| Summary of Significant Accounting Policies | 5. Summary of Significant Accounting Policies Principles of Consolidation The financial statements include the accounts
of Intellinetics and the accounts of all the subsidiaries in which a controlling interest is held by the Company. Under U.S. GAAP,
consolidation is generally required for investments of more than 50% of the outstanding voting stock of an investee, except when
control is not held by the majority owner. The Company’s subsidiaries include: Intellinetics Ohio and Graphic Sciences. The
Company considers the criteria established under Financial Accounting Standards Board (“FASB”) Accounting Standard
Codification (“ASC”) Topic 810, “Consolidations” in its consolidation process. All significant intercompany
balances and transactions have been eliminated in consolidation. Use of Estimates The preparation of condensed consolidated financial
statements in conformity with U.S. GAAP requires management to make estimates and assumptions. Such estimates and assumptions affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed
consolidated financial statements and the reported amounts of revenues and expenses. Actual results could differ from estimated
amounts. Significant estimates and assumptions include
valuation allowances related to receivables, accounts receivable -unbilled, allowance for obsolescence or slow-moving parts and
supplies inventory, the recoverability of long-term assets, depreciable lives of property and equipment, purchase price allocations
for acquisitions, fair value for goodwill and intangibles, the lease liabilities, estimates of fair value deferred taxes and related
valuation allowances. The Company’s management monitors these risks and assesses its business and financial risks on a quarterly
basis. Revenue Recognition In accordance with ASC 606, the Company follows
a five-step model to assess each contract of a sale or service to a customer: identify the legally binding contract, identify the
performance obligations, determine the transaction price, allocate the transaction price, and determine whether revenue will be
recognized at a point in time or over time. Revenue is recognized when a performance obligation is satisfied and the customer obtains
control of promised goods and services. The amount of revenue recognized reflects the consideration to which we expect to be entitled
to receive in exchange for these goods and services. In addition, ASC 606 requires disclosures of the nature, amount, timing, and
uncertainty of revenue and cash flows arising from contracts with customers. We categorize revenue as software, software
as a service, software maintenance services, professional services, and storage and retrieval services. We earn the majority of
our revenue from the sale of professional services, followed by the sale of software maintenance services and software as a service.
Specific revenue recognition policies apply to each category of revenue. a) Sale of software Revenues included in this classification typically
include sales of licenses with professional services to new customers, additional software licenses to existing customers, and
sales of software with or without services to the Company’s resellers (See section j) - Reseller Agreements, below. Our software
licenses are functional intellectual property and typically provide customers with the right to use our software in perpetuity
as it exists when made available to the customer. We recognize revenue from software licenses at a point in time upon delivery,
provided all other revenue recognition criteria are met. b) Sale of software
as a service Sale of software as a service (“SaaS”)
consists of revenues from arrangements that provide customers the use of the Company’s software applications, as a service,
typically billed on a monthly or annual basis. Advance billings of these services are not recorded to the extent that the term
of the arrangement has not commenced and payment has not been received. Revenue on these services is recognized over the contract
period. c) Sale of software
maintenance services Software maintenance services revenues consist
of revenues derived from arrangements that provide post-contract support (“PCS”), including software support and bug
fixes, to the Company’s software license holders. Advance billings of PCS are not recorded to the extent that the term of
the PCS has not commenced and payment has not been received. PCS are considered distinct services. However, these distinct services
are considered a single performance obligation consisting of a series of services that are substantially the same and have the
same pattern of transfer to the customer. These revenues are recognized over the term of the maintenance contract. d) Sale of professional
services Professional services revenues consist of revenues
from document scanning and conversion services, consulting, discovery, training, and advisory services to assist customers with
document management needs, as well as repair and maintenance services for customer equipment. We recognize professional services
revenue over time as the services are delivered using an input or output method (e.g., labor hours incurred as a percentage of
total labor hours budgeted, images scanned, or similar milestones), as appropriate for the contract, provided all other revenue
recognition criteria are met. e) Sale of storage
and retrieval services Sale of document storage and retrieval services
consist principally of secured warehouse storage of customer documents, as well as retrieval per agreement terms and certified
destruction if desired. We recognize revenue from document storage and retrieval services over the term of the contract for storage
and for the retrieval and destructions components, as the services are delivered. f) Arrangements with
multiple performance obligations In addition to selling software licenses, software
as a service, software maintenance services, professional services, and storage and retrieval services on a stand-alone basis,
a portion of our contracts include multiple performance obligations. For contracts with multiple performance obligations, the Company
allocates the transaction price of the contract to each distinct performance obligation, on a relative basis using its standalone
selling price. The Company determines the standalone selling price based on the price charged for the deliverable when sold separately. g) Contract balances When the timing of our delivery of goods or
services is different from the timing of payments made by customers, we recognize either a contract asset (performance precedes
contractual due date) or a contract liability (customer payment precedes performance). Customers that prepay are represented by
deferred revenue until the performance obligation is satisfied. Contract assets represent arrangements in which the good or service
has been delivered but payment is not yet due. Our contract assets consisted of accounts receivable, unbilled, which are disclosed
on the condensed consolidated balance sheets. Our contract liabilities consisted of deferred (unearned) revenue, which is generally
related to software as a service or software maintenance contracts. We classify deferred revenue as current based on the timing
of when we expect to recognize revenue, which are disclosed on the condensed consolidated balance sheets. The following table present changes in our
contract assets and liabilities during the nine months ended September 30, 2020 and 2019:
Balance at Addition Revenue Billings Balance at
Nine months ended September 30, 2020
Contract assets: Accounts receivable, unbilled $ 23,371 $ 276,023 $ 602,692 $ (398,444 ) $ 503,642
Nine months ended September 30, 2019
Contract assets: Accounts receivable, unbilled $ 65,118 $ - $ 133,505 $ (163,271 ) $ 35,352 h) Deferred revenue Amounts that have been invoiced are recognized
in accounts receivable, deferred revenue or revenue, depending on whether the revenue recognition criteria have been met. Deferred
revenue represents amounts billed for which revenue has not yet be recognized. Deferred revenues typically relate to maintenance
and software-as-a-service agreements which have been paid for by customers prior to the performance of those services, and payments
received for professional services and license arrangements and software-as-a-service performance obligations that have been deferred
until fulfilled under our revenue recognition policy. Remaining performance obligations represent
the transaction price from contracts for which work has not been performed or goods and services have not been delivered. We expect
to recognize revenue on approximately 96% of the remaining performance obligations over the next 12 months, with the remainder
recognized thereafter. As of September 30, 2020, the aggregate amount of the transaction price allocated to remaining performance
obligations for software as a service and software maintenance contracts with a duration greater than one year was $43,337. As
of December 31, 2019, the aggregate amount of the transaction price allocated to remaining performance obligations for software
as a service and software maintenance contracts with a duration greater than one year was $69,381. This does not include revenue
related to performance obligations that are part of a contract whose original expected duration is one year or less.
Balance at Addition Billings Recognized Balance at
Nine months ended September 30, 2020
Contract liabilities: Deferred revenue $ 754,073 $ 198,659 $ 2,215,742 $ (2,146,222 ) $ 1,022,252
Nine months ended September 30, 2019
Contract liabilities: Deferred revenue $ 723,619 $ - $ 2,010,090 $ (2,060,993 ) $ 672,716 i) Rights of return
and customer acceptance The Company does not generally offer variable
consideration, financing components, rights of return or any other incentives such as concessions, product rotation, or price protection
and, therefore, does not provide for or make estimates of rights of return and similar incentives. Our contracts with customers
generally do not include customer acceptance clauses. j) Reseller agreements The Company executes certain sales contracts
through resellers. The Company recognizes revenues relating to sales through resellers when all the recognition criteria have been
met including passing of control. In addition, the Company assesses the credit-worthiness of each reseller, and if the reseller
is undercapitalized or in financial difficulty, any revenues expected to emanate from such resellers are deferred and recognized
only when cash is received and all other revenue recognition criteria are met. k) Contract costs The Company capitalizes the incremental costs
of obtaining a contract with a customer. We have determined that certain sales commissions meet the requirement to be capitalized,
and we amortize these costs on a consistent basis with the pattern of transfer of the goods and services in the contract. Total
capitalized costs to obtain contracts were immaterial during the periods presented and are included in other current and long-term
assets on our consolidated balance sheets. l) Sales taxes Sales taxes charged to and collected from customers
as part of the Company’s sales transactions are excluded from revenues, as well as the determination of transaction price
for contracts with multiple performance obligations, and recorded as a liability to the applicable governmental taxing authority. m) Disaggregation
of revenue The Company provides disaggregation of revenue
based on product groupings in our consolidated statements of operations as it believes this best depicts how the nature, amount,
timing, and uncertainty of revenue and cash flows are affected by economic factors. Revenues from contracts are primarily within
the United States. International revenues were not material to the condensed consolidated financial statements for the nine months
ended September 30, 2020 and 2019. n) Significant financing
component The Company’s customers typically do
not pay in advance for goods or services to be transferred in excess of one year. As such, it is not necessary to determine if
the Company benefits from the time value of money and should record a component of interest income related to the upfront payment
due to the practical expedient of ASC 606-10-32-18. Concentrations of Credit Risk The Company maintains its cash with high credit
quality financial institutions. At times, the Company’s cash and cash equivalents may be uninsured or in deposit accounts
that exceed the Federal Deposit Insurance Corporation insurance limit. The number of customers that comprise the Company’s
customer base, along with the different industries, governmental entities and geographic regions, in which the Company’s
customers operate, limits concentrations of credit risk with respect to accounts receivable, with the exception of the State of
Michigan. In the nine months ended September 30, 2020, the Company’s sales to the State of Michigan totaled approximately
43% of revenues. The Company expects revenues from the State of Michigan to be a slightly higher percentage of total revenues in
future periods. The Company is not aware of any losses by Graphic Sciences resulting from nonpayment by the State of Michigan. The Company does not generally require collateral
or other security to support customer receivables; however, the Company may require its customers to provide retainers, up-front
deposits or irrevocable letters-of-credit when considered necessary to mitigate credit risks. The Company has established an allowance
for doubtful accounts based upon facts surrounding the credit risk of specific customers and past collections history. Credit losses
have been within management’s expectations. At September 30, 2020 and December 31, 2019, the Company’s allowance for
doubtful accounts was $59,706 and $35,733, respectively. Parts and Supplies Parts and supplies are valued at the lower
of cost or net realizable value. Costs are determined using the first-in, first-out method. Parts and supplies are used for scanning
and document conversion services. A provision for potentially obsolete or slow-moving parts and supplies inventory is made based
on parts and supplies levels, future sales forecasted and management’s judgment of potentially obsolete parts and supplies.
The Company recorded an allowance of $10,500 at September 30, 2020 and there was no allowance recorded as of September 30, 2019. Property and Equipment Property, equipment and leasehold improvements
are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed over the estimated
useful lives of the related assets on a straight-line basis. Furniture and fixtures, computer hardware and purchased software are
depreciated over three to seven years. Leasehold improvements are amortized over the life of the lease or the asset, whichever
is shorter, generally seven to ten years. Upon retirement or other disposition of these assets, the cost and related accumulated
depreciation and amortization of these assets are removed from the accounts and the resulting gains and losses are reflected in
the results of operations. Intangible All intangible assets have finite lives and
are stated at cost, net of amortization. Amortization is computed over the useful life of the related assets on a straight-line
method. Goodwill The carrying value of goodwill is not amortized,
but is tested for impairment annually as of December 31, as well as on an interim basis whenever events or changes in circumstances
indicate that the carrying amount of a reporting unity may not be recoverable. An impairment charge is recognized for the amount
by which the carrying amount exceeds the recorded fair value. Impairment of Long-Lived Assets The Company accounts for the impairment and
disposition of long-lived assets in accordance with ASC 360, “Property, Plant, and Equipment.” The Company tests long-lived
assets or asset groups, such as property and equipment, for recoverability when events or changes in circumstances indicate that
their carrying amount may not be recoverable. Circumstances which could trigger a review
include, but are not limited to: significant adverse changes in the business climate or legal factors; current period cash flow
or operating losses combined with a history of losses or a forecast of continuing losses associated with the use of the asset;
and a current expectation that the asset will more likely than not be sold or disposed of before the end of its estimated useful
life. Recoverability is assessed based on comparing
the carrying amount of the asset to the aggregate pre-tax undiscounted cash flows expected to result from the use and eventual
disposal of the asset or asset group. Impairment is recognized when the carrying amount is not recoverable and exceeds the fair
value of the asset or asset group. The impairment loss, if any, is measured as the amount by which the carrying amount exceeds
fair value, which for this purpose is based upon the discounted projected future cash flows of the asset or asset group. There
were no impairment of long lived assets in the periods ended September 30, 2020 or 2019. Stock-Based Compensation The Company accounts for stock-based payments
to employees in accordance with ASC 718, “Compensation - Stock Compensation.” Stock-based payments to employees include
grants of stock that are recognized in the consolidated statement of operations based on their fair values at the date of grant. The Company accounts for stock-based payments
to non-employees in accordance with ASC 718, “Compensation - Stock Compensation,” which requires that such equity instruments
are recorded at their fair values on the grant date. The grant date fair value of stock option awards
is recognized in earnings as stock-based compensation cost over the requisite service period of the award using the straight-line
attribution method. The Company estimates the fair value of the stock option awards using the Black-Scholes-Merton option pricing
model. The exercise price of options is specified in the stock option agreements. The expected volatility is based on the historical
volatility of the Company’s stock for the previous period equal to the expected term of the options. The expected term of
options granted is based on the midpoint between the vesting date and the end of the contractual term. The risk-free interest rate
is based upon a U.S. Treasury instrument with a life that is similar to the expected term of the options. The expected dividend
yield is based upon the yield expected on date of grant to occur over the term of the option. Software Development Costs The Company designs, develops, tests, markets,
licenses, and supports new software products and enhancements of current products. The Company continuously monitors its software
products and enhancements to remain compatible with standard platforms and file formats. In accordance with ASC 985-20, “Costs
of Software to be Sold, Leased or Otherwise Marketed,” the Company expenses software development costs, including costs to
develop software products or the software component of products to be sold, leased, or marketed to external users, before technological
feasibility is reached. Once technological feasibility has been established, certain software development costs incurred during
the application development stage are eligible for capitalization. Based on the Company’s software development process, technical
feasibility is established upon completion of a working model. Technological feasibility is typically reached shortly before the
release of such products. No such costs were capitalized during the periods presented in this report. In accordance with ASC 350-40, “Internal-Use
Software,” the Company capitalizes purchase and implementation costs of internal use software. Once an application has reached
development stage, internal and external costs, if direct and incremental, are capitalized until the software is substantially
complete and ready for its intended use. Capitalization ceases upon complete of all substantial testing. The Company also capitalize
costs related to specific upgrades and enhancements when it is probable that the expenditure will result in additional functionality.
No such costs were capitalized during the periods presented in this report. For the three and nine months ended September
30, 2020 and 2019, our expensed software development costs were $60,085 and $228,834, respectively, and $101,885 and $349,111,
respectively. Recent Accounting Pronouncements Intangibles – Goodwill and Other –
Internal-Use Software In August 2018, the FASB issued ASU 2018-15,
which addresses a customer’s accounting for implementation costs incurred in a cloud computing arrangement that is a service
contract. Under the new guidance, customers will apply the same criteria for capitalizing implementation costs as they would for
an arrangement that has a software license. ASC 2018-15 was effective for the Company beginning in its first quarter of 2020. The
Company has concluded that the impact on its condensed consolidated financial statements and related disclosures is not material. Fair Value In August 2018, the FASB issued ASU 2018-13,
which is guidance that changes the fair value measurement disclosure requirements of ASC 820. ASU 2018-13 was effective for the
Company beginning in its first quarter of 2020. The Company has concluded that the impact on its condensed consolidated financial
statements and related disclosures is not material. Leases In February 2016, the FASB issued ASU No. 2016-02,
Leases (“ASC 842”) (“ASU 2016-02”), which modified lease accounting for both lessees and lessors to increase
transparency and comparability by recognizing lease assets and lease liabilities by lessees for those leases classified as operating
leases under previous accounting standards and disclosing key information about leasing arrangements. ASU 2016-02 was effective
for the Company beginning in its first quarter of 2019. On January 1, 2019, the Company recorded a lease liability of $143,761
and a net right-of-use asset of $138,549 using the required modified retrospective approach. On March 2, 2020, the Company recorded
a lease liability of $2,947,684 and a net right-of-use asset of $2,885,619 using the required modified retrospective approach for
the newly acquired subsidiary, Graphic Sciences. In adopting ASC 842, the Company elected to utilize the available package of practical
expedients permitted under the transition guidance within the new standard, which does not require the reassessment of the following:
i) whether existing or expired arrangements are or contain a lease, ii) the lease classification of existing or expired leases,
and iii) whether previous initial costs would qualify as capitalization under the new lease standard. Recently Issued Accounting Pronouncements
Not Yet Effective Financial Instruments – Credit Losses In June 2016, the FASB issued ASU 2016-13,
Financial Instruments – Credit Losses (Topic 326) Reference Rate Reform In March 2020, the FASB issued ASU 2020-04,
“Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting” which
provides optional relief through specific exceptions and practical expedients for transitioning away from reference rates that
are expected to be discontinued. The relief generally applies to eligible modifications of contractual terms that change (or have
the potential to change) the amount or timing of contractual cash flows related to replacement of a reference rate. The relief
allows such modifications to be accounted for as continuations of existing contracts without additional analysis. The optional
relief is available from March 2020 through December 31, 2022. The Company is currently evaluating the impact of this ASU. Income Taxes In December 2019, the FASB issued ASU 2019-12,
“Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes” which removes certain exceptions related to
intra-period tax allocations and deferred tax accounting on outside basis differences in foreign subsidiaries and equity method
investments. Additionally, it provides other simplifying measures for the accounting for income taxes. The new standard is effective
for fiscal years beginning after December 15, 2021 with early adoption permitted. The Company is currently evaluating the impact
of this ASU. Equity Securities, Equity Method Investments
and Certain Derivatives In January 2020, the FASB issued ASU 2020-01,
“Clarifying the Interactions Between Topic 321, Topic 323, and Topic 815.” This ASU clarifies the interaction between
accounting standards related to equity securities, equity method investments and certain derivatives. The effective date of the
standard will be for annual periods beginning after December 15, 2020, and interim periods within those fiscal years. The Company
is currently evaluating the impact of the adoption of the new standard on its condensed consolidated financial statements and related
disclosures. Lease Accounting and COVID-19 In April 2020, the FASB issued a question-and-answer
document to address stakeholder questions on the application of the lease accounting guidance for lease concessions related to
the effects of the COVID-19 pandemic. The guidance will allow concessions related to the timing of payments, where the total consideration
has not changed, to not be accounted for as lease modifications. Instead, any such concessions can be accounted for as if no change
was made to the contract or as variable lease payments. The Company is currently assessing the impact of the question-and-answer
document on its condensed consolidated financial statements. All other Accounting Standards Updates issued
but not yet effective are not expected to have a material effect on the Company’s future condensed consolidated financial
statements. Advertising The Company expenses the cost of advertising
as incurred. Advertising expense for the three and nine months ended September 30, 2020 and 2019 amounted to $1,651 and 5,331,
respectively, $1,028 and $3,084, respectively. Earnings (Loss) Per Share Basic income or loss per share is computed
by dividing net income or loss by the weighted average number of shares of common stock outstanding during the period. Diluted
income or loss per share is computed by dividing net income or loss by the diluted weighted average number of shares of common
stock outstanding during the period. The diluted weighted average number of shares gives effect to all dilutive potential common
shares outstanding during the period using the treasure stock method. Diluted earnings per share exclude all diluted potential
shares if their effect is anti-dilutive, including warrants or options which are out-of-the-money and for those periods with a
net loss. For the three months ended September 30, 2020, all applicable options and warrants were out-of-the-money. The nine months
ended September 30, 2020 and the three and nine months ended September 30, 2019 reported a net loss. Income Taxes The Company and its subsidiaries file a consolidated
federal income tax return. The provision for income taxes is computed by applying statutory rates to income before taxes. Deferred income taxes are recognized for the
tax consequences in future years of temporary differences between the financial reporting and tax bases of assets and liabilities
as of each period-end based on enacted tax laws and statutory rates. Valuation allowances are established when necessary to reduce
deferred tax assets to the amount expected to be realized. A 100% valuation allowance has been established on deferred tax assets
at September 30, 2020 and December 31, 2019, due to the uncertainty of our ability to realize future taxable income. For the nine
months ended September 30, 2020 the Company recovered a net $179,400 of its valuation allowance in conjunction with the consolidation
of the net deferred tax liability of its wholly owned subsidiary, Graphic Sciences. The Company accounts for uncertainty in income
taxes in its financial statements as required under ASC 740, “Income Taxes.” The standard 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. The standard also provides guidance on de-recognition, classification, interest and penalties, accounting
in interim periods, disclosure and transition accounting. Management determined there were no material uncertain positions taken
by the Company in its tax returns. Segment Information Operating segments are defined in the criteria
established under ASC 280, “Segment Reporting,” as components of public entities that engage in business activities
from which they may earn revenues and incur expenses for which separate financial information is available and which is evaluated
regularly by the Company’s chief operating decision maker (“CODM”) in deciding how to assess performance and
allocate resources. The Company’s CODM assesses performance and allocates resources based on two operating segments: Document
Management and Document Conversion. These segments contain individual business components that have been combined on the basis
of common management, customers, solutions offered, service processes and other economic characteristics. The Company currently
has no intersegment sales. The Company evaluates the segments’ performance based on gross profits. The Document Management Segment provides cloud-based
content services software. Its modular suite of solutions complements existing operating and accounting systems to serve a mission-critical
role for organizations to make content secure, compliant, and process-ready. This segment conducts its primary operations in the
United States. Markets served include highly regulated, risk and compliance-intensive markets in healthcare, K-12 education, public
safety, other public sector, risk management, financial services, and others. Solutions are sold both directly to end-users and
through resellers. The Document Conversion Segment provides services
for scanning and indexing, converting images from paper to digital, paper to microfilm, and microfiche to microfilm, as well as
long-term physical document storage and retrieval. This segment conducts its primary operations in the United States. Markets served
include business and federal, county, and municipal governments. Solutions are sold both directly to end-users and through a reseller
distributor. Information by operating segment is as follows:
Three months ended Three months ended
Revenues
Document Management $ 780,834 $ 738,957
Document Conversion 1,730,448 16,611
Total revenues $ 2,511,282 $ 755,568
Gross profit
Document Management $ 605,451 $ 610,998
Document Conversion 884,843 (3,120 )
Total gross profit $ 1,490,294 $ 607,878
Capital additions, net
Document Management $ - $ -
Document Conversion 33,676 -
Total capital additions, net $ 33,676 $ -
Nine months ended Nine months ended
Revenues
Document Management $ 2,018,208 $ 1,879,187
Document Conversion 3,539,378 32,374
Total revenues $ 5,557,586 $ 1,911,561
Gross profit
Document Management $ 1,526,283 $ 1,506,071
Document Conversion 1,880,648 (14,769 )
Total gross profit $ 3,406,931 $ 1,491,302
Capital additions, net
Document Management $ 7,911 $ -
Document Conversion 51,205 5,489
Total capital additions, net $ 59,116 $ 5,489
September 30, 2020 December 31, 2019
Total assets
Document Management $ 1,825,343 $ 986,574
Document Conversion 4,995,089 -
Corporate 3,561,977 -
Total assets $ 10,382,409 $ 986,574 Statement of Cash Flows For purposes of reporting cash flows, cash
includes cash on hand and demand deposits held by banks. Reclassifications Certain amounts reported in prior filings of
the condensed consolidated financial statements have been reclassified to conform to current presentation. |
