NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The consolidated financial statements are presented in accordance with accounting principles generally accepted in the United States. These statements include the accounts of AdCare Health Systems, Inc. and its controlled subsidiaries (collectively, “AdCare”, the “Company” or “we”). Controlled subsidiaries include AdCare’s majority owned subsidiaries and variable interest entities (“VIE”) in which AdCare has control as primary beneficiary. A primary beneficiary is the party in a VIE that has both of the following characteristics: (a) The power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (b) The obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.

The Company delivers skilled nursing, assisted living and home health services through wholly owned separate operating subsidiaries. All inter-company accounts and transactions were eliminated in the consolidation. The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the information and notes required for complete annual financial statements and should be read in conjunction with the Company’s audited consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 (the “Annual Report”). In the opinion of the Company’s management, all adjustments considered for a fair presentation are included and are of a normal recurring nature. Operating results for the three and six months ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. Certain prior year amounts have been reclassified to conform to the current year presentation.

As described in the Explanatory Note to this Form 10-Q/A herein and in Note 2, the interim consolidated financial statements for 2012 presented herein have been restated from those previously issued.

Earnings per Share

Basic earnings per share is computed by dividing net income or loss by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is similar to basic earnings per share except net income or loss is adjusted by the impact of the assumed issuance of common shares upon conversion or exercise of convertible securities and the weighted-average number of common shares outstanding includes potentially dilutive securities, such as options, warrants, non-vested shares, and additional shares issuable under convertible notes outstanding during the period when such potentially dilutive securities are not anti-dilutive. Potentially dilutive securities from options, warrants and non-vested shares are calculated in accordance with the treasury stock method, which assumes that proceeds from the exercise of all options and warrants with exercise prices exceeding the average market value are used to repurchase common stock at market value. The incremental shares remaining after the proceeds are exhausted represent the potentially dilutive effect of the securities. Potentially dilutive securities from convertible debt are calculated based on the assumed issuance at the beginning of the period, as well as any adjustment to income that would result from their assumed issuance.

	Three Months Ended June 30,
	2012							2011
(Amounts in 000’s, except per share data)	Income (loss) Restated (Note 2)			Shares (1)	Per Share			Loss			Shares (1)	Per Share
Continuing Operations:
Loss from continuing operations	$	(175	)					$	(4,471	)
Net loss attributable to noncontrolling interests	141							165
Basic income (loss) from continuing operations	$	(34	)	13,463	$	0.00		$	(4,306	)	8,847	$	(0.49	)
Effect from options, warrants and non-vested shares	—			—				—			—
Effect from assumed issuance of convertible shares (2)	—			—				—			—
Diluted net income (loss)from continuing operations	$	(34	)	13,463	$	0.00		$	(4,306	)	8,847	$	(0.49	)

Discontinued Operations:
Basic loss from discontinued operations	$	(170	)	13,463	$	(0.01	)	$	(91	)	8,847	$	(0.01	)
Diluted loss from discontinued operations	$	(170	)	13,463	$	(0.01	)	$	(91	)	8,847	$	(0.01	)

Net Loss Attributable to AdCare:
Basic net loss	$	(204	)	13,463	$	(0.01	)	$	(4,397	)	8,847	$	(0.50	)
Diluted net loss	$	(204	)	13,463	$	(0.01	)	$	(4,397	)	8,847	$	(0.50	)

	Six Months Ended June 30,
	2012							2011
(Amounts in 000’s, except per share data)	Loss Restated (Note 2)			Shares (1)	Per Share			Loss			Shares (1)	Per Share
Continuing Operations:
Loss from continuing operations	$	(2,479	)					$	(5,377	)
Net loss attributable to noncontrolling interests	286							341
Basic loss from continuing operations	$	(2,193	)	12,844	$	(0.17	)	$	(5,036	)	8,806	$	(0.58	)
Effect from options, warrants and non-vested shares	—			—				—			—
Effect from assumed issuance of convertible shares (2)	—			—				—			—
Diluted net loss from continuing operations	$	(2,193	)	12,844	$	(0.17	)	$	(5,036	)	8,806	$	(0.58	)

Discontinued Operations:
Basic loss from discontinued operations	$	(279	)	12,844	$	(0.02	)	$	(126	)	8,806	$	(0.01	)
Diluted loss from discontinued operations	$	(279	)	12,844	$	(0.02	)	$	(126	)	8,806	$	(0.01	)

Net Loss Attributable to AdCare:
Basic net loss	$	(2,472	)	12,844	$	(0.19	)	$	(5,162	)	8,806	$	(0.59	)
Diluted net loss	$	(2,472	)	12,844	$	(0.19	)	$	(5,162	)	8,806	$	(0.59	)

(1) The weighted average shares outstanding includes retroactive adjustments for the stock dividend issued on October 1, 2011 (see Note 10).

(2) The impact of the conversion of the 2010 and 2011 convertible notes were excluded as the impact would be anti-dilutive.

Intangible Assets and Goodwill

There have been no required impairment adjustments to intangible assets and goodwill during the six months ended June 30, 2012.

Intangible assets consist of the following:

Amounts in (000’s)	Lease Rights			Bed Licenses (included in property and equipment) Restated (Note 2)			Bed Licenses - Separable		Total
Balances, December 31, 2011, net	$	8,460		$	22,922		$	1,189	$	32,571
Deconsolidation of Oklahoma Owners	—			(3,458		)	—		(3,458		)
Acquisitions	—			7,297			1,188		8,485
Amortization expense	(535		)	(355		)	—		(890		)
Balances, June 30, 2012, net	$	7,925		$	26,406		$	2,377	$	36,708

For the six months ended June 30, 2012, amortization expense was approximately $355,000 for bed licenses included in property and equipment. There was no amortization of bed licenses for the six months ended June 30, 2011. For the six months ended June 30, 2012 and 2011, amortization expense was $535,000 and $442,000, respectively, for lease rights. Estimated amortization expense for each of the following years ending December 31 is as follows:

(Amounts in 000’s)	Bed Licenses Restated (Note 2)		Lease Rights
2012 (remainder)	$	354	$	534
2013	709		1,069
2014	709		1,010
2015	709		885
2016	709		885
Thereafter	23,216		3,542
Total	$	26,406	$	7,925

The following table summarizes the changes in the carrying amount of goodwill at June 30, 2012 as compared with December 31, 2011:

Amounts in (000’s)	June 30, 2012 Restated (Note 2)
Balance, December 31, 2011	$	3,600
Deconsolidation of variable interest entities	(1,123		)
Acquired in acquisitions	635
Impairment charge	—
Balance, June 30, 2012	$	3,112

Goodwill as previously reported in the 2011 consolidated financial statements was $0.9 million. In 2012, a reclassification adjustment was made to the December 31, 2011 balance sheet to recognize $2.7 million of goodwill from 2011 acquisitions that was previously reported as bed licenses in property and equipment. The Company does not amortize goodwill or indefinite lived intangibles.

Compensated Absences

In 2012, the Company removed the ability for employees to accumulate earned but unused vacation beyond the current calendar year. As a result, vacation time previously accumulated must be used by the employee by December 31, 2012 or it will be forfeited. Management has estimated the potential forfeitures and has adjusted the vacation accrual accordingly.