96,682	)
	$	417,922		$	52,184

Property and Equipment

Property and equipment are recorded at cost and depreciated over their estimated useful lives using the straight-line method once placed in service. Upon retirement or sale, the cost of the assets disposed of and the related accumulated depreciation are removed from the accounts, and any resulting gain or loss is recognized. Repairs and maintenance costs are expensed as incurred. The estimated useful lives of assets are as follows:

Leasehold improvements Lesser of estimated useful life or life of the lease

Furniture and equipment 3 - 7 years

Vehicles 5 years

Debt Issuance Costs and Debt Discount

These items are amortized over the life of the related debt to interest expense using the straight line method which approximates the interest method. If a conversion, extinguishment or repayment of the underlying debt occurs, a proportionate share of the unamortized portion of these amounts will be immediately expensed.

Fair Value of Financial Instruments

The Company’s financial instruments, including cash, accounts receivable, accounts payable and accrued expenses, are carried at cost, which approximates their fair value because of the short-term nature of these financial instruments.

For purpose of this disclosure, the fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation.

Derivative Financial Instruments

Fair value accounting requires bifurcation of embedded derivative instruments such as conversion features in convertible debt or equity instruments, and measurement of their fair value for accounting purposes. In determining the appropriate fair value, the Company uses the binomial option-pricing model. In assessing the convertible debt instruments, management determines if the convertible debt host instrument is conventional convertible debt and further if there is a beneficial conversion feature requiring measurement. If the instrument is not considered conventional convertible debt, the Company will continue its evaluation process of these instruments as derivative financial instruments.

Once determined, the derivative liabilities are adjusted to reflect fair value at each reporting period end, with any increase or decrease in the fair value being recorded in results of operations as an adjustment to fair value of derivatives. In addition, the fair value of freestanding derivative instruments such as warrants, are also valued using the binomial option-pricing model. At September 30, 2011 and December 31, 2010, respectively, the Company had derivative liabilities in the amounts of $14,769,967 and $905,701.

Impairment of Long-Lived Assets

Long-lived assets such as property and equipment and definite-lived intangible assets (DVD or CD master production copies, or "masters") are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. If the sum of the expected undiscounted future cash flows is less than the carrying amount of the asset, an impairment loss is recognized in the amount that the carrying amount of the asset exceeds its fair value. Fair value is determined based on discounted future net cash flows associated with the use of the asset.

The Company performs an annual impairment analysis based on the Company's expected future undiscounted cash flows generated by the masters. No impairment was recorded at September 30, 2011 and 2010.

Indefinite-Lived Intangible Assets

Indefinite-lived intangible assets are recorded at cost and consist of domestic and foreign trademarks. Trademarks are not amortized since they have indefinite lives, but instead are reviewed annually for impairment. Costs to renew trademarks are expensed as incurred.

Revenue recognition

The Company recognizes revenue when all of the following have occurred: (1) persuasive evidence of an arrangement exists, (2) the product is delivered, (3) the sales price to the customer is fixed or determinable, and (4) collectability of the related customer receivable is reasonably assured. There is no right of return for products. Product sales are recognized upon shipment, where risk and title to the Company’s inventory passes to the customer.

The Company also enters into licensing agreements whereby the licensee agrees to pay a percentage of net sales of the licensed products. Most of the agreements require the licensee to pay guaranteed minimum royalty payments upon entering into the agreement. Advanced royalty payments associated with these agreements are recorded as deferred revenue and royalties are recognized as revenue over the period or the agreement based on the greater of the monthly minimums or the licensees’ sales of the licensed products.

Cost of sales

Cost of sales represents costs directly related to the production and manufacturing of the Company’s products. Costs include product development, freight, packaging and print production costs. Cost of sales also represent licensing fees in accordance with a licensing contract with a related party.

Shipping and handling costs

The Company classifies shipping and handling amounts billed to customers as product sales and shipping and handling costs as a component of cost of sales.

Advertising

Costs incurred for producing and communicating advertising for the Company are charged to operations as incurred as follows:

Three Months Ended September 30, 2011				Three Months Ended September 30, 2010				Nine Months Ended September 30, 2011				Nine Months Ended September 30, 2010
$	193,903			$	16,065			$	2,073,606			$	47,357

Share-based payments

Generally, all forms of share-based payments, including stock option grants, restricted stock grants and stock appreciation rights are measured at their fair value on the awards’ grant date, based on the estimated number of awards that are ultimately expected to vest. Share-based compensation awards issued to non-employees for services rendered are recorded at either the fair value of the services rendered or the fair value of the share-based payment, whichever is more readily determinable. The expense resulting from share-based payments are recorded in general and administrative expense in the consolidated statements of operations, depending on the nature of the services provided.

Earnings per share

In accordance with accounting guidance now codified as FASB ASC Topic 260, “Earnings per Share,” basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during each period. Diluted earnings (loss) per share is computed by dividing net income (loss), adjusted for changes in income or loss that resulted from the assumed conversion of convertible notes, by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during the period.

The Company had the following common stock equivalents at September 30, 2011:

2010 Convertible notes – face amount of $2,806,489, conversion price of $0.20			14,032,445
2011 Convertible notes – face amount of $1,900,000, conversion price of $0.20			9,500,000
Common stock warrants, exercise price of $0.20			54,187,502
Total common stock equivalents			77,719,947

The Company had no common stock equivalents at September 30, 2010.

In connection with the reverse acquisition and recapitalization, all share and per share amounts have been retroactively restated.

Reclassification

Certain items in the 2010 consolidated financial statements presentation have been reclassified to conform to the 2011 presentation. Such reclassifications have no effect on previously reported net income (loss).

BRAINY BRANDS COMPANY, INC. 10-Q