CGYV China Energy Recovery Inc (CE)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 1 – Organization and Basis of Presentation

China Energy Recovery, Inc. ("CER" or the "Company"), formerly known as MMA Media Inc. and Commerce Development Corporation Ltd., was incorporated under the laws of the State of Maryland in May, 1998. On February 5, 2008, the Company changed its name to China Energy Recovery, Inc. On January 24, 2008, the Company entered into a Share Exchange Agreement with Poise Profit International, Ltd. ("Poise Profit"), a company incorporated on November 23, 2007, under the laws of the British Virgin Islands, and the shareholders of Poise Profit. Pursuant to the Share Exchange Agreement, the Company agreed to acquire all of the issued and outstanding shares of Poise Profit's common stock in exchange for the issuance of 20,757,090 shares, or 81.5% of the Company's common stock on a post 1-for-2 reverse stock split basis, to the shareholders of Poise Profit. The share exchange transaction (the "Share Exchange") was consummated on April 15, 2008 and Poise Profit became a wholly-owned subsidiary of the Company. On April 16, 2008, the Company conducted a 1-for-2 reverse stock split pursuant to which each two shares of CER's common stock, issued and outstanding on the record date of April 15, 2008, converted into one share of CER's common stock.

Poise Profit is an off-shore holding company and has no operating business activities. Poise Profit owns 100% of HAIE Hi-tech Engineering (Hong Kong) Company, Limited ("Hi-tech") and CER (Hong Kong) Holdings Limited (“CER Hong Kong”), which were incorporated in Hong Kong on January 4, 2002 and August 13, 2008, respectively.

In order to restructure the holding structure of the Company, on December 2, 2008, 100% of the shares of CER Hong Kong were transferred to Poise Profit from Mr. Qinghuan Wu, the Company’s Chairman and Chief Executive Officer, and his wife, Mrs. Jialing Zhou, and all the contracts between Hi-tech and Shanghai Engineering were transferred to CER Hong Kong. Thereafter, CER Hong Kong, through its wholly owned subsidiaries and a consolidated variable interest entity (Shanghai Engineering) located in the People's Republic of China ("PRC"), designs, develops, manufactures and markets waste heat boilers and pressure vessels in the fields of chemical industry, petrochemical industry, oil refining, fine chemicals, water and power conservancy, metallurgical industry, environmental protection, waste heat utilization ,and power generation from waste heat recovery.

On November 11, 2008, CER Energy Recovery (Shanghai) Co., Ltd. (“CER Shanghai”) was incorporated in Shanghai by CER Hong Kong. CER Shanghai’s registered capital is $5,000,000. As of December 31, 2010, CER Hong Kong had contributed all the registered capital. CER Shanghai is mainly engaged in the development of energy recovery and environmental protection technologies, and design, installation and servicing of waste heat recovery systems.

CER Energy Recovery (Yangzhou) Co., Ltd. (“CER Yangzhou”) was incorporated on August 28, 2009 in Yangzhou by CER Hong Kong. CER Yangzhou’s registered capital is $20,000,000. As of December 31, 2011, CER Hong Kong had contributed all the registered capital. CER Yangzhou is mainly engaged in the development and manufacturing of waste heat recovery systems and other related energy efficiency equipment.

On July 2, 2012, CER Hong Kong and CER Shanghai entered into a share transfer agreement, whereby all of CER Hong Kong’s equity interests in CER Yangzhou were transferred to CER Shanghai. This share transfer is intended to change CER Yangzhou’s entity from foreign capital to domestic capital, so as to make it more competitive in the domestic Chinese economy. As a result of the reorganization, all of CER Hong Kong’s equity interests in CER Yangzhou were transferred to CER Shanghai. As the reorganization was under common control of the Company, except for income tax for the intra-entity sales of the subsidiary’s shares, it will not have a material impact on the Company’s consolidated financial position or results of operations of the Company or its subsidiaries in any material respect. The reorganization was completed on August 21, 2012 and income taxes of $206,147 for the intra-entity sales of the subsidiary’s shares were recorded in the consolidated statement of operation as of September 30, 2012.

CER, Poise Profit, CER Hong Kong, Hi-tech, Shanghai Engineering, CER Shanghai, and CER Yangzhou are collectively hereinafter referred to as the “Group”.

The basis of presentation for the Group’s financial statements is accounting principles generally accepted in the United States of America (U.S. GAAP) and the reporting currency is the U.S. dollar.

The accompanying financial statements have been prepared assuming the Group will continue as a going concern. However, as of September 30, 2012, the Group reported a negative working capital balance of $31.3 million and had negative operating cash flows of $0.4 million for the nine months ended September 30, 2012. The Group expects such negative working capital to continue into the foreseeable future and will need to obtain new sales orders and additional financing to fund its daily operations. These factors raise substantial doubt about the Group ’s ability to continue as a going concern. In order to continue its operations, the Group must obtain additional sales orders to achieve profitable operations, raise more funds, and/or curtail its capital expenditures. The Group implemented plans to postpone spending for capital expenditures and has been and continues to be in negotiations with several domestic banks in China and state-owned companies for additional financing. There can be no assurance, however, that such financing will be successfully completed or completed on terms acceptable to the Group. The Group’s plans of operations, even if successful, may not result in cash flow sufficient to finance and maintain its business. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Please refer to Note 7 – Short Term Loans for additional information.  

Note 2 – Summary of Significant Accounting Policies

The accompanying unaudited interim consolidated financial statements as of September 30, 2012 and for the three and nine months ended September 30, 2012 and 2011 have been prepared by the Company, in accordance with generally accepted accounting principles, or GAAP, for interim financial reports and the instructions for Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared under generally accepted accounting principles have been condensed or omitted pursuant to such regulations. In the opinion of the Company’s management, the unaudited interim consolidated financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the Company’s financial position, results of operations and cash flows. The results of operations for the three and nine months ended September 30, 2012 are not necessarily indicative of the results of operations for the year ending December 31, 2012. The balance sheet at December 31, 2011 has been derived from the audited consolidated financial statements at that date. The unaudited interim financial statements and footnotes do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

The principal accounting policies adopted in the preparation of these consolidated financial statements are set out below:

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“US GAAP”). The consolidated financial statements include the financial statements of the Company, its wholly-owned subsidiaries Poise Profit, CER Hong Kong, Hi-tech, CER Shanghai, and CER Yangzhou; and its variable interest entity (“VIE”) Shanghai Engineering. All significant inter-company transactions and balances among the Company, its subsidiaries and VIE are eliminated upon consolidation.

In accordance with U.S. GAAP, variable interest entities are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders lack adequate decision making ability. Each variable interest entity with which the Company is affiliated must be evaluated to determine who the primary beneficiary of the risks and rewards of ownership of the variable interest entity. The primary beneficiary is required to consolidate the variable interest entity's financial information for financial reporting purposes.

Management has concluded that Shanghai Engineering is a variable interest entity and that CER Hong Kong is the primary beneficiary thereof. Pursuant to the contractual arrangements described elsewhere in this filing on Form 10-Q, the Company recovers substantially all of the profits of its VIE through service fees charged (particularly under a consulting and service agreement) and has the unilateral ability to do so through its wholly owned subsidiaries. Through such contractual arrangements, the Company (as applicable, through wholly-owned subsidiaries) has the power to direct the activities most significant to the economic performance of the VIE and absorbs all, or substantially all, of the profits or losses. Accordingly, the Company is the primary beneficiary of such arrangements. Under the requirements of the FASB’s accounting standard regarding VIEs, the Company consolidates the financial statements of Shanghai Engineering.

Under the contractual arrangements with Shanghai Engineering, the Company has the power to direct its activities, and can have assets transferred freely out of the entity without any restrictions. Therefore the Company considers that there is no asset of the consolidated VIE that can be used only to settle obligations of the VIE, except for registered capital and PRC statutory reserves of the VIE amounting to a total of $1.43 million as of September 30, 2012. As the consolidated VIE is incorporated as a limited liability company under the PRC Company Law, creditors of the VIE do not have recourse to the general credit of the Company for any of the liabilities of the consolidated VIE, which at September 30, 2012 consisted of receipts in advance of $6.6 million, payables to suppliers and agents of $10.1 million, and other accrued liabilities of $2.2 million, totaling $18.9 million. As of September 30, 2012, the VIE held a cash balance of $61,050. Currently there is no contractual arrangement that could require the Company to provide additional financial support to the consolidated VIE. As the Company is conducting certain business in the PRC mainly through the VIE, the Company may provide such support on a discretionary basis in the future, which could expose the Company to a loss.

(b) Use of estimates

In preparing financial statements in conformity with US GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reported periods. Significant estimates include useful lives of equipment, allowances for doubtful accounts, deferred tax assets and related valuation allowances, and the completion percentage of construction contracts.  Actual results could differ from those estimates.

(c) Concentrations of risk

The Company maintains cash balances at financial institutions within the U.S., Hong Kong, and PRC. Balances at financial institutions or state owned banks within the PRC are not covered by insurance. Balances at financial institutions within the United States are covered by the Federal Deposit Insurance Corporation for $250,000 per depositor per institution. Balances at financial institutions within Hong Kong are insignificant. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risks on its cash in bank accounts.

For the three months ended September 30, 2011 and 2012, the Company’s five top customers accounted for 87% and 73% of the Company's sales, respectively. For the nine months ended September 30, 2011 and 2012, the Company’s five top customers accounted for 73% and 57% of the Company's sales, respectively. Receivables from these five top customers were 56% and 69% of total accounts receivable at September 30, 2011 and 2012, respectively. Among those customers, the two largest customers were Ningbo Xinfu and Wuxi Green. Ningbo Xinfu accounted for 19% of revenue for the nine months ended September 30, 2012 and 0% of receivables as of September 30, 2012. Wuxi Green accounted for 12% of revenue for the nine months ended September 30, 2012 and 0% of receivables as of September 30, 2012.

For the three months ended September 30, 2011 and 2012, the five top suppliers provided approximately 23% and 26% of the Company's purchases of raw materials, respectively. For the nine months ended September 30, 2011 and 2012, the five top suppliers accounted for approximately 25% and 18% of the Company's purchases of raw materials, respectively. Payables to these five suppliers were approximately 13% and 15.1% of total accounts payable at September 30, 2011 and 2012, respectively.

The Company's operations are carried out in the PRC. Accordingly, the Company's business, financial condition and results of operations may be influenced by the political, economic and legal environments in the country, and by the general state of the country's economy. The Company's operations in the PRC are subject to specific considerations and significant risks not typically associated with companies carrying out operations in the United States. These include risks associated with, among others, the political, economic and legal environments in the PRC and foreign currency exchange. The Company's results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.

(d) Foreign currency translation

The reporting and functional currency of the parent Company and of CER Hong Kong is the U.S. dollar. Our subsidiaries Shanghai Engineering, CER Shanghai, and CER Yangzhou use the Chinese yuan Renminbi ("RMB") as their functional currency. Results of operations are translated at average exchange rates during the period, and assets and liabilities are translated at the end of period exchange rates. Cash flows are also translated at average exchange rates for the period, therefore, amounts reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet. Translation adjustments resulting from this process are included in accumulated other comprehensive income (loss) in stockholders' equity. For the three months ended September 30, 2011 and 2012, foreign currency translation gains amounted to $458,788 and to $344,248, respectively. For the nine months ended September 30, 2011 and 2012, foreign currency translation gains amounted to $766,370and to $120,696, respectively.

Transaction gains and losses that arise from exchange rate fluctuations from transactions denominated in a currency other than the functional currency are included in the consolidated statements of operations and other comprehensive income (loss) as incurred within “non-operating income (expenses), net.”

The PRC government imposes significant exchange restrictions on fund transfers out of the PRC that are not related to business operations. These restrictions have not had a material impact on the Company because it has not engaged in any significant transactions that are subject to the restrictions.

Accumulated other comprehensive income amounted to $1,286,126 and $1,406,822 as of December 31, 2011 and September 30, 2012, respectively. The balance sheet accounts with the exception of equity at December 31, 2011 and September 30, 2012 were translated at RMB6.30 to $1.00 and RMB6.28 to $1.00 respectively.

The average translation rates applied to income and cash flow statement amounts for the three months ended September 30, 2011 and 2012 were RMB6.40 to $1.00 and RMB6.35 to $1.00 respectively. For the nine months ended September 30, 2011 and 2012, the average translation rates were RMB6.49 to $1.00 and RMB6.33 to $1.00, respectively.

(e) Cash and restricted cash

Cash includes cash on hand and demand deposits with banks, which are unrestricted as to withdrawal and use, and which have original maturities less than three months.

Restricted cash represents a cash portion of the guaranty for the bids on contracts and is deposited in a separate bank account subject to withdrawal restrictions controlled by the customer to secure the Company’s performance of the project in process. The deposit cannot be drawn or transferred by the Company until the restriction period has expired. The Company also classified certain cash as restricted that is not available for immediate use due to its collateralization on certain short term borrowings and notes payable, etc.

(f) Notes receivable

Notes receivable represent trade accounts receivable due from various customers where the customers’ banks have guaranteed the payment of the receivables. The notes are non-interest bearing and normally paid within three to six months. The Company has the ability to submit a request for payment to the customer’s bank earlier than the scheduled payment date, but will incur an interest charge and a processing fee. 

(g) Receivables and allowances for doubtful accounts

Receivables include trade accounts due from customers and revenues earned in excess of amounts billed on EPC contracts (unbilled receivables). Pursuant to ASC Topic 850, such amounts attributable to related parties are separately presented in the balance sheet. Management regularly reviews the aging of receivables and changes in payment trends, and records a reserve when collection of amounts due is at risk.  

Accounts receivable which are expected to be collected after one year are reclassified as long-term accounts receivable.  The provision for accounts receivable balances described above is further described in Note 3.

(h) Inventories

Inventories are comprised of raw materials, work in progress and finished goods and are stated at the lower of cost or market value. Costs of work in progress include direct labor, direct materials, and production overhead before the goods are ready for sale. Management reviews inventories for obsolescence or cost in excess of market value periodically. The obsolescence, if any, is recorded as a reserve against the inventory. The cost in excess of market value is written off and recorded as cost of revenues.

(i) Advances on purchases

Advances on purchases are money advanced to outside vendors for inventory purchases and property, plant and equipment purchases. This amount is refundable and bears no interest.

(j) Property, plant and equipment, net

Property, plant and equipment are stated at cost. Depreciation is calculated principally by use of the straight-line method over the estimated useful lives of the related assets. Expenditures for maintenance and repairs, which do not improve or extend the expected useful lives of the assets, are charged to operations as incurred, while renewals and betterments are capitalized.

Management established a 5% residual value for property, plant and equipment. The estimated useful lives of the property, plant and equipment are as follows:

The gain or loss on disposal of property, plant and equipment is the difference between the net sales proceeds and the carrying amount of the relevant assets’, gains or losses, if any, and are recognized in the consolidated statement of income and other comprehensive income. There were no disposals of assets during the three and nine months ended September 30, 2012. During the three and nine months ended September 30, 2011, the Company disposed of machinery with a carrying value of $37,949 and two cars with carrying value of $39,646 and recognized loss for disposal of $52,732 from the transactions.

(k) Impairment of assets

The Company assesses the carrying value of long-lived assets each reporting period, more often when factors indicating impairment are present, and reduces the carrying value of such assets by the amount of the impairment. The Company determines the existence of such impairment by measuring the expected future cash flows (undiscounted and without interest charges) and comparing such amount to the net asset carrying value. An impairment loss, if it exists, is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Fair value generally means based on either quoted market price, if available, or discounted cash flow analysis. There were no impairments of long lived assets recognized for the three and nine months ended September 30, 2011 and 2012.

(l) Advances from customers

Advances from customers represent amounts advanced by customers on product or service orders. The product (service) is shipped (rendered) within one year after receipt of the advance payment, and the related sales are recognized in accordance with the Company’s revenue recognition policy.

(m) Income taxes

Income taxes are accounted for under the asset and liability method. Deferred income taxes are recognized for temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements, net operating loss carry forwards and credits, by applying enacted statutory tax rates in the year in which those temporary differences are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Current income taxes are provided for in accordance with the laws of the relevant taxing authorities.

In assessing uncertain tax positions, the Company applies a more likely than not threshold and a two-step approach for the tax position measurement and financial statement recognition. For the two-step approach, the first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is greater than 50% likely to be realized upon settlement. As of September 30, 2012, the Company does not have any uncertain tax positions required to be recognized and measured under the accounting standard for income taxes.

(n) Value added tax

Sales revenue represents invoiced values, net of a value-added tax ("VAT"). All of the Company's products that are sold in the PRC are subject to a Chinese value-added tax at a rate of 17% of the gross sales price. This VAT may be offset by VAT paid by the Company on raw materials and other materials. The Company records VAT payable and VAT receivable, net of payments, in the financial statements. The VAT tax return is filed offsetting the payables against the receivables.

(o) Operating leases

Leases where substantially all the rewards and risks of ownership of assets remain with the leasing company are accounted for as operating leases. Payments made under operating leases are charged to the statement of operations and comprehensive (loss) income on a straight line basis over the lease periods.

(p) Stock based compensation

In accordance with ASC 718, Compensation-Stock Compensation , the Company measures the cost of employee services received in exchange for stock based compensation at the grant date fair values of the awards.

The Company recognizes stock based compensation costs, net of a forfeiture rate, on a straight-line basis over the requisite service period for each award. ASC 718 requires forfeitures to be estimated at the time of grant and revised in subsequent periods if actual forfeitures differ from those estimates.  There were no stock options granted in the three and nine months ended September 30, 2011 and 2012.

Cost of goods acquired or services received from non-employees is measured based on the fair value of the awards issued on the measurement date as defined in ASC 505, “ Equity .” Awards granted to non-employees are remeasured at each reporting date using the fair value as at each period end. Changes in fair values between the interim reporting dates are attributed consistent with the method used in recognizing the original stock based compensation costs.

(q) Shipping and handling costs

Shipping and handling costs are included in selling, general and administrative expenses which totaled $301,735 and $138,133 for the three month periods ended September 30, 2011 and 2012, respectively, and $410,108 and $285,422 for the nine month periods ended September 30, 2011 and 2012, respectively.

(r) Revenue recognition

The Company derives revenues principally from:

In accordance with the accounting standard regarding performance of construction-type and certain production-type contracts, and long-term construction-type contracts, the Company adopted the percentage of completion method to recognize revenues and cost of sales for EPC contracts. EPC contracts are long-term, complex contracts involving multiple elements, such as design, manufacturing and installation, which all form one integral EPC project. The energy recovery system involved in an EPC project is highly customized to the specific customer's facilities and essentially not transferable to any other facilities without significant modification and cost. It would be difficult, if not impossible, to beneficially use a single element of a specific EPC project on a standalone basis other than in connection with the facilities for which it was intended. EPC contracts are by nature long-term construction-type contracts, usually lasting more than one accounting period, and the Company is able to reasonably estimate the progress toward completion, including contract revenues and contract costs. EPC contacts specify the customers' rights to the goods, the consideration to be paid and received, and the terms of payment. Specifically, the Company has the right to require a customer to make progress payments upon completion of determined stages of the project which serve as evidence of the customer's approval and acceptance of the work completed to date as complying with the terms of the particular EPC contract.

Sales of the Company's energy recovery systems and related products are essentially product sales. The products consist mainly of waste heat boilers and other related equipment manufactured according to specific customers' specifications. Once manufactured, the Company ships the products to its customers in their entirety in one batch. The Company’s service arrangement also includes a limited warranty to its customers pursuant to which the customers retain between 5% and 10% of the particular contract price as retainage during the limited warranty period (usually 12-18 months). The Company generally recognizes revenues including retainage from product sales when (i) persuasive evidence of an arrangement exists, which is generally represented by a contract between the Company and the customer; (ii) products are shipped; (iii) title and risks of ownership have passed to the customer, which generally occurs at the time of delivery; (iv) the customer accepts the products upon a quality inspection performed by them; (v) the purchase price is agreed to between the Company and the customer; and (vi) collectability is reasonably assured. Net revenues represent the invoiced value of products, less returns and discounts, and are net of value-added tax.

In providing design services, the Company designs energy recovery systems and other related systems based on a customer's requirements and the deliverable consists of engineering drawings. The customer may elect to engage the Company to manufacture the designed system or choose to present the Company's drawings to other manufacturers for manufacturing and installation. The Company recognizes revenues from design services when the services are provided, the design drawings are delivered, invoices are issued and collectability is reasonably assured. The Company generally delivers the drawings in one batch.

 (s) Fair value of financial instruments

The accounting standard regarding fair value measurements defines financial instruments and requires fair value disclosures for those financial instruments. The fair value standard also establishes a three-level valuation hierarchy for disclosures of fair value measurement and enhances disclosure requirements for fair value measurements. The carrying amounts reported in the accompanying consolidated balance sheets for current assets and current liabilities such as cash, restricted cash, accounts and notes receivable, long term accounts receivable, short term loans, accounts payable, and other payables qualify as financial instruments. Management concluded the carrying values of these financial instruments are reasonable approximations of their respective fair values because of the short period of time between the origination of such instruments and their expected realization and the current market rates of interest. The three levels of the valuation hierarchy are defined as follows:

The measurement basis for current assets and current liabilities such as cash, restricted cash, accounts and notes receivable, long term accounts receivable, short term loans, accounts payable, and other payables is carrying value, which approximates fair value. All such current assets and liabilities with the exception of cash and restricted cash (Level 1) and short term loans (Level 2) would be classified as Level 3 measurements due to the presence of Company-specific unobservable inputs. The following table presents information about the company’s fair value financial liabilities classified as Level 2 and Level 3 as of December 31, 2011 and September 30, 2012.

A summary of changes in the Level 2-classified guaranty contract liability related to Zhejiang Kailin project (Note 16) for the year ended December 31, 2011 and for the nine months ended September 30, 2012 is as follows:

For the three and nine months ended September 30, 2012, the Company recorded change in fair value of guaranty contract liability of $26,635 and $54,700, respectively.

A summary of changes in the Level 3-classified derivative liabilities related to stock purchase warrants and a loan for the year ended December 31, 2011 and for the nine months ended September 30, 2012 is as follows:

For the three and nine months ended September 30, 2012, the Company recorded $4,651 and $35,892 fair value change of derivative liability respectively.

(t) Segment reporting

The Group reports its segments in accordance with ASC 280. The Group primarily operates in China and measures its business as a single operating segment. All of the group’s long term assets are located in China.

(u) Subsidy income

The Company, in connection with its occupancy and use of certain industrial park land, receives from time to time certain subsidies wholly at the discretion of the management authority of a third party research and development fund related to the industrial park which are not tied to future tenancy or performance by the Company; receipt of such subsidy income is not contingent upon any further actions or performance by the Company and the amounts do not have to be refunded under any circumstances. These amounts are not tied to land use rights or any other transactions. Upon receipt, these incentives are recognized within other income (loss) in the consolidated statements of operations and other comprehensive (loss) income.

(v) Restatements and reclassifications

The Company, effective with the annual 2011 financial statements included in Form 10-K, reclassified its presentation of revenue and costs of revenue in the consolidated statements of (loss) income and other comprehensive (loss) income to depict EPC revenue attributable to third party customers, EPC revenue attributable to related parties, and product revenue given the growth in the number and per-contract revenue associated with EPC contracts and 2011 amounts have been reclassified to conform to the current presentation.

On March 30, 2012 the Company filed, on Form 8-K, a report announcing the restatement of its unaudited quarterly financial statements for the first three quarters of 2011. The root cause of the necessary adjustments to the quarterly interim unaudited financial information for the first three quarters of 2011 was identified during the preparation of the Company’s annual 2011 financial statements as reported in Form 10-K filed March 30, 2012. The Company determined that transaction losses resulting from variations in foreign currency exchange rates on certain purchase transactions denominated in U.S. dollars involving the Company’s onshore PRC subsidiaries (which use the yuan renminbi, or RMB as their functional currency) were incorrectly classified as translation losses and were incorrectly included in other comprehensive income (loss). These losses should have been reported in the statement of operations within other income (expense). Such transaction losses only impacted the first three quarters of 2011 as the underlying business activity involving purchasing of raw materials related to the Group’s then-under-construction Yangzhou production facility started in 2011 and was substantially completed by the end of 2011. The transaction losses arose as a result of cash advances made for purchase transactions in which goods were acquired outside of mainland China and imported to the Company’s onshore PRC subsidiaries. Continued weakening of the U.S. dollar against the RMB led to a decrease in the RMB value of purchased goods subsequently received relative to the asset already recorded for the refundable purchase advance made in cash.

Accordingly, the Company undertook further evaluation to identify and quantify the necessary adjustments to restate the previously issued unaudited financial information for the first three quarters of 2011. Adjustments were limited to the change in classification of foreign exchange transaction losses from other comprehensive income to non-operating income (loss), net in the consolidated unaudited statement of operations. Such adjustments were reported in amended Forms 10-Q for the first three quarters of 2011 filed with the SEC on May 15, 2012. The comparative amounts for 2011 included in this Form 10-Q reflect the restated financial information.

(w) Recent accounting pronouncements

In December 2011, the FASB issued ASU 2011-11,  Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities  (ASU 2011-11). This newly issued accounting standard requires an entity to disclose both gross and net information about instruments and transactions eligible for offset in the statements of financial position as well as instruments and transactions executed under a master netting or similar arrangement and was issued to enable users of financial statements to understand the effects or potential effects of those arrangements on their financial position. This ASU is required to be applied retrospectively and is effective for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. As this accounting standard only requires enhanced disclosure, the adoption of this standard is not expected to have an impact on the Company’s financial position.

Current receivables also include revenue recognized in excess of amounts billed for EPC contracts. As of December 31, 2011 and September 30, 2012, revenue recognized in excess of amounts billed amounted to approximately $18,085,048 and $ 18,791,747, respectively.

The Company classifies accounts receivable and revenue recognized in excess of amounts billed which are to be collected after one year as long-term accounts receivable.

Long-term accounts receivable, net, which are presented in the below table net of the discounting effect for interest (see Note 16 for further description), included revenue recognized in excess of amounts billed of approximately $0 and $7,687,761 as of December 31, 2011 and September 30, 2012, respectively.

Long-term accounts receivable consisted of two customers, Zhenjiang Kailin and Jiangsu SOPO, for both periods presented.

CER and Zhenjiang Kailin, a related party, agreed to revise the payment schedule of receivables related to a project originally entered into in January 2011, which was completed on May 31, 2012, from all remaining amounts due by August 31, 2012 to 4 installments due by December 31, 2013 with no interest to be earned (refer to note 16 for more details about the Zhenjiang Kailin receivable collection schedule).

A reconciliation of the accounts receivable (including both current and non-current portions) from Zhenjiang Kailing and the amount from collection schedule as at September 30, 2012 is as follows:

In August 2012, based on developments subsequent to the balance sheet date, including communication with Zhenjiang Kailin, it was determined that the first payment would be delayed to December 2012. Zhenjiang Kailin only begun to generate cash flow commencing in May 2012 due to the delayed opening of its facility following CER’s completion thereof and required extra time to pay by December 2012. There were no other payment installments that were subject to delay, and based upon an evaluation of all the facts and circumstances the Company determined that it expected to fully collect all amounts due over the revised payment schedule incorporating the December extension of the first installment. After considering the further extension of the first installment payment to December 31, 2012, the Company reassessed the discount impact applicable to this payment extension using the original interest rate of 10.65% (which considered the risk free rate and Zhenjiang Kailin’s credit risk). As of September 30, 2012, the accounts receivable (including both current and non-current portions) from Zhenjiang Kailin under the contract was $14,396,913 after discounting for the time value of money pursuant to applicable accounting guidance (the discount rate was determined as 10.65% considering the risk free rate and Zhenjiang Kailin’s credit risk). The discount reflected as a reduction to revenue in the statement of operations arising from this extension of payment terms was $0 and $1,703,369 for the three and nine months ended September 30, 2012; the accretion for interest income included in interest income was $661,093. Of the total balance of $14,396,913, $2,951,128 represented the non-current balance due from Zhenjiang Kailin which is to be collected over one year; the remaining $11,445,785 is included in current receivables due from a related party.

Long term accounts receivable, net due from third party of $4,736,633 represents a balance due from Jiangsu SOPO. On October 18, 2011, CER signed a contract for the manufacture, design, and installation of a major dock storage and tube project with Jiangsu SOPO, a third party customer of CER and related party of Zhenjiang Kailin. The contract was originally valued at RMB 50 million (approximately $7.9 million), including the procurement part of RMB 40 million (approximately $6.3 million) and construction part of RMB 10 million (approximately $1.6 million). Due to the strong relationship between CER and Jiangsu SOPO, CER was retained as the contractor, and was allowed to sub-contract substantially all of the work to a third party sub-contractor. Jiangsu SOPO has agreed to CER’s retention of 10% as a profit margin (based upon the contract value), or approximately an 11% markup on costs of the project. CER has concluded that gross recognition of the revenue is appropriate as it is the primary obligor and certain of the costs represent CER product.

On April 15, 2012, CER and Jiangsu SOPO entered into a repayment agreement. Pursuant to the agreement, the total contract price will be allocated 90% to the subcontractor and CER earns the remaining 10% margin. The project has been fully completed by the end of June 2012. The current best estimate of the total contract price is RMB 57.1 million (approximately $9 million) based upon project completion and discussions with Jiangsu SOPO, and this amount is the basis for the repayment agreement. Jiangsu SOPO will pay the project price of RMB 57.1 million (approximately $9 million), plus interest over time of RMB 6.4 million (approximately $1 million), for a total of RMB 63.5 million (approximately $10 million) in exchange for an extension of the payment terms involving 36 installments due on a monthly basis starting from May, 2012. The discount rate used to discount these receivable cash flows under the applicable accounting guidance for Jiangsu SOPO was 8% (considering its stated-owned background and AA credit rating), which is same as the contractual rate of interest included in the contract. For the three and nine months ended September 30, 2012, $0 and $8,259,628 in revenue was recognized in relation to this EPC project, respectively, and the accretion of interest income was $250,190, as further described in Note 14. The receivable from Jiangsu SOPO as of September 30, 2012 was $7,605,077, among which $4,736,633 was classified as long-term accounts receivable.

Both of the arrangements described above regarding extensions of payment terms for these two particular customers were originally recognized in the March 31, 2012 balances and revenue for the quarter then ended as the underlying facts and circumstances leading to the arrangements existed, or were in the early stages of negotiation, at that time. With respect to the additional discount reflected in revenue for the Zhenjiang Kailin project due to the extension of the August 2012 payment to December 2012, such adjustment was reflected in revenue for the quarter ended June 30, 2012 as it related to facts and circumstances which likely existed at June 30, 2012.

For the three months ended September 30, 2011 and 2012, no accrual for inventory provision was required. For the nine month periods ended September 30, 2011 and 2012, the Group accrued inventory provisions of $26,621 and $0, respectively, through charges to income.

Depreciation expense for the three months ended September 30, 2011 and 2012 was $450,730, and $398,971, respectively. Depreciation expense for the nine months ended September 30, 2011 and 2012 was $949,145, and $1,187,929, respectively.

Intangible assets mainly represent purchases of land usage rights in Yangzhou where the Company’s sole manufacturing plant is located and software. The Company obtained the usage title of its first land parcel in December 2009. The land use right was recorded at cost of $2,438,632 and is being amortized over the lease term of 50 years starting from November 2009 when it was acquired and the software is being amortized over 3 years. In July 2011, the Company obtained the usage title of another parcel of land. The land use right was recorded at cost of $2,331,869 and is being amortized over the lease term of 50 years starting from July 2011. Amortization expense for intangible assets recorded for three months ended September 30, 2011 and 2012 amounted to $30,785 and $40,610, respectively. Amortization expense for intangible assets recorded for the nine months ended September 30, 2011 and 2012 amounted to $64,940 and $128,958, respectively.

Note 7 – Short Term Loans

Short-term borrowings and letter of credit

A tabular reconciliation of the Company’s short term borrowings including balances outstanding at December 31, 2011 and September 30, 2012 and activity during the period (including letters of credit) is as follows. Where borrowings are denominated in Renminbi, the U.S. dollar outstanding balance at the respective period end, translated at the applicable period-end exchange rate, is included in the tabular presentation.