2. Summary of Significant Accounting Policies

Basis of Consolidation

The consolidated financial statements include the accounts of the Company 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 date of three months or less from the date of purchase 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

Pharmaceutical Accounts Receivable

The Company invoices 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 pharmaceutical customers have primarily been large pharmaceutical companies. As a result, bad debts from clinical accounts receivable to date have been minimal. Pharmaceutical company accounts receivable as of December 31, 2011 and June 30, 2012 were $1,701,837 and $1,257,526, respectively. There were no allowances for doubtful accounts recorded against these pharmaceutical accounts receivable at December 31, 2011 and June 30, 2012.

ResponseDX^®Accounts Receivable

ResponseDX^® accounts receivable are recorded from two primary payors: Medicare and third party and private payors (“Private Payors”). ResponseDX^® accounts receivable 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. Management performs ongoing valuations of accounts receivable balances based on management’s evaluation of historical collection experience and industry trends in order to record an allowance for doubtful accounts. Based on the historical experience for the Company’s Medicare and Private Payor accounts, management has determined that related accounts receivable associated with billings over one year are unlikely to be collected. Any outstanding receivable balance that is over one year old is written off. The Company’s bad debt expense for the three months ended June 30, 2011 and June 30, 2012, was $159,713 and $51,340, respectively, and $299,931 and $307,265 for the six months ended June 30, 2011 and 2012.

ResponseDX^®accounts receivable as of December 31, 2011 and June 30, 2012, consisted of the following:

	December 31, 2011			June 30, 2012
				(Unaudited)
Net Medicare receivable	$	506,308		$	750,507
Net Private Payor receivable		2,634,838			2,622,380
Other		42,826			—
		3,183,972			3,372,887
Allowance for doubtful accounts		(838,750	)		(607,858	)
Total	$	2,345,222		$	2,765,029

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 (5 to 7 years) or the lease term

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. The Company has capitalized costs related to the development of database software (see Note 3). The portion of this database placed into service is amortized in accordance with ASC 350-40, Internal-Use Software. The amortization period is three years using the straight-line method.

Revenue Recognition

Pharmaceutical Revenue

Revenues that are derived from 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 that 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

Revenues that are derived from ResponseDX^® testing services are 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 that 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. We record revenues when our tests have confirmed results which is evidence that the services have been performed.

Revenues are recorded on an accrual basis as the contractual obligations are completed and as a set of assays is processed through our laboratory under a specified contractual protocol.

ResponseDX^® Private Payor and Medicare revenues are recorded on an accrual basis 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’s Medicare provider number allows it to invoice and collect from Medicare. The Company’s invoicing to Medicare is primarily based on amounts allowed by Medicare for the service provided as defined by Common Procedural Terminology.

The following details ResponseDX^®revenue for the three and six months ended June 30, 2011 and 2012:

	Three Months				Six Months
	Ended June 30,				Ended June 30,
	(Unaudited)				(Unaudited)
	2011		2012		2011		2012

Net Medicare revenue	$	1,307,906	$	1,306,989	$	2,456,868	$	2,767,307

Private Payor revenue		1,671,404		1,526,684		3,623,446		3,012,327

Other		5,529		512		4,797		6,353

Net ResponseDX^® revenue	$	2,984,839	$	2,834,185	$	6,085,111	$	5,785,987

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, which include diagnostic test providers such as the Company, and there can be no assurance that future measures designed to limit payments made to providers will not adversely affect the Company.

Regulatory Matters

A portion of the Company’s revenues are derived from Medicare reimbursement. Laws and regulations governing Medicare programs are complex and subject to interpretation, and the Company may be adversely affected by future governmental investigations, lawsuits or private actions which include mandatory damages, fines, penalties, criminal charges, loss of suspension of licenses and/or suspension or exclusion from Medicare and certain other 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.

Medicare reimbursement rates are subject to regulatory changes and government funding restrictions. The Company is not aware of specific details related to any significant future rate changes that may occur in early 2013. However, significant changes to the reimbursement rates could have a material adverse effect on the Company’s operations.

Cost of Revenue

Cost of revenue represents the cost of materials, direct labor, royalties, costs associated with processing tissue specimens including pathological review, staining, microdissection, paraffin extraction, reverse transcription polymerase chain reaction, ALK Break Apart fluorescence in situ hybridization (FISH), 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.

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 certain patents related to the polymerase chain reaction (“PCR”) of Roche Molecular Systems, Inc. (“Roche”). The Company pays Roche 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 expensed as incurred in relation to direct costs that can be identified and classified as research and development costs. Certain costs such as lab supplies and reagents that cannot be specifically identified are allocated based on the number of samples processed in total by the lab and R&D departments in total. 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.

Line of Credit

On July 14, 2011, the Company entered into a line of credit agreement with Silicon Valley Bank (the “Bank”). The line of credit is collateralized by the Company’s pharmaceutical and Medicare receivables. The maximum amount that can be borrowed from the credit line is $3,000,000. The amount the Company can draw from the loan is equal to the calculated borrowing base, which is 80% of the Company’s pharmaceutical accounts receivable that have not aged greater than 90 days. As of June 30, 2012, the amount available for the borrowing base is $1,178,264. As part of the line of credit the Bank will issue letters of credit up to a maximum amount of $500,000. Any issued letters of credit reduce the amount available to borrow under the line of credit on a dollar for dollar basis. The interest fees associated with this line of credit are set at the prime rate plus 1%. For the period ended June 30, 2012, the rate being charged to the Company was 5%. As needed from time to time, the Company may draw on this line for use for general corporate purposes. As of June 30, 2012 and December 31, 2011, the Company has drawn $1,000,000 against the line of credit and no letters of credit were outstanding. The line of credit is subject to various financial covenants and, as of June 30, 2012, the Company was not in compliance with certain covenants. Management is pursuing a cure of the violation and or a waiver of the violation from the Bank but as of the time of this filing the Company has not obtained a waiver. There is no guarantee that any violation could be cured or that the Bank would agree to a waiver. As of December 31, 2011, and June 30, 2012, the line of credit was classified as a current liability of the Company on the accompanying balance sheet.

From time to time the Company’s borrowing base under its Bank line of credit may decrease to a level where the Company is in an over-advance position. This occurred on one occasion during the second quarter of 2012 based on the May 2012 borrowing base, as a result of which the Company was required to repay $298,000 to the Bank. The Company drew down the same amount one week later once the June 2012 borrowing base was determined to be sufficiently higher than the May 2012 borrowing base, thereby giving the Company the capacity to borrow such additional amount.

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, 2011 and June 30, 2012, 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. For the period ended June 30, 2012 there were no interest or penalties recorded on the Consolidated Statement of Operations.

Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with ASC 718, Stock Compensation, Share-Based Payment. 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 period. As further described in Note 7, certain awards granted to Thomas Bologna, the Company’s Chairman and Chief Executive Officer, were recognized based on an accelerated vesting basis triggered by market conditions rather than a straight-line basis.

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. Significant estimates in these consolidated financial statements have been made for revenue, accounts receivable, allowances for contractual and doubtful accounts, impairment of long-lived assets, depreciation of property and equipment and stock-based compensation. 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 assets cost is not recoverable, the 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 subsidiary 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).

Comprehensive Loss

The components of comprehensive loss are accumulated net loss and foreign currency translation adjustments for the three and six months ended June 30, 2011 and 2012.

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 12.

Sales 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, 2011 and 2012 were $16,595 and $4,090, respectively and $66,477 and $12,971 for the six months ended June 30, 2011 and 2012, respectively.

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. The Company has never experienced any losses related to these balances. All of the Company’s non-interest bearing cash balances were fully insured at June 30, 2012 due to a temporary federal program in effect from December 31, 2011 through December 31, 2012. Under the program, there is no limit to the amount of insurance for eligible accounts. Beginning on January 1, 2013, federal insurance coverage is scheduled to revert to $250,000 per depositor at each financial institution, and the Company’s non-interest bearing cash balances may again exceed federally insured limits. There were no funds in interest-bearing accounts that exceeded the federally insured limits as of June 30, 2012. At June 30, 2012, $9,895 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,
	2011					2012					2011					2012
	(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	$	3,080,349		46	%	$	235,917		6	%	$	5,581,038		44	%	$	955,004		12	%

Medicare, net of contractual allowances	$	1,307,906		20	%	$	1,306,989		34	%	$	2,456,869		19	%	$	2,767,307		35	%

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

	As of December 31, 2011					As of June 30, 2012
	(Unaudited)					(Unaudited)
	Receivable Balance		Percent of Total Receivables			Receivable Balance		Percent of Total Receivables

GlaxoSmithKline and GlaxoSmithKline Biologicals	$	1,556,096		31	%	$	751,276		19	%

Medicare, net of contractual allowances	$	506,308		10	%	$	750,507		19	%

Many of the supplies and reagents used in the Company’s testing process are procured from 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 could identify alternative sources, if necessary, but it is possible such sources may not be identified in sufficient time to avoid an adverse impact on the Company’s 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 and purchases from these two companies accounted for approximately 84% and 69% of the Company’s reagent purchases for the three months ended June 30, 2011 and 2012, respectively and approximately 75% and 69% for the six months ended June 30, 2011 and 2012, respectively.

Recent Accounting Pronouncements

Not Applicable