Note 1. Nature of Business and Significant Accounting Policies

Nature of Business

iSECUREtrac develops, markets, leases and services products that assist in “monitoring compliance and modifying behavior” of individuals who are under the supervision of the criminal justice system and social service agencies, primarily in the United States.  The Company’s suite of services  (e.g. Global Positioning System (“GPS”) tracking systems, house arrest, visual breath alcohol monitoring and supplemental monitoring services) are designed to offer an alternative to incarceration thereby reducing  the overall cost associated with individuals under correctional or community supervision.

We conduct our operations under one business segment.

The Company deploys equipment and services through two methods: through direct contracts with state, local and county agencies or through resellers who have contracts with state, local and county agencies. The actual number of units deployed by the Company's customers will vary from month to month and the Company's revenue will vary accordingly. Therefore, in the absence of new contracts won, the Company's revenue may increase and in the absence of contracts lost, the Company's revenue may decrease.

Direct contracts with the state, county or local agencies - These contracts are generally won through the competitive bid processes as required by the particular state, county or local procurement laws. The length of contracts vary and range from one year to five years, including renewal options and typically include cancellation clauses with 30 to 60 days notice. In general, contracts do not specify a minimum or maximum number of units.

Resellers - These contracts are won through direct solicitation to the reseller. They generally have no stated expiration or automatically renew on a month to month basis with cancellation clauses of 30 to 60 days notice.

Significant Accounting Policies

Principles of consolidation: The consolidated financial statements include the accounts of iSECUREtrac and its wholly-owned subsidiary, iSt Services, Inc., formed September 25, 2002. All material intercompany balances and transactions have been eliminated in consolidation.

Accounting estimates and assumptions: 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 amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Reclassification: Certain amounts in the prior years’ financial statements and footnotes have been reclassified to conform to the current year presentation.

Cash and cash equivalents: For financial statement purposes, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less when purchased to be cash equivalents. The carrying value of these investments approximates fair value due to the nature of the maturity period.

Trade accounts receivable: Trade accounts receivable are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful receivables by regularly evaluating individual customer receivables and considering a customer’s financial condition, credit history and current economic conditions. Trade accounts receivable are written off when deemed uncollectible. Recoveries of trade accounts receivable previously written off are recorded when received. The Company generally offers credit terms of 45 days. Additionally, the Company reserves the right to assess finance charges on delinquent accounts where such charges are permitted. Accounts are considered delinquent after 45 days. There was $256,757 and $0 of bad debt expense for 2011 and 2010, respectively.

Inventories: Inventories consist of repair parts or components that will be used in the production or repair of revenue producing equipment. Inventory is stated at lower of cost or market. Inventories are reviewed for obsolescence on a quarterly basis.

Leasehold improvement and equipment: Leasehold improvements and equipment are recorded at cost. Equipment, including monitoring equipment, is depreciated on the straight-line method over the estimated useful lives of the related assets ranging from 3 to 10 years. The cost of leasehold improvements is amortized over the lesser of the estimated lives of the assets or the lease term. Amortization of assets acquired under capital leases is included with depreciation expense on the owned assets.

During the three month period ended June 30, 2010 management lengthened the estimated useful life of certain monitoring equipment to more accurately reflect the expected life of the related assets.

The Company assesses the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. These computations utilize judgments and assumptions inherent in management’s estimate of future undiscounted and discounted cash flows to determine recoverability of these assets. If management’s assumptions about these assets were to change as a result of events or circumstances, the Company may be required to record an impairment loss. With respect to the Company’s long lived assets, the Company recorded no impairment charges for the years ended December 31, 2011 and 2010.

Product development: The Company capitalizes software and hardware development costs when a product's technological feasibility has been established and ends when the product is available for general release to customers. All software and hardware development costs are amortized on a straight-line basis over 36 months. As of December 31, 2011, the Company had capitalized development costs of $321,207 related to the System 5000 (included within Equipment) and $726,049 related to the improvements in the functionality of our web-based software and customer-facing interfaces. Of these amounts, $306,234 and $236,227, respectively, had been amortized through December 31, 2011. The net value of these capitalized software and hardware development costs are included in the Leasehold improvements and equipment line of the Consolidated Balance Sheets.

Research and development expenses: Research and development cost of $822,647 and $1,120,293, net of amounts capitalized, were charged to operations for the years ended December 31, 2011 and 2010, respectively.

Goodwill: Goodwill represents the excess of purchase price paid over the net identifiable assets of the acquired business. It is subject to annual tests for impairment, or whenever an impairment indicator is identified. The Company has recorded no impairment charges related to goodwill for the years ended December 31, 2011 and 2010.

Earnings (loss) per share: Basic Earnings (Loss) Per Common Share is computed by dividing income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted Earnings (Loss) Per Common Share shall be computed by including contingently issuable shares with the weighted average shares outstanding during the period. When inclusion of the contingently issuable shares would have an antidilutive effect upon earnings per share, no diluted earnings (loss) per share shall be presented. The following potentially dilutive shares were not included in diluted earnings (loss) per common share as they would have an antidilutive effect upon earnings (loss) per share:

Revenue recognition and deferred revenue: The Company derives revenue from equipment leasing and services and patent royalties.

Equipment leasing and services – the Company charges a daily rate for equipment leasing and service revenue (e.g. per day/per individual being monitored) and recognizes revenue as equipment leasing and services are provided.     The majority of the Company’s contracts are billed on a monthly basis in arrears.  However, in some instances customers are billed in advance, in which case, those billings are reflected as deferred revenue and recognized as equipment leasing and services are provided.

Royalty revenue – the Company entered into a Patent License Agreement in 2005 with Satellite Tracking of People, L.L.C.  (STOP), which grants STOP a license to utilize specific technology that is patented by the Company.  In exchange for that license the Company was entitled to receive a royalty payment from STOP equal to 2.5% of the revenue utilizing such technology, due annually by March 31 of each year, up to $1,500,000.   The Company accounts for these revenues on an accrual basis as the amounts are estimable and probable of collection.    The Company has earned the maximum amount of royalties it could earn under the STOP Patent License Agreement. Accordingly, the Company expects no future royalty revenue to be recognized and all payments were received as of March 31, 2011.

Income taxes: Deferred taxes are provided for by the liability method wherein deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

Uncertain Tax Positions. The Company accounts for all income taxes in accordance with ASC 740 – Income Taxes 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. It requires that we recognize in our consolidated financial statements, only those tax positions that are “more-likely-than-not” of being sustained as of the adoption date, based on the technical merits of the position. There are no unrecognized tax benefits in the Company’s financial statements as of December 31, 2011 and 2010.

The Company recognizes interest and penalties related to uncertain tax positions in general and administrative expense. As of December 31, 2011, the Company has not recorded any provisions for accrued interest and penalties related to uncertain tax positions.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. The significant assumptions used in the Black Scholes model to estimate compensation expense are as follows:

The risk-free interest rate is determined on the date the grant is issued. This rate is equal to the rates based on yields from U.S. Treasury zero-coupon issues with maturity of 7 years. Expected volatilities are based upon looking back at historical stock prices over the expected option term.

The Company is required to estimate forfeitures. The forfeiture rate is the rate at which options are expected to be forfeited prior to full vesting. The forfeiture rate is determined based on actual forfeiture rate experience as follows: For each historical year of option issuance, the total options issued for the year is compared to the options forfeited prior to having vested. For option years in which the two year vesting period has not passed, past experience is used to project future forfeitures. The total of pro forma forfeitures is then compared to total options awarded and the resultant percentage is used as the forfeiture rate. This forfeiture rate is recalculated on an annual basis.

The annual rate of quarterly dividends is 0% since iSECUREtrac has historically not paid dividends on its common stock and does not anticipate paying dividends on its common stock in the future.

The Company recorded pre-tax compensation expense for stock options issued to its employees of $272,878 and $183,080 for the years ended December 31, 2011 and 2010, respectively. The Company has recorded a full valuation allowance on deferred tax assets and, therefore, no tax benefit is recognized.

The fair value of stock warrants issued to non-employees is also accounted for using ASC 718. Related compensation expense is charged to income when incurred.

Advertising costs: Advertising costs are expensed as incurred. Advertising expense for the years ended December 31, 2011 and 2010 was $16,732 and $10,235, respectively.

Recent Accounting Pronouncements:

In October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (ASC 605): Multiple-Deliverable Revenue Arrangements (a consensus of the FASB Emerging Issues Task Force); effective for years beginning after June 15, 2010. Vendors often provide multiple products and/or services to their customers as part of a single arrangement.  These deliverables may be provided at different points in time or over different time periods.  The existing guidance regarding how and whether to separate these deliverables and how to allocate the overall arrangement consideration to each was originally captured in EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, which is now codified at ASC 605-25, Revenue Recognition - Multiple-Element Arrangements.  The issuance of ASU 2009-13 amends ASC 605-25 and represents a significant shift from the existing guidance that was considered abuse-preventative and heavily geared toward ensuring that revenue recognition was not accelerated.  The application of this new guidance is expected to result in accounting for multiple-deliverable revenue arrangements that better reflects their economics as more arrangements will be separated into individual units of accounting.  Our adoption of ASU No. 2009-13 did not have a material effect on our consolidated financial statements.

In October 2009, the FASB issued ASU No. 2009-14, Software (ASC 985): Certain Revenue Arrangements That Include Software Elements (a consensus of the FASB Emerging Issues Task Force); effective for years beginning after June 15, 2010. ASU 2009-14 modifies the existing scope guidance in ASC 985-605, Software Revenue Recognition, for revenue arrangements with tangible products that include software elements.  This modification was made primarily due to the changes in ASC 605-25 noted previously, which further differentiated the separation and allocation guidance applicable to non-software arrangements as compared to software arrangements.  Prior to the modification of ASC 605-25, the separation and allocation guidance for software and non-software arrangements was more similar.  Under ASC 985-605, which was originally issued as AICPA Statement of Position 97-2, Software Revenue Recognition, an arrangement to sell a tangible product along with software was considered to be in its scope if the software was more than incidental to the product as a whole. Our adoption of ASU No. 2009-14 did not have a material effect on our consolidated financial statements.

In December 2010, the FASB issued ASU 2010-28, Intangibles – Goodwill and Other (Topic 350). This ASU modifies the first step of the goodwill impairment test to include reporting units with zero or negative carrying amounts. For these reporting units, the second step of the goodwill impairment test shall be performed to measure the amount of impairment loss, if any, when it is more likely than not that a goodwill impairment exists. This ASU is effective for fiscal years and interim periods beginning after December 15, 2010. Our adoption of ASU 2010-28 did not have a material impact on our consolidated financial statements.

In September 2011, the FASB issued ASU 2011-08 – Goodwill and Other (Topic 350). This ASU simplifies the approach to testing goodwill for impairment. The ASU permits an entity to first assess qualitative factors to determine with it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. This ASU is effective for fiscal years beginning after December 15, 2011. Our adoption of ASU 2011-08 will not have a material impact on our consolidated financial statements.