Note 2 - Summary of Significant Accounting Policies

9 Months Ended

Sep. 30, 2011

Significant Accounting Policies [Text Block]

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial statements and with the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly, they may not contain all information and notes required by GAAP for complete financial statements. The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. In the opinion of management, all adjustments necessary (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011. The condensed balance sheet as of December 31, 2010 has been derived from the Company’s audited financial statements as of that date, but does not include all of the information and notes required by GAAP for complete financial statements. For further information refer to the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, filed with the Securities and Exchange Commission (“SEC”) on March 30, 2011, and updated, as necessary, in this Quarterly Report on Form 10-Q.

Consolidation Policy

The accompanying consolidated balance sheets and consolidated statements of operations, stockholders’ equity, and cash flows for the quarter ended September 30, 2011, include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of 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. These estimates and assumptions include valuing equity securities and derivative financial instruments issued as consideration in business combinations and/or in financing transactions and in share based payment arrangements, accounts receivable reserves, deferred taxes and related valuation allowances, allocating the purchase price to the fair values of assets acquired and liabilities assumed in business combinations (including separately identifiable intangible assets and goodwill) and estimating the fair values of long lived assets to assess whether impairment charges may be necessary. Certain of the Company’s estimates, including accounts receivable and the carrying amounts of intangible assets could be affected by external conditions including those unique to our industry and general economic conditions. It is reasonably possible that these external factors could have an effect on its estimates that could cause actual results to differ from our estimates. The Company re-evaluates all of its accounting estimates at least quarterly based on these conditions and record adjustments, when necessary.

Cash and Cash Equivalents

The Company considers all highly liquid investments with a maturity of three months or less to be cash equivalents.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to a concentration of credit risk consist principally of cash and cash equivalents. The Company places its cash with one financial institution. Accounts are guaranteed by the Federal Deposit Insurance Corporation up to $250,000. At times, balances may exceed federally insured limits.

Goodwill and Intangible Assets

The Company accounts for goodwill and intangible assets in accordance with Accounting Standards Codification (“ASC”) 350, Intangibles - Goodwill and Other (“ASC 350”). ASC 350 requires that goodwill and other intangibles with indefinite lives should be tested for impairment annually or on an interim basis if events or circumstances indicate that the fair value of an asset has decreased below its carrying value.

Goodwill represents the excess of the purchase price over the fair value of net assets acquired in business combinations. GAAP requires that goodwill be tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests when circumstances indicate that the recoverability of the carrying amount of goodwill may be in doubt. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value. Significant judgment is required to estimate the fair value of reporting units including estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value and/or goodwill impairment. Upon consideration of our operations, the Company has determined that it operates a single reporting unit.

The Company’s business includes one goodwill reporting unit. It annually reviews goodwill for possible impairment by comparing the fair value of the reporting unit to the carrying value of the assets. If the fair value exceeds the carrying value of net asset, no goodwill impairment is deemed to exist. If the fair value does not exceed the carrying value, goodwill is tested for impairment and written down to its implied fair value if it is determined to be impaired. We determined that goodwill was not impaired as of September 30, 2011.

The Company’s amortizable intangible assets consist of acquired subscriber bases. These costs are being amortized using the straight-line method over their estimated useful lives. The Company amortizes customer relationships on a straight line basis over a 36 to 48 month estimated useful life.

The Company reviews the carrying value of intangibles and other long-lived assets for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets is measured by comparing the carrying amount of the asset or asset group to the undiscounted cash flows that the asset or asset group is expected to generate. If the undiscounted cash flows of such assets are less than the carrying amount, the impairment to be recognized is measured by the amount by which the carrying amount of the property, if any, exceeds its fair market value. The Company intends to re-evaluate the carrying amounts of our amortizable intangibles at least quarterly to identify any triggering events. As described above, if triggering events require the Company to undertake an impairment review, it is not possible at this time to determine whether it would be necessary to record a charge or if such charge would be material.

Revenue Recognition

The Company’s revenue is recognized when the following criteria are met: (1) persuasive evidence of an arrangement exists, (2) delivery or performance has occurred, (3) the fee is fixed or determinable, and (4) collectability of the sale is reasonably assured.

The Company charges a recurring subscription fee for providing its various Internet access and VoIP services to its subscribers and recognizes revenues when they are earned, which generally occurs as the service is provided. Subscriptions to the services are in the form of one, two, three and five year contracts and are billed monthly, quarterly, semi-annually or annually in advance. Payments received in advance for subscriptions are deferred and recognized as the services are provided. Deferred revenues for payments received in advance of subscription services amounted to $259,264 and $253,596 at September 30, 2011 and December 31, 2010, respectively. For the satellite video business in which the Company is a retailer of video services from DISH Network Corporation (“DISH”), the Company recognizes revenues at the time of installation.

Income Taxes

The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

As of December 31, 2010, the Company had approximately $23,238,000 and $17,377,000 of federal and state net operating loss carryovers (“NOLS”) which begin to expire in 2025. The net operating loss carryovers may be subject to limitation under Section 382 of the Internal Revenue Code should there be a greater than 50% ownership change as determined under the applicable regulations.

Management prepared an analysis of the Company’s stock ownership activity from November 2007 through March 2011 and concluded that no ownership change occurred prior to December 31, 2010, but an ownership change did occur in March 2011 with the result being that our ability to use $23,000,000 of federal and state NOL carryforwards is subject to an annual limitation.

In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax strategies in making this assessment. Based on this assessment, management has established a full valuation allowance against all of the deferred tax assets for every period, since it is more likely than not that all of the deferred tax assets will not be realized.

The Company accounts for uncertain tax positions based upon authoritative guidance that prescribes a recognition and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return (ASC 740-10). The guidance also provides direction on derecognition and classification of interest and penalties. Management has evaluated and concluded that there are no material uncertain tax positions requiring recognition in the financial statements for any of the periods presented. The Company files a federal income tax return as well as income tax returns in eight state jurisdictions in the United States. The tax years ended December 31, 2007 through 2009 remain subject to examination for federal, state and local income tax purposes as of Decembers 31, 2010.

The Company’s policy is to classify assessments, if any, for tax related interest as interest expense and penalties as tax expense

Net Loss per Common Share

Basic net loss per common share is computed by dividing the net loss by the weighted average number of common shares outstanding. Diluted net income per share is computed by dividing net income, if any, by the sum of the weighted average number of common shares outstanding and the dilutive potential common share equivalents then outstanding. Potential common share equivalents consist of the weighted average number of shares issuable upon the exercise of outstanding stock options and warrants to acquire common stock, and shares issuable upon conversion of convertible debt. If the Company generates net income and these potential common share equivalents are dilutive, the Company computes diluted net income per share using the treasury stock method.

Due to the fact that the Company has incurred net losses for the three and nine months ended September 30, 2011, weighted average common share equivalents of 58,835,166 and 51,169,685, respectively, are not included in the calculation of diluted net loss per common share because they are anti-dilutive.

The table of all of our common stock equivalents is as follows:

	September 30,
	2011		2010

Common stock purchase warrants		4,750,494		3,657,161
Warrants to purchase convertible Series A preferred stock - convertible into common stock on a 1 for 1 basis		10,300,000		-
Stock options		2,484,344		1,245,723
Convertible note convertible into Series A Preferred Stock - convertible into common stock on a 1 for 1 basis		3,466,667		-
Convertible Series A preferred stock- convertible into common stock on a 1 for 1 basis		16,811,225		20,000,000
		37,812,730		24,902,884

The numerator in the diluted loss per share calculation for the three months ended September 30, 2010 gives effect to addbacks of (1) $542,466 of contractual interest expense under our convertible notes, and (2) $542,566 of accretion of discount under the convertible notes (recorded as interest expense) and (3) the elimination of the $4,458,953 change in the fair value of the derivative liability associated with the conversion option embedded in our convertible notes. The number of shares included in the presentation of diluted loss per share for the three months ended September 30, 2010 includes (1) 641,456 employee stock options and (2) 231,785 common stock purchase warrants, each with exercises prices that are less than the average share price of $0.51 per share for the three months ended September 30, 2010 and (3) 20,000,000 shares of common stock underlying the conversion option embedded in our convertible notes described in Note 7.

The numerator in the diluted loss per share calculation for the nine months ended September 30, 2010 gives effect to addbacks of (1) $782,466 of contractual interest expense under our convertible notes, and (2) $1,392,868 of accretion of discount under the convertible notes (recorded as interest expense) and (3) the elimination of the $12,207,767 change in the fair value of the derivative liability associated with the conversion option embedded in our convertible notes. The number of shares included in the presentation of diluted loss per share for the nine months ended September 30, 2010 includes (1) 1,873,785 employee stock options and (2) 656,456 common stock purchase warrants, each with exercises prices that are less than the average share price of $1.04 per share for the nine months ended September 30, 2010 and (3) 20,000,000 shares of common stock underlying the conversion option embedded in our convertible notes as described in Note 7.

The adjustment for employee stock options was calculated using the treasury stock method and the adjustment for the conversion option embedded in our notes was calculated using the “if converted” method.

Share-Based Payments

The Company accounts for all share based payments in accordance with ASC 718, Compensation — Stock Payments which results in the recognition of expense under applicable GAAP and requires measurement of compensation cost for all share based payment awards at fair value on the date of grant and recognition of compensation expense over the service period for awards expected to vest. The Company calculates the fair value of stock options using the Black-Scholes option pricing model. The fair value of restricted stock is determined based on the number of shares granted and the fair value of our common stock on date of grant. The recognized expense is net of expected forfeitures.

Common Stock Purchase Warrants and Derivative Financial Instruments

The Company classifies all of its common stock purchase warrants and derivative financial instruments as equity if the contracts (1) require physical settlement or net-share settlement or (2) give the Company a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement). The Company classifies as assets or liabilities any contracts that (1) require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the Company), (2) give the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement), or (3) contracts that contain reset provisions. The Company assesses classification of its common stock purchase warrants and other derivatives at each reporting date to determine whether a change in classification between assets and liabilities is required.

Fair Value Measurements

As defined in Financial Accounting Standards Board (“FASB”) ASC 820, Fair Value Measurements and Disclosures, fair value is based on 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. In order to increase consistency and comparability in fair value measurements, FASB ASC 820 establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels, which are described below:

Level 1

Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities.

Level 2

Other inputs that are observable directly or indirectly, such as quoted prices for similar assets and liabilities or market corroborated inputs.

Level 3

Unobservable inputs that are used when little or no market data is available, which requires the Company to develop its own assumptions about how market participants would value the assets or liabilities.

Determining which category an asset or liability falls within the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosure each quarter. Assets and liabilities measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2010 are summarized as follows:

	Fair Value as of September 30, 2011
	Level 1		Level 2		Level 3		Total

Liabilities
Derivative liability	$	-	$	-	$	167	$	167
Total	$	-	$	-	$	167	$	167

	Fair Value as of December 30, 2010
	Level 1		Level 2		Level 3		Total

Assets
Marketable Securities	$	5,746,612	$	-	$	-	$	5,746,612
Total	$	5,746,612	$	-	$	-	$	5,746,612

Liabilities
Derivative liability	$	-	$	-	$	2,390,515	$	2,390,515
Total	$	-	$	-	$	2,390,515	$	2,390,515

The following table presents the fair value reconciliation of Level 3 liabilities measured at fair value on a recurring basis during the nine months ended September 30, 2011and for the year ended December 31, 2010:

	September 30,			December 31,
	2011			2010
Beginning Balance	$	2,390,515		$	-
Aggregate fair value of derivative issued		14,937			44,792,150
Issuance date charge for difference between fair value of Derivative Instrument		-			(29,792,150	)
Change in fair value of derivative		(173,880	)		(12,609,485	)
Elimination of derivative upon the conversion of related Note into Series A Preferred Stock to paid in capital		(2,231,405	)		-
Ending Balance	$	167		$	2,390,515

The significant assumptions and valuation methods that we used to determine fair value and the change in fair value of the derivative financial instrument at issue are discussed in Note 7.

Recent Accounting Pronouncements

In September 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-08, Intangibles-Goodwill and Other that will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under these amendments, an entity would not be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The amendments include a number of events and circumstances for an entity to consider in conducting the qualitative assessment. The guidance is effective for fiscal years beginning after December 15, 2011 with early adoption permitted. The Company does not expect that the adoption of this update will have a material impact on its consolidated financial statements at this time.

In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income that improves the comparability, consistency, and transparency of financial reporting and increases the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments in this standard require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Under either method, adjustments must be displayed for items that are reclassified from other comprehensive income (“OCI”) to net income, in both net income and OCI. The standard does not change the current option for presenting components of OCI gross or net of the effect of income taxes, provided that such tax effects are presented in the statement in which OCI is presented or disclosed in the notes to the financial statements. Additionally, the standard does not affect the calculation or reporting of earnings per share. For public entities, the amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and are to be applied retrospectively, with early adoption permitted. The Company does not expect the adoption of this standard to have a material impact on its consolidated financial statements.

In May 2011, FASB issued ASU No. 2011-04, Fair Value Measurements (ASC Topic 820). This ASU provides additional guidance on fair value disclosures. This guidance contains certain updates to the measurement guidance as well as enhanced disclosure requirements. The most significant change in disclosures is an expansion of the information required for “Level 3” measurements including enhanced disclosure for: (1) the valuation processes used by the reporting entity; and (2) the sensitivity of the fair value measurement to changes in unobservable inputs and the interrelationships between those unobservable inputs, if any. This guidance is effective for interim and annual periods beginning on or after December 15, 2011, with early adoption prohibited. Other than requiring additional disclosures on the Company’s “Level 3” disclosures, the adoption of this new guidance will not have a material impact on the Company’s consolidated results of operations and financial position.

In December 2010, the FASB issued ASU 2010-29, Business Combinations (ASC Topic 805). The amendment affects any public entity as defined by Topic 805, Business Combinations that enters into business combinations that are material on an individual or aggregate basis. The comparative financial statements should present and disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments are effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The adoption of this standard did not have a material impact on the Company’s consolidated financial position and results of operations.

In December 2010, the FASB issued ASU 2010-28, Intangibles — Goodwill and Other (Topic 350). ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts by requiring an entity to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. This update will be effective for fiscal years beginning after December 15, 2010. The adoption of this standard did not have a material impact on the Company’s consolidated financial position and results of operations.

Other accounting standards that have been issued or proposed by the FASB, SEC and/or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.

KeyOn Communications Holdings Inc. 10-Q