2. Summary of Significant Accounting Policies

Basis of Consolidation

The consolidated financial statements include the accounts of Response Genetics, Inc. and its wholly owned subsidiary, Response Genetics, Ltd., a Scottish corporation, which was incorporated in November 2006. All significant intercompany transactions and balances have been eliminated in consolidation.

Cash and Cash Equivalents

The Company considers all highly liquid investments with a maturity at date of purchase of three months or less to be cash equivalents. The carrying value of cash equivalents approximates fair value due to the short-term nature and liquidity of these instruments. The Company’s cash equivalents are comprised of cash on hand, deposits in banks and money market investments.

Accounts Receivable

Clinical Accounts Receivable

The Company invoices its clients as specimens are processed and any other contractual obligations are met. The Company’s contracts with clients typically require payment within 45 days of the date of invoice. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its clients to make required payments. The Company specifically analyzes accounts receivable and historical bad debts, client credit, current economic trends and changes in client payment trends when evaluating the adequacy of the allowance for doubtful accounts. Account balances are charged-off against the allowance when it is probable the receivable will not be recovered. To date, the Company’s clients have primarily been large pharmaceutical companies. As a result, bad debts to date have been minimal. Pharmaceutical company accounts receivable as of December 31, 2010 and June 30, 2011 were $1,694,130 and $3,421,048 respectively. There were no allowances for doubtful accounts recorded against these accounts receivable at December 31, 2010 and June 30, 2011.

ResponseDX Accounts Receivable

Response DX accounts receivable are recorded from two primary payors: Medicare, and Private Payors, based upon their respective applicable billing rates. ResponseDX accounts receivable related to Medicare are recorded at established billing rates less an estimated billing adjustment, based on reporting models utilizing historical cash collection percentages and updated for current effective reimbursement factors. Currently the Company determines historical cash collection percentages based on a rolling twelve month average that is calculated quarterly. Management performs ongoing valuations of accounts receivable balances based on management’s evaluation of historical collection experience and industry trends. Based on the historical experience for our Medicare accounts, management has determined that billings over one year are unlikely to be collected. The Company has not recorded an allowance for doubtful accounts of June 30, 2011. During the three months ended June 30, 2010 and June 30, 2011, the Company recorded bad debt expense of $27,772 and $159,713, for the six months ended June 30, 2010 and 2011, the Company recorded bad debt expense of $132,186 and $299,931, respectively.

ResponseDX accounts receivable as of December 31, 2010 and June 30, 2011, consisted of the following:

	December 31, 2010			June 30, 2011
				(Unaudited)
Net Medicare receivable	$	1,092,386		$	883,038
Net Private Payor receivable		2,061,020			2,037,895
Other		—			44,605
		3,153,406			2,965,538
Allowance for doubtful accounts - Medicare		(113,838	)		—
Net ResponseDX accounts receivable	$	3,039,568		$	2,965,538

The receivable for Medicare is net of contractual allowances. The receivables for Private Payors are net of an allowance to reflect the estimated collection percentage established from historical collection data.

Property and Equipment

Property and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are calculated using the double declining balance and straight-line methods over the estimated useful lives of the assets. The Company has determined the estimated useful lives of its property and equipment, as follows:

Laboratory equipment		5 to 7 years
Furniture and Equipment		5 to 7 years
Leasehold Improvements		Shorter of the useful life or the lease term (5 to 7 years)

Maintenance and repairs are charged to expense as incurred. The cost and accumulated depreciation of assets sold or otherwise disposed of are removed from the related accounts and the resulting gain or loss is reflected in the statements of operations. As of December 31, 2010 and June 30, 2011, the Company has capitalized costs related to database software development (see Note 3). The Company has not yet placed this database into service and accordingly has not depreciated this software development cost. The Company intends to place this database software cost into service in 2011 and begin amortizing those costs in accordance with ASC 350-40, Internal-Use Software. The amortization period will be three years using the straight line method.

Revenue Recognition

Pharmacogenomic Revenue

Revenues that are derived from pharmacogenomic testing services provided to pharmaceutical companies are recognized on a contract specific basis pursuant to the terms of the related agreements. Revenue is recognized in accordance with ASC 605, Revenue Recognition, which requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred and title and the risks and rewards of ownership have been transferred to the client or services have been rendered; (3) the price is fixed or determinable; and (4) collectability is reasonably assured.

Revenues are recorded on an accrual basis as the contractual obligations are completed and as a set of assays is processed through the Company’s laboratory under a specified contractual protocol and are recorded on the date the tests are resulted. Certain contracts have minimum assay requirements that, if not met, result in payments that are due upon the completion of the designated period. In these cases, revenues are recognized when the end of the specified contract period is reached.

On occasion, the Company may enter into a contract that requires the client to provide an advance payment for specimens that will be processed at a later date. In these cases, the Company records this advance as deferred revenue and recognizes the revenue as the specimens are processed or at the end of the contract period, as appropriate.

ResponseDX Revenue

The Company recognizes all product revenue from its ResponseDX tests on an accrual basis. ResponseDX and Medicare revenue are recorded at established billing rates less an estimated billing adjustment, based on reporting models utilizing historical cash collection percentages and updated for current effective reimbursement factors. The Company determines historical cash collection percentages based on a rolling twelve month average that is calculated quarterly.

The change from the cash basis to the accrual basis of recording revenue for ResponseDX tests paid by Private Payors in the second quarter of 2010 resulted in, a one-time adjustment to increase revenue by $1,507,187, which represents the amount of ResponseDX tests completed in prior periods for which cash payment under the former revenue recognition method had not been received as of April 1, 2010. Since all sales of Response DX tests are on the accrual basis from April 1, 2010, the Company does not expect any such future one-time adjustments to revenue. The revenue recorded from ResponseDX sales to Private Payors and Medicare for the six months ended June 30, 2010 and June 30, 2011 was $5,230,945 and $6,085,111, respectively.

The Company has received its Medicare provider number which allows it to invoice and collect from Medicare. Invoicing to Medicare is primarily based on amounts allowed by Medicare for the service provided as defined by Common Procedural Terminology (CPT) codes. ResponseDX revenues related to Medicare billings are recorded at established billing rates net of an estimated billing adjustment, based on reporting models utilizing historical cash collection percentages and updated for current effective reimbursement factors. Response DX revenue related to Private Payors are recorded at established billing rates less an allowance to reflect the revenue at the amounts expected based on historical collections patterns.

The following details ResponseDX revenue for the three and six months ended June 30, 2010 and 2011:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	(Unaudited)				(Unaudited)
	2010		2011		2010		2011

Net Medicare revenue	$	983,416	$	1,307,906	$	1,890,201	$	2,456,868

Private Payor Revenue		2,454,979		1,671,404		3,172,263		3,623,446

Other		72,300		5,529		168,481		4,797

Net ResponseDX revenue	$	3,510,695	$	2,984,839	$	5,230,945	$	6,085,111

Cost-Containment Measures

Both government and private pay sources have instituted cost-containment measures designed to limit payments made to providers of health care services, and there can be no assurance that future measures designed to limit payments made to providers will not adversely affect the Company.

Regulatory Matters

Laws and regulations governing Medicare programs are complex and subject to interpretation. Compliance with such laws and regulations can be subject to future governmental review and interpretation, as well as significant regulatory action including fines, penalties and exclusions from certain governmental programs. The Company believes that it is in compliance with all applicable laws and regulations and is not aware of any pending or threatened investigations involving allegations of potential wrongdoing.

A portion of the Company’s revenues are derived from Medicare for which reimbursement rates are subject to regulatory changes and government funding restrictions. Although the Company is not aware of any significant future rate changes, significant changes to the reimbursement rates could have a material effect on the Company’s operations.

Cost of Revenue

Cost of revenue represents the cost of materials, direct labor, costs associated with processing tissue specimens including pathological review, staining, microdissection, paraffin extraction, reverse transcription polymerase chain reaction, or (“RT-PCR”) and quality control analyses, license fees and delivery charges necessary to render an individualized test result. Costs associated with performing tests are recorded as the tests are processed. Costs of revenue associated with the Private Payor revenue recognized as of April 1, 2010, were incurred and expensed in prior periods.

License Fees

The Company has licensed technology for the extraction of mRNA from formalin-fixed, paraffin-embedded tumor specimens from the University of Southern California (“USC”). Under the terms of the license agreement, the Company is required to pay royalties to USC based on the revenue generated by use of this technology. The Company maintains a non-exclusive license to use the polymerase chain reaction (“PCR”), homogenous PCR, and reverse transcription PCR processes of Roche Molecular Systems, Inc. (“Roche”). The Company pays Roche Molecular Systems a royalty fee based on revenue that the Company generates through use of this technology. The Company accrues for such royalties at the time revenue is recognized. Such royalties are included in cost of revenues in the accompanying statements of operations.

Research and Development

The Company expenses costs associated with research and development activities as incurred. Research and development costs are allocated on a pro rata basis using an estimate of employee time as a percentage of total hours worked for which specific employees are conducting research and development. Research and development costs include employee costs (salaries, payroll taxes, benefits, and travel), equipment depreciation and warranties and maintenance, laboratory supplies, primers and probes, reagents, patent costs and occupancy costs.

Income Taxes

Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

ASC 740, Income Taxes, clarifies the accounting for uncertainty in income taxes recognized in financial statements and requires the impact of a tax position to be recognized in the financial statements if that position is more likely than not of being sustained by the taxing authority. As of December 31, 2010 and June 30, 2011, the Company does not have a liability for unrecognized tax benefits. The Company recognizes interest and penalties associated with tax matters as part of the income tax provision and includes accrued interest and penalties with the related tax liability in the balance sheet.

Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with Accounting Standards Codification (“ASC”) 718, Stock Compensation. Stock-based compensation expense for all stock-based compensation awards granted is based on the grant-date fair value estimated in accordance with the provisions of ASC 718. The Company recognizes these compensation costs on a straight-line basis over the requisite service period of the award, which is generally the option vesting term of three to four years

The Company accounts for equity instruments issued to non-employees in accordance with ASC 505, Equity, Under ASC 505, stock option awards issued to non-employees are measured at fair value using the Black-Scholes option-pricing model and recognized pursuant to a performance model.

Management Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and 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 materially from those estimates.

Long-lived Assets

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company evaluates potential impairment by comparing the carrying amount of the asset with the estimated undiscounted future cash flows associated with the use of the asset and its eventual disposition. Should the review indicate that the asset is not recoverable, the Company’s carrying value of the asset would be reduced to its estimated fair value, which is measured by future discounted cash flows.

Foreign Currency Translation

The financial position and results of operations of the Company’s foreign operations are determined using local currency as the functional currency. Assets and liabilities of these operations are translated at the exchange rate in effect at each period-end. Statement of Operations amounts are translated at the average rate of exchange prevailing during the period. Translation adjustments arising from the use of differing exchange rates from period to period are included in accumulated other comprehensive loss in stockholders’ equity (deficit). The Company accounts for deferred revenue related to a specific contract as a nonmonetary obligation using historical exchange rates.

Comprehensive Loss

Comprehensive loss encompasses the change in equity from transactions and other events and circumstances from non-owner sources and the Company’s net loss. The components of comprehensive loss and accumulated other comprehensive loss comprise net loss and foreign currency translation adjustments as of December 31, 2010 and June 30, 2011, and for the three and six months ended June 30, 2010 and 2011.

Fair Value of Financial Instruments

Cash and cash equivalents are stated at cost, which approximates fair market value. Cash equivalents consist of money market accounts, with fair values estimated based on quoted market prices. For additional information see Note 14.

Selling and Marketing Costs

The Company markets its services through its advertising activities in trade publications and on line. Advertising costs are included in selling and marketing expenses on the statements of operations and are expensed as incurred. Advertising costs for the three months ended June 30, 2010 and 2011 were $89,077 and $16,595, respectively, and $235,378 and $66,477 for the six months ended June 30, 2010 and 2011, respectively.

Reclassifications

Prior year amounts in the consolidated financial statements have been reclassified to conform with the current year presentation. Reclassified amounts had no impact on the company’s net losses.

Concentration of Credit Risk and Clients and Limited Suppliers

Cash and cash equivalents are maintained at financial institutions and, at times, balances may exceed federally insured limits. We have never experienced any losses related to these balances. All of our non-interest bearing cash balances were fully insured at June 30, 2011 due to a temporary federal program in effect from December 31, 2010 through December 31, 2012. Under the program, there is no limit to the amount of insurance for eligible accounts. Beginning 2013, insurance coverage will revert to $250,000 per depositor at each financial institution, and our non-interest bearing cash balances may again exceed federally insured limits. In addition, the Company has invested its excess cash in money market instruments which are not insured under the Federal Deposit Insurance Corporation but are insured under the Securities Industry Protection Corporation. At June 30, 2011, the Company had $10,000 of cash in money market instruments and has not incurred any losses on these cash balances. At June 30, 2011, $114,029 of cash was held outside of the United States and is uninsured.

Revenue sources that account for greater than 10 percent of total revenue are provided below.

	Three Months Ended June 30,									Six Months Ended June 30,
	2010				2011					2010				2010
	(Unaudited)									(Unaudited)
	Revenue		Percent of Total Revenue		Revenue		Percent of Total Revenue			Revenue		Percent of Total Revenue		Revenue		Percent of Total Revenue
GlaxoSmithKline and GlaxoSmithKline Biologicals	$	1,578,260		28%	$	3,080,349		46	%	$	3,151,694		34%	$	5,581,038		44	%

Medicare, net of contractual allowances	$	983,416		17%	$	1,307,906		20	%	$	1,890,201		20%	$	2,456,869		19	%

Customers that account for greater than 10 percent of accounts receivable are provided below.

	As of December 31, 2010					As of June 30, 2011
						(Unaudited)
	Receivable Balance		Percent of Total Receivables			Receivable Balance		Percent of Total Receivables
GlaxoSmithKline and GlaxoSmithKline Biologicals	$	1,305,829		28	%	$	2,813,968		44	%

Medicare, net of contractual allowances	$	1,092,386		23	%	$	883,038		14	%

Many of the supplies and reagents used in the Company’s testing process are procured by a limited number of suppliers. Any supply interruption or an increase in demand beyond the suppliers’ capabilities could have an adverse impact on the Company’s business. Management believes it can identify alternative sources, if necessary, but it is possible such sources may not be identified in sufficient time to avoid an adverse impact on its business. Refer also to Note 6 for further discussion regarding these supply agreements. The Company purchases certain laboratory supplies and reagents primarily from two suppliers. Purchases from the top two of those companies accounted for approximately 72% and 84% of the Company’s reagent purchases for the three months ended June 30, 2010 and 2011, respectively, and approximately 71% and 75% for the six months ended June 30, 2010 and 2011, respectively.

Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-06, Improving Disclosures about Fair Value Measurements, amends FASB ASC 820-10, Fair Value Measurements and Disclosures, and requires new disclosures about transfers into and out of Level 1 and 2 of the fair value hierarchy and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements. It is effective for interim and annual reporting periods beginning after December 15, 2009, except for the Level 3 measurement disclosures, which are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Early adoption is permitted. The partial adoption of this guidance did not have a material effect on our results of operations or financial position with the adoption of the remaining portion of this not expected.

In April 2010, the FASB issued ASU No. 2010-17, “Revenue Recognition — Milestone Method (Topic 605): Milestone Method of Revenue Recognition”. This ASU provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition. Consideration that is contingent on achievement of a milestone in its entirety may be recognized as revenue in the period in which the milestone is achieved only if the milestone is judged to meet certain criteria to be considered substantive. The updated guidance is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Entities may elect to adopt the amendments in the ASU retrospectively for all prior periods. The adoption of these provisions did not have a material effect on our consolidated financial statements.

In October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (Topic 605)—Multiple-Deliverable Revenue Arrangements: a consensus of the FASB Emerging Issues Task Force (ASU 2009-13). ASU 2009-13 establishes a selling-price hierarchy for determining the selling price of each element within a multiple-deliverable arrangement. Specifically, the selling price assigned to each deliverable is to be based on vendor-specific objective evidence (VSOE) if available, third-party evidence, if VSOE is unavailable, and estimated selling prices if neither VSOE or third-party evidence is available. In addition, ASU 2009-13 eliminates the residual method of allocating arrangement consideration and instead requires allocation using the relative selling price method. ASU 2009-13 will be effective prospectively for multiple-deliverable revenue arrangements entered into, or materially modified, in fiscal years beginning on or after June 15, 2010. The adoption of this guidance did not have a material effect on our results of operation or financial position.

In July 2011, the FASB issued ASU 2011-7, “Health Care Entities (Topic 954): Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities” (“ASU2011-7”). In accordance with ASU 2011-7, the Company will be required to present its provision for doubtful accounts related to patient service revenue as a deduction from revenue, similar to contractual discounts. Accordingly, the Company’s revenues will be required to be reported net of both contractual discounts as well as its provision for doubtful accounts related to patient service revenues. Additionally, ASU 2011-7 will require the Company to make certain additional disclosures designed to help users understand how contractual discounts and bad debts affect recorded revenue in both interim and annual financial statements. ASU 2011-7 is required to be applied retrospectively and is effective for public companies for fiscal years beginning after December 15, 2011, and interim periods within those fiscal years. Early adoption is permitted. Management is still evaluating the potential effect that the adoption of this guidance will have on the results of operations or our financial position.