NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

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 or notes required for complete annual financial statements and should be read in conjunction with the AdCare Health Systems, Inc.’s audited consolidated financial statements and notes included in AdCare Health Systems, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2011 (the “Annual Report”). These statements include the accounts of AdCare Health Systems, Inc. (“AdCare”) and its controlled subsidiaries (collectively with 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.

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 nine months ended September 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 or exercisable 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 September 30,
	2012 Restated (Note 2)							2011
(Amounts in 000’s, except per share data)	Income (loss)			Shares (1)	Per Share			Income (loss)			Shares (1)	Per Share
Continuing Operations:
Income (loss) from continuing operations	$	(4,438	)					$	2,938
Net loss attributable to noncontrolling interests	134							748
Basic income (loss) from continuing operations	$	(4,304	)	14,498	$	(0.30	)	$	3,686		11,275	$	0.33
Effect from options, warrants and non-vested shares	—			—				—			1,111
Effect from assumed issuance of convertible shares (2)	—			—				—			938
Diluted net income (loss)from continuing operations	$	(4,304	)	14,498	$	(0.30	)	$	3,686		13,324	$	0.28

Discontinued Operations:
Basic loss from discontinued operations	$	(202	)	14,498	$	(0.01	)	$	(158	)	11,275	$	(0.01	)
Diluted loss from discontinued operations	$	(202	)	14,498	$	(0.01	)	$	(158	)	11,275	$	(0.01	)

Net Income (Loss) Attributable to AdCare:
Basic net income (loss)	$	(4,506	)	14,498	$	(0.31	)	$	3,528		11,275	$	0.32
Diluted net income (loss)	$	(4,506	)	14,498	$	(0.31	)	$	3,528		13,324	$	0.27

	Nine Months Ended September 30,
	2012 Restated (Note 2)							2011
(Amounts in 000’s, except per share data)	Income (loss)			Shares (1)	Per Share			Income (loss)			Shares (1)	Per Share
Continuing Operations:
Loss from continuing operations	$	(6,917	)					$	(2,439	)
Net loss attributable to noncontrolling interests	420							1,090
Basic loss from continuing operations	$	(6,497	)	13,825	$	(0.47	)	$	(1,349	)	9,923	$	(0.14	)
Effect from options, warrants and non-vested shares	—			—				—			—
Effect from assumed issuance of convertible shares (2)	—			—				—			—
Diluted loss from continuing operations	$	(6,497	)	13,825	$	(0.47	)	$	(1,349	)	9,923	$	(0.14	)

Discontinued Operations:
Basic loss from discontinued operations	$	(481	)	13,825	$	(0.03	)	$	(285	)	9,923	$	(0.03	)
Diluted loss from discontinued operations	$	(481	)	13,825	$	(0.03	)	$	(285	)	9,923	$	(0.03	)

Net Loss Attributable to AdCare:
Basic loss	$	(6,978	)	13,825	$	(0.50	)	$	(1,634	)	9,923	$	(0.17	)
Diluted loss	$	(6,978	)	13,825	$	(0.50	)	$	(1,634	)	9,923	$	(0.17	)

(1) The weighted average shares outstanding include retroactive adjustments for the stock dividends paid on October 22, 2012 and October 1, 2011 (See Note 11).

(2) The impact of the conversion of the subordinated convertible notes issued in 2010, 2011 and 2012 were excluded in those periods where the impact would be anti-dilutive.

Intangible Assets and Goodwill

There have been no impairment adjustments to intangible assets and goodwill during the nine months ended September 30, 2012.

Intangible assets consist of the following:

Amounts in (000’s)	Lease Rights			Bed Licenses (included in property and equipment)			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	—			13,670			1,282		14,952
Amortization expense	(802		)	(622		)	—		(1,424		)
Balances, September 30, 2012, net	$	7,658		$	32,512		$	2,471	$	42,641

For the nine months ended September 30, 2012, amortization expense was approximately $0.6 million for bed licenses included in property and equipment. For the nine months ended September 30, 2012 and 2011, amortization expense was $0.8 million and $0.7 million, 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)	$	207	$	267
2013	828		1,069
2014	828		1,010
2015	828		885
2016	828		885
Thereafter	27,101		3,542
	$	30,620	$	7,658

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

Amounts in (000’s)	September 30, 2012 Restated (Note 2)
Balance, December 31, 2011	$	3,600
Deconsolidation of variable interest entities	(1,122		)
Acquired in acquisitions	2,267
Impairment charge	—
Balance, September 30, 2012	$	4,745

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 from 2011 acquisitions that was previously reported as bed licenses included 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.