| Summary of Significant Accounting Policies | 2. SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES This summary of significant
accounting policies of Sunworks, Inc. is presented to assist in understanding the Company’s financial statements. The financial
statements and notes are representations of the Company’s management, which is responsible for their integrity and objectivity.
These accounting policies conform to accounting principles generally accepted in the United States of America and have been consistently
applied in the preparation of the financial statements. Principles of Consolidation The accompanying consolidated
financial statements include the accounts of Sunworks, Inc., and its wholly owned operating subsidiaries, Sunworks United, Inc.
(d/b/a Sunworks United), MD Energy, Inc., and Elite Solar Acquisition Sub, Inc. All material intercompany transactions have been
eliminated upon consolidation of these entities. Use of Estimates 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 reported amounts of assets and liabilities, disclosure of contingent assets and liabilities
at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates. Significant estimates include estimates used to review the Company’s goodwill,
impairments and estimations of long-lived assets, project construction costs, revenue recognition on percentage of completion type
contracts, allowances for uncollectible accounts, warranty reserves, inventory valuation, debt beneficial conversion features,
valuations of non-cash capital stock issuances and the valuation allowance on deferred tax assets. The Company bases its estimates
on historical experience and on various other assumptions that are believed to be reasonable in the circumstances, the results
of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent
from other sources. Actual results may differ from these estimates under different assumptions or conditions. Reclassifications and
Corrections Certain reclassifications
have been made to conform prior period data to the current presentation. In addition, the Company identified an error and revised
its financial statements for the three months and nine months ended September 30, 2016 related to the elimination of certain intercompany
revenues. Management concluded that the errors had no material impact on any of the Company’s previously issued financial
statements, are immaterial to the Company’s results for the first, second, and third quarters of 2016 and full year 2016
results, and had no material effect on the trend of the Company’s financial results. As a result of the immaterial errors
discussed above, the unaudited condensed consolidated financial statements reflect the following adjustments for the three months
ended September 30, 2016: a reduction in revenue of $6,000, an increase in cost of goods sold of $75,000 and a net decrease in
Operating Expenses and Other Expenses of $81,000. The effect of the reclassifications and immaterial errors had no effect on reported
net loss. The unaudited condensed consolidated financial statements reflect the following adjustments for the nine months ended
September 30, 2016: an increase in cost of goods sold of $460,000 and a net decrease in Operating Expenses and Other Expenses of
$460,000. The effect of the reclassifications and immaterial errors had no effect on reported net loss for the nine months ended
2016. Revenue Recognition Revenues and related costs
on construction contracts are recognized using the “percentage of completion method” of accounting in accordance with
ASC 605-35, Accounting for Performance of Construction-Type and Certain Production Type Contracts (“ASC 605-35”). Under
this method, contract revenues and related expenses are recognized over the performance period of the contract in direct proportion
to the costs incurred as a percentage of total estimated costs for the entirety of the contract. Costs include direct material,
direct labor, subcontract labor and any allocable indirect costs. All un-allocable indirect costs and corporate general and administrative
costs are charged to the periods as incurred. However, in the event a loss on a contract is foreseen, the Company will recognize
the loss as it is determined. Revisions in cost and profit
estimates during the course of the contract are reflected in the accounting period in which the facts, which require the revision,
become known. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined.
Changes in job performance, job conditions, and estimated profitability, including those arising from contract penalty provisions,
and final contract settlements may result in revisions to costs and income and are recognized in the period in which the revisions
are determined. The Asset, “Costs in
excess of billings”, represents revenues recognized in excess of amounts billed on contracts in progress. The Liability,
“Billings in excess of costs”, represents billings in excess of revenues recognized on contracts in progress. At September
30, 2017 and December 31, 2016, the costs in excess of billings balance were $5,314,000 and $4,307,000, and the billings in excess
of costs balance were $7,210,000 and $4,997,000, respectively. Residential contract revenues are recognized using the “completed
contract” method of accounting. Contract receivables are
recorded on contracts for amounts currently due based upon progress billings, as well as retention, which are collectible upon
completion of the contracts. Accounts payable to material suppliers and subcontractors are recorded for amounts currently due based
upon work completed or materials received, as are retention due subcontractors, which are payable upon completion of the contract.
General and administrative expenses are charged to operations as incurred and are not allocated to contract costs. Contract Receivable The Company performs ongoing
credit evaluation of its customers. Management monitors outstanding receivables based on factors surrounding the credit risk of
specific customers, historical trends, age of receivables and other information, and records bad debts using the allowance method.
Accounts receivable are presented net of an allowance for doubtful accounts of $240,000 at September 30, 2017, and $50,000 at December
31, 2016. Cash and Cash Equivalent The Company considers all
highly liquid investments with an original maturity of three months or less to be cash equivalents. Concentration Risk Cash includes amounts deposited
in financial institutions in excess of insurable Federal Deposit Insurance Corporation (FDIC) limits. At times throughout the year,
the Company may maintain cash balances in certain bank accounts in excess of FDIC limits. As of September 30, 2017, the cash balance
in excess of the FDIC limits was $6,060,000. The Company has not experienced any losses in such accounts and believes it is not
exposed to any significant credit risk in these accounts. Inventory average on a first-in, first-out
method. Inventory primarily consists of modules, inverters, mounting racks and other materials, and is recorded net of an estimated
allowance of $100,000 for obsolesce, shrink and spoilage as of September 30, 2017 and $0 as of September 30,2016. Property and Equipment Property and equipment are
stated at cost. Depreciation for property and equipment commences when it’s put into service and are depreciated using the
straight-line method over its estimated useful lives:
Machinery & equipment 3-7 Years
Furniture & fixtures 5-7 Years
Computer equipment 3-5 Years
Vehicles 5-7 Years
Leaseholder improvements 3-5 Years Depreciation expense for
the three months ended September 30, 2017 and 2016 was $102,000 and $101,000, respectively. Depreciation expense for the nine months
ended September 30, 2017 and 2016 was $308,000 and $218,000, respectively. Advertising and Marketing The Company expenses advertising
and marketing costs as incurred. Advertising and marketing costs include printed material, billboards, sponsorships, direct mail,
radio, telemarketing, tradeshow costs, magazine, and catalog advertisement. Included within selling and marketing expenses are
advertising and marketing costs for the three months ended September 30, 2017 and 2016 of $123,600 and $725,300, respectively.
Advertising and marketing costs for the nine months ended September 30, 2017 and 2016 were $807,500 and $2,705,100, respectively. Warranty Liability The Company establishes warranty
liability reserves to provide for estimated future expenses as a result of installation and product defects, product recalls and
litigation incidental to the Company’s business. Liability estimates are determined based on management’s judgment,
considering such factors as historical experience, the likely current cost of corrective action, manufacturers’ and subcontractors’
participation in sharing the cost of corrective action, consultations with third party experts such as engineers, and discussions
with the Company’s outside counsel retained to handle specific product liability cases. Solar panel manufacturers currently
provide substantial warranties between ten to twenty-five years with full reimbursement to replace and install replacement panels
while inverter manufacturers currently provide warranties covering ten to fifteen-year replacement and installation. Warranty reserve
liability as of September 30, 2017 and December 31, 2016 is $216,000 and $116,000, respectively. Stock-Based Compensation The Company periodically
issues stock options, restricted stock, and warrants to employees and non-employees in non-capital raising transactions for services
and for financing costs. The Company accounts for stock option, restricted stock and warrant grants issued and vesting to employees
based on the authoritative guidance provided by the Financial Accounting Standards Board whereas the value of the award is measured
on the date of grant and recognized over the vesting period. The Company accounts for stock option and warrant grants issued and
vesting to non-employees in accordance with the authoritative guidance of the Financial Accounting Standards Board where the value
of the stock compensation is based upon the measurement date as determined at either a) the date at which a performance commitment
is reached, or b) at the date at which the necessary performance to earn the equity instruments is complete. Non-employee stock-based
compensation charges generally are amortized over the vesting period on a straight-line basis. In certain circumstances where there
are no future performance requirements by the non-employee, option grants are immediately vested and the total stock-based compensation
charge is recorded in the period of the measurement date. Basic and Diluted Net
(Loss) Income per Share Calculations Income (Loss) per Share dictates
the calculation of basic earnings per share and diluted earnings per share. Basic earnings per share are computed by dividing income
available to common shareholders by the weighted-average number of common shares available. Diluted earnings per share is computed
similar to basic earnings per share except that the denominator is increased to include the number of additional common shares
that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive.
The shares for employee options, restricted stock, warrants and convertible notes were not used in the calculation of the net loss
per share. A net loss causes all outstanding
common stock options, restricted stock, warrants, convertible preferred stock, and convertible notes to be anti-dilutive. As a
result, the basic and diluted losses per common share are the same for the nine months ended September 30, 2017 and 2016. As of September 30, 2017,
the potentially dilutive securities that have been excluded from the computations of weighted average shares outstanding include
811,924 stock options, 1,134,615 restricted stock grants, 2,997,000 warrants, and 3,589,978 shares underlying convertible notes
and preferred stock. As of September 30, 2016,
the potentially dilutive securities that have been excluded from the computations of weighted average shares outstanding include
938,188 stock options and 2,997,000 warrants because they were below the period ending stock price. We also excluded 1,506,024
shares of Series B preferred stock convertible into common stock at a 1 to 1 ratio because of trading restrictions. Dilutive per share amounts
are computed using the weighted-average number of common shares outstanding and potentially dilutive securities, using the treasury
stock method if their effect would be dilutive. Long-Lived Assets The Company reviews its property
and equipment and any identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. The test for impairment is required to be performed by management at least annually.
Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted
operating cash flow expected to be generated by the asset. 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 asset exceeds the fair value of the asset. Long-lived assets to be
disposed of are reported at the lower of carrying amount or fair value less costs to sell. Indefinite Lived Intangibles
and Goodwill Assets The Company accounts for
business combinations under the acquisition method of accounting in accordance with ASC 805, “Business Combinations,”
where the total purchase price is allocated to the tangible and identified intangible assets acquired and liabilities assumed based
on their estimated fair values. The purchase price is allocated using the information currently available, and may be adjusted,
up to one year from acquisition date, after obtaining more information regarding, among other things, asset valuations, liabilities
assumed and revisions to preliminary estimates. The purchase price in excess of the fair value of the tangible and identified intangible
assets acquired less liabilities assumed is recognized as goodwill. The Company tests for indefinite
lived intangibles and goodwill impairment in the fourth quarter of each year and whenever events or circumstances indicate that
the carrying amount of the asset exceeds its fair value and may not be recoverable. In accordance with its policies, the Company
performed a qualitative assessment of indefinite lived intangibles and goodwill at December 31, 2016. Fair Value of Financial
Instruments Disclosures about fair value
of financial instruments, requires disclosure of the fair value information, whether or not recognized in the balance sheet, where
it is practicable to estimate that value. As of September 30, 2017, the amounts reported for cash, accrued interest and other expenses,
and notes payable approximate the fair value because of their short maturities. We adopted ASC Topic 820
as of January 1, 2008 for financial instruments measured as fair value on a recurring basis. ASC Topic 820 defines fair value,
established a framework for measuring fair value in accordance with accounting principles generally accepted in the United States
and expands disclosures about fair value measurements. Fair value is defined as
the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants
at the measurement date. ASC Topic 820 established a three-tier fair value hierarchy which prioritizes the inputs used in measuring
fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities
(level 1measurements) and the lowest priority to unobservable inputs (level 3 measurements). These tiers include:
● Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets;
● Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable such as quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active; and
● Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable. Business Combinations We allocate the fair value
of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated
fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities
is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect
to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected
cash flows from acquired customer lists, acquired technology, and trade names from a market participant perspective, useful lives
and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which
are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period,
which is one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the
corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. Income Taxes The Company uses the liability
method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable
to financial statements carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and
tax credit carry-forwards. The measurement of deferred tax assets and liabilities is based on provisions of applicable tax law.
The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance based on the amount of tax benefits that,
based on available evidence, is not expected to be realized. Segment Reporting Operating segments are defined
as components of an enterprise for which separate financial information is available and evaluated regularly by the chief operating
decision maker, or decision-making group, in deciding the method to allocate resources and assess performance. The Company currently
has one reportable segment for financial reporting purposes, which represents the Company’s core business. New Accounting Pronouncements In January 2017, the FASB
issued ASU No. 2017-04, Simplifying the Test for Goodwill Impairment, which simplifies the subsequent measurement of goodwill by
eliminating Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, current U.S.
GAAP requires the performance of procedures to determine the fair value at the impairment testing date of assets and liabilities
(including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of
assets acquired and liabilities assumed in a business combination. Instead, the amendments under this ASU require the goodwill
impairment test to be performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge
should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss
recognized should not exceed the total amount of goodwill allocated to that reporting unit. The ASU becomes effective for the Company
on January 1, 2020. The amendments in this ASU should be applied on a prospective basis. Early adoption is permitted for interim
or annual goodwill impairment tests performed. We are currently evaluating the impact ASU No. 2017-04 will have on our consolidated
financial statements and associated disclosures. In November 2016, the FASB
issued ASU 2016-18, Statement of Cash Flows (Topic 230) – Restricted Cash. ASU 2016-18 requires that the statement of cash
flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted
cash or restricted cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement
of cash flows. The ASU is effective for fiscal years beginning after December 15, 2017. From January 1, 2018 we will begin including
amounts generally described as restricted cash and restricted cash equivalents with cash and cash equivalents when reconciling
the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. In February 2016, the FASB
issued ASU 2016-02, Leases (Topic 842), to increase transparency and comparability among organizations by recognizing a right-of-use
asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as
either operating or financing, with such classification affecting the pattern of expense recognition in the income statement. ASU
2016-02 is effective for fiscal years and interim periods within those years beginning after December 15, 2018, and early adoption
is permitted. We are currently evaluating the impact ASU 2016-02 will have on our consolidated financial statements and associated
disclosures. In May 2014, the FASB issued
ASU 2014-09, Revenue from Contracts with Customers (Topic 606), to clarify the principles of recognizing revenue and create common
revenue recognition guidance between U.S. GAAP and International Financial Reporting Standards. Under ASU 2014-09, revenue is recognized
when a customer obtains control of promised goods or services and is recognized at an amount that reflects the consideration expected
to be received in exchange for such goods or services. In addition, ASU 2014-09 requires disclosure of the nature, amount, timing,
and uncertainty of revenue and cash flows arising from contracts with customers. The ASU is effective for fiscal years beginning
after December 15, 2017. The new revenue standard is principle based and interpretation of those principles may vary from company
to company based on their unique circumstances. It is possible that interpretation, industry practice, and guidance may evolve
as companies and the accounting profession work to implement this new standard. The Company is still in the process of evaluating
the effect of the new standard on the Company’s historical financial statements and disclosures. As the Company completes
its evaluation of this new standard, new information may arise that could change the Company’s current understanding of the
impact to revenue and expense recognized. Additionally, the Company will continue to monitor industry activities and any additional
guidance provided by regulators, standards setters, or the accounting profession and adjust the Company’s assessment and
implementation plans accordingly. |
