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NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 9 Months Ended
Sep. 30, 2023
Organization, Consolidation and Presentation of Financial Statements [Abstract]  
NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations

The Company’s principal business activity involves acquiring raw land and developed lots for the purpose of building and selling single family and multi-family dwellings in Washington, California, Texas, and Florida.

On August 1, 2019, the Company changed its name from Harbor Custom Homes, Inc. to Harbor Custom Development, Inc.

The Company became an effective filer with the SEC and started trading on The Nasdaq Stock Market LLC (“Nasdaq”) on August 28, 2020.

Principles of Consolidation

The condensed consolidated financial statements include the following subsidiaries of Harbor Custom Development, Inc. as of the reporting period ending date, as follows:

NamesDates of FormationAttributable Interest
September 30, 2023December 31, 2022
Saylor View Estates, LLC*March 30, 2014N/AN/A
Belfair Apartments, LLCDecember 3, 2019100 %100 %
Pacific Ridge CMS, LLCMay 24, 2021100 %100 %
Tanglewilde, LLCJune 25, 2021100 %100 %
HCDI FL CONDO LLCJuly 30, 2021100 %100 %
HCDI Mira, LLC**August 31, 2021N/AN/A
HCDI, Bridgeview LLCOctober 28, 2021100 %100 %
HCDI Wyndstone, LLCSeptember 15, 2021100 %100 %
HCDI Semiahmoo, LLCDecember 17, 2021100 %100 %
Mills Crossing, LLCJuly 21, 2022100 %100 %
Broadmoor Ventures, LLCAugust 24, 2022100 %100 %
GPB Holdings LLCOctober 29, 2022100 %100 %
Winding Lane Estate LLCNovember 30, 2022100 %100 %
Beacon Studio Farms LLCMarch 20, 2023100 %N/A

*Saylor View Estates, LLC was voluntarily dissolved with the State of Washington as of January 20, 2022.
**HCDI Mira, LLC was voluntarily dissolved with the State of Washington as of April 26, 2023.

As of September 30, 2023 and December 31, 2022, the aggregate non-controlling interest was $0 and $0, respectively.

Basis of Presentation

The unaudited condensed consolidated financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. These financial statements should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2022. The accompanying unaudited condensed consolidated financial statements include all adjustments that are of a normal recurring nature and necessary for the fair presentation of the results for the interim periods presented. Results for interim periods are not necessarily indicative of results to be expected for the full year.
All numbers in the financial statements are rounded to the nearest $100, except for numbers related to Shares Issued and Earnings (Loss) per Share (“EPS”) data, and numbers in the notes to the financial statements are rounded to the nearest million, where appropriate.

Reclassification

Certain prior year amounts have been reclassified for consistency with the current year presentation. These reclassifications had no effect on the reported results of operations.

Use of Estimates

Management uses estimates and assumptions in preparing these financial statements in accordance with GAAP. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Actual results could vary from the estimates that were used.

Going Concern Uncertainty

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern.

Under Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) 205-40, the Company’s management has the responsibility to evaluate whether conditions and/or events raise substantial doubt about the Company’s ability to meet its financial obligations as they become due within one year after the date that the financial statements are issued. As required by this standard, the evaluation shall initially not take into consideration the potential mitigating effects of the Company’s plans that have not been fully implemented as of the date the financial statements are issued.

Regarding the first step of this assessment, the Company concluded that under the standards of ASC 205-40, the following conditions raised substantial doubt about the Company’s ability to continue as a going concern: during the year ended December 31, 2022, the Company failed to maintain compliance with certain financial covenants within its loan agreements requiring loan amendment or covenant waivers; it has no borrowing availability under its revolving credit facility; it has significant debt of $116.7 million maturing over the next 12 months as of September 30, 2023; it had significant uses of cash flows from operations over the past two years; it had a $16.9 million net loss during the year ended December 31, 2022, an $18.3 million net loss for the third quarter of 2023, and a net loss of $27.5 million for the nine months ended September 30, 2023; and the real estate and construction industries are experiencing declining market conditions which have negatively impacted property valuations as well as financing capabilities and terms.

In performing the second step of this assessment, management is required to evaluate whether the Company’s plans to mitigate the conditions above alleviate the substantial doubt about the Company's ability to meet its obligations as they become due within one year after the date that the financial statements are issued.

The Company has undertaken and completed the following plans and actions to improve its available cash balances, liquidity, and cash generated from operations:

•executed an Amendment to the Revolver Loan Agreement with BankUnited to alleviate the breach of financial covenants and the bank’s ability to call the loan;
•closed $1.0 million in sales after September 30, 2023 and has $21.7 million under contract as of November 9, 2023 with significant additional assets that are held for sale;
•has construction loans in place which enables the Company to continue construction;
•met its equity requirement for its Pacific Ridge, Wyndstone, Meadowscape, and Belfair Phase 1 projects, which enables the Company to fund the projects without additional out of pocket costs;
•substantially completed its fee build contracts;
•shut down its quarry operations, eliminated most of its full time employees in its horizontal infrastructure division, and sold a significant majority of its heavy construction equipment, all of which were directly or indirectly associated with significant net loss generating activities during the year ended December 31, 2022 and the three months ended March 31, 2023; and
•raised net proceeds of $8.9 million from a public offering in May 2023.

Additionally, the Company’s future plans include: raising additional funds through the sales of real estate assets; obtaining new debt financing and/or refinancing existing debt; pulling cash out of one or more of its multi-family properties by obtaining a project level equity partner; and/or raising capital in the private or public equity or debt markets. The future viability of the Company is dependent on its ability to raise additional funds to finance its operations and/or restructure or
refinance its existing debt obligations. The Company’s inability to raise additional funds as and when needed and/or restructure or refinance its debt obligations will have a negative impact on its financial condition and ability to continue operations. There can be no assurance that these future plans will be achieved or additional financing will be available on terms acceptable to the Company or at all.

The accompanying condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the ordinary course of business. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might result from the outcome of this uncertainty.

Stock-Based Compensation

Effective November 19, 2018, the Company’s Board of Directors and stockholders approved and adopted the 2018 Incentive and Nonstatutory Stock Option Plan (the “2018 Plan”). The 2018 Plan allows the Administrator (as defined in the 2018 Plan), currently the Compensation Committee, to determine the issuance of incentive stock options and non-qualified stock options to eligible employees and outside directors and consultants of the Company. The Company has 133,784 shares of common stock reserved for issuance under the 2018 Plan.

Effective December 3, 2020, the Company’s Board of Directors and stockholders approved and adopted the 2020 Restricted Stock Plan (the “2020 Plan”). The 2020 Plan allows the Administrator, currently the Compensation Committee, to determine the issuance of restricted stock to eligible officers, directors, and key employees. The Company has 135,000 shares of common stock reserved for issuance under the 2020 Plan.

The Company accounts for stock-based compensation in accordance with FASB ASC Topic 718, “Compensation – Stock Compensation” (“ASC 718”) which establishes financial accounting and reporting standards for stock-based employee and non-employee compensation. It defines a fair value-based method of accounting for an employee stock option or similar equity instrument.

The Company recognizes all forms of share-based payments, including stock option grants, warrants, and restricted stock grants, at their fair value on the grant date.

Options and warrants are valued using a Black-Scholes option pricing model. Grants of share-based payment awards issued to non-employees for services rendered have been recorded at the fair value of the share-based payment. The grants are amortized on a straight-line basis over the requisite service periods, which are generally the vesting periods. The Company accounts for forfeitures of stock options as they occur. When forfeitures occur, the unvested portion of the previously recognized compensation cost is reversed in the period of the forfeiture.

Stock-based compensation expenses are included in operating expenses in the condensed consolidated statement of operations.

For the nine months ended September 30, 2023 and 2022 when computing fair value of share-based awards, the Company has considered the following range of assumptions:

 September 30, 2023September 30, 2022
Risk-free interest rate
 4.30%
 1.73% - 3.54%
Exercise price
$3.73
$22.40 - $60.00
Expected life of grants in years
 6.38
3.93 - 6.51
Expected volatility of underlying stock
 43.50%
42.34% - 48.13%
Dividends——

The expected term is computed using the “simplified method” as permitted under the provisions of FASB ASC Topic 718-10-S99. The Company uses the simplified method to calculate the expected term of share options and similar instruments as the Company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term. The share price is the closing price on the date of grant. Expected volatility is based on the historical stock price volatility of comparable companies’ common stock as the stock does not have sufficient historical trading activity. Risk free interest rates were obtained from U.S. Treasury rates for the applicable expected terms.
Repurchase of Equity Securities

Share repurchases are recorded to common stock at the value of the cash consideration paid, as the Company's common stock has no par value. These shares were being repurchased for the purpose of constructive retirement. (See Note 15. Stockholders’ Equity.)

Reverse Stock Split

On March 6, 2023, the Company effected a 1-for-20 reverse stock split of its issued and outstanding shares of common stock (the “Reverse Stock Split”) on the Nasdaq Capital Market. Accordingly, all share and per share data included in these condensed consolidated financial statements and notes thereto have been adjusted retroactively to reflect the impact of the Reverse Stock Split.

2023 Public Offering

On May 18, 2023, the Company closed on a public offering of 160,500 shares of common stock, 1,790,718 pre-funded warrants, and 1,951,218 common warrants for net proceeds of $8.9 million. In addition, upon closing of this public offering, the Company issued to the placement agent 117,073 warrants to purchase shares of common stock.

The pre-funded warrants and common warrants were evaluated in accordance with FASB ASC Topics 480, Distinguishing Liabilities from Equity and 815, Derivatives and Hedging. The Company assessed whether the pre-funded warrants and common warrants are freestanding financial instruments that are legally detachable and separately exercisable from the equity instruments, are mandatorily redeemable, embody obligations to repurchase shares or issue a variable number of shares, are exercisable without any contingent provisions, permit the holders to receive a fixed number of shares of common stock upon exercise, are indexed to the Company's common stock, and are settled in shares. Based on this assessment, the pre-funded warrants and common warrants were classified as a component of permanent stockholders' equity within additional paid-in capital and were recorded at the issuance date using a relative fair value allocation method. The Company values these equity instruments at issuance and allocated net proceeds from the sale proportionately to the common stock, the pre-funded warrants, and the common warrants. Of the net proceeds, $0.6 million was allocated to common stock, $6.7 million was allocated to pre-funded warrants, $1.6 million was allocated to common warrants, and $0.1 million was allocated to the placement agent warrants.

The common warrants and placement agent warrants were valued using a Black-Scholes pricing model. When computing the fair value of these warrants, the Company used 3.94% as the risk free interest rate, an exercise price of $5.00 or $6.41, an expected life of 2.5 years, and expected volatility of 37.83% as assumptions in the model. (See Note 15. Stockholders’ Equity.)

Earnings (Loss) Per Share (“EPS”)

EPS is the amount of earnings attributable to each share of common stock. For convenience, the term is used to refer to either earnings or loss per share. EPS is computed pursuant to ASC Topic 260-10-45 of the FASB ASC. Pursuant to ASC Paragraphs 260-10-45-10 through 260-10-45-16, basic EPS shall be computed by dividing income available to common stockholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Income available to common stockholders shall be computed by deducting both the dividends declared in the period on preferred stock (whether or not paid) and the dividends accumulated for the period on cumulative preferred stock (whether or not earned) from income from continuing operations (if that amount appears in the income statement) and also from net income. The computation of diluted EPS is similar to the computation of basic EPS except that the numerator may have to adjust for any dividends and income or loss associated with potentially dilutive securities that are assumed to have resulted in the issuance of shares of common stock and the denominator may have to adjust to include the number of additional shares of common stock that would have been outstanding if the dilutive potential shares of common stock had been issued during the period to reflect the potential dilution that could occur from shares of common stock issuable through a contingent shares issuance arrangement, stock options, warrants, RSUs, or convertible preferred stock. For purposes of determining diluted earnings per common share, the treasury stock method is used for stock options, warrants, and RSUs, and the if-converted method is used for convertible preferred stock as prescribed in FASB ASC Topic 260. Because of the net loss for the three and nine months ended September 30, 2023, the impact of including these in our computation of diluted EPS was anti-dilutive.

In accordance with FASB ASC Topic 260-10-45, pre-funded warrants have been included in the weighted average common shares outstanding number for the purpose of calculating EPS.
The following table provides a reconciliation of the numerator and denominator used in computing basic and diluted net loss attributable to common stockholders per share of common stock for the three and nine months ended September 30, 2023 and 2022.

For the Three Months Ended September 30,
For the Nine Months Ended September 30,
 2023202220232022
Numerator:
Net loss attributable to common stockholders$(20,178,300)$(5,318,500)$(33,223,500)$(12,134,200)
Effect of dilutive securities:— — — — 
 
Diluted net loss$(20,178,300)$(5,318,500)$(33,223,500)$(12,134,200)
 
Denominator:
Weighted average common shares outstanding - basic (b)2,686,426717,545 1,695,452693,143 
Dilutive securities (a):
Restricted Stock Awards————
  Options————
  Warrants————
Convertible Preferred Stock————
 
Weighted average common shares outstanding and assumed conversion – diluted2,686,426717,545 1,695,452693,143 
 
Basic net earnings (loss) per common share$(7.51)$(7.41)$(19.60)$(17.51)
 
Diluted net earnings (loss) per common share$(7.51)$(7.41)$(19.60)$(17.51)
 
(a) - Outstanding anti-dilutive securities excluded:
Unvested restricted stock awards1,16713,7301,16713,730
Stock options106,92240,047106,92240,047
Warrants to purchase common stock (20:1) (1)
18,447,56418,447,56418,447,56418,447,564
Warrants to purchase common stock (1:1) (2)
2,068,291—2,068,291—
Convertible preferred stock (3)
3,799,7993,799,799 3,799,7993,799,799 
Warrants to purchase convertible preferred stock (3)
12,00012,00012,00012,000
(b) - Outstanding shares of Pre-funded warrants included in the weighted average outstanding shares
Pre-funded warrants357,109—357,109—
(1) The number of outstanding warrants, issued prior to the reverse stock split on March 6, 2023, did not change or split pursuant to the reverse stock split, but the number of shares of common stock issuable upon exercise of these warrants was adjusted based on a 1 to 0.05 ratio.
(2) The number of outstanding warrants issued after the reverse stock split on March 6, 2023 are exercisable for shares of common stock on a 1 to 1 ratio.
(3) Preferred stock and warrants to purchase convertible preferred stock are convertible into common stock on a 0.2778 to 1 ratio.

Fair Value of Financial Instruments

For purpose of this disclosure, the fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation. The carrying amount of the Company’s short-term financial instruments approximates fair value due to the relatively short period to maturity for these instruments.
Cash and Cash Equivalents

The Company considers all short-term debt securities purchased with a maturity of three months or less to be cash equivalents. There were no cash equivalents as of September 30, 2023 and December 31, 2022.

Restricted Cash

On August 10, 2021, the Company entered into a Letter of Credit (“LOC”) agreement with WaFd Bank in the amount of $0.6 million. The Company signed a lease on October 5, 2021 for a new office space. The landlord of the property, University Street Properties I, LLC, is the beneficiary of the LOC. The amount of funds that cover this LOC were moved by WaFd Bank to a controlled account on August 13, 2021. (See Note 10. Letter of Credit.)

Accounts Receivable

Accounts receivables are reported at the amount the Company expects to collect from outstanding balances. The Company provides for an allowance for credit losses based upon a review of the outstanding accounts receivable, historical collection information, and existing economic conditions. The Company determines if receivables are past due based on days outstanding, and amounts are written off when determined to be uncollectible by management. The allowance for credit losses was $0 as of September 30, 2023 and December 31, 2022.

Notes Receivable

Notes receivables are recorded at amounts due to the Company according to the contractual terms of the loan agreement. The Company's notes receivables are for the sale of real estate properties or financing the development of the properties prior to acquisition and are each secured by the underlying improved real estate properties.

The Company reviews notes receivable for impairment whenever events or circumstances indicate that the note may not be fully recoverable. Impairment is present when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. If management determines an amount to be uncollectible, impairment is measured based on the estimated uncollectible amount less the fair value of the underlying collateral. Impairment is recognized with a valuation allowance against the note receivable with a corresponding charge to bad debt expense under operating expenses. The valuation allowance is written down when the remaining note amount is collected in full. There was no valuation allowance as of September 30, 2023. The valuation allowance was $1.2 million for notes receivable as of December 31, 2022. (See Note 3. Notes Receivable.)

In March 2022, the Company entered into a promissory note with Rocklin Winding Lane 22, LLC for $4.8 million (“the note”) for the sale of developed lots. In the third quarter of 2022, Rocklin Winding Lane 22, LLC defaulted on the note due to a missed interest payment on June 30, 2022. As a result, the Company issued a letter of default in August 2022 and began foreclosure proceedings on the underlying real estate asset in October 2022. In the third quarter of 2022, the Company recorded a valuation allowance against the note and related bad debt expense within operating expenses of $0.8 million. In the fourth quarter of 2022, the Company foreclosed on the underlying property and took ownership of the property, which was recorded for a fair value of $5.1 million at the time of repossession. Pursuant to the subordination agreement, the underlying real estate asset had a $1.0 million senior loan to a third party that was taken over by the Company upon the foreclosure of the property.

Property and Equipment and Depreciation

Property and equipment are recorded at cost. Expenditures for major additions and betterments are capitalized. Maintenance and repair charges are expensed as incurred. Depreciation is computed by the straight-line method (after considering their respective estimated residual values) over the estimated useful lives:

Construction Equipment
5-10 years
Leasehold Improvements
The lesser of 10 years or the remaining life of the lease
Furniture and Fixtures 5 years
Computers3 years
Vehicles10 years
Real Estate Assets

Real estate assets are recorded at cost, except when real estate assets are acquired that meet the definition of a business combination in accordance with FASB ASC Topic 805, “Business Combinations,” where acquired assets are recorded at fair value. Interest, property taxes, insurance, and other incremental costs (including salaries) directly related to a project are capitalized during the construction period of major facilities and land improvements. The capitalization period begins when activities to develop the parcel commence and ends when the asset construction is completed and ready for rental or when the asset is sold, depending on the asset and the intended use. The capitalized costs are recorded as part of the asset to which they relate and are expensed as part of the rental costs or when the underlying asset is sold.

The Company capitalized interest (refund) from related party borrowings of $(0.1) million and $0.3 million for the three months ended September 30, 2023 and 2022, respectively. The Company capitalized interest from related party borrowings of $0.4 million and $0.9 million for the nine months ended September 30, 2023 and 2022, respectively. The Company capitalized interest from third-party borrowings of $2.0 million and $1.5 million for the three months ended September 30, 2023 and 2022, respectively. The Company capitalized interest from third-party borrowings of $8.1 million and $3.4 million for the nine months ended September 30, 2023 and 2022, respectively.

A property is classified as “held for sale” when all of the following criteria for a plan of sale have been met:

(1) Management, having the authority to approve the action, commits to a plan to sell the property;

(2) The property is available for immediate sale in its present condition, subject only to terms that are usual and customary;

(3) An active program to locate a buyer and other actions required to complete the plan to sell have been initiated;

(4) The sale of the property is probable and is expected to be completed within one year of the contract date;

(5) The property is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and

(6) Actions necessary to complete the plan of sale indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.

The real estate assets classified as held for sale were $164.9 million and $34.4 million as of September 30, 2023 and December 31, 2022, respectively.

In addition to the annual assessment of potential triggering events in accordance with FASB ASC Topic 360, the Company applies a fair value-based impairment test to the net book value of assets on an annual basis and on an interim basis if certain events or circumstances indicate that an impairment loss may have occurred.

The Company recorded impairment charges of $2.5 million relating to the Wyndstone apartments, $1.0 million relating to the Darkhorse lots, $1.5 million relating to the Summit Rock lots and homes, $0.8 million relating to the Cimarron Hills homes, $0.4 million relating to Sienna Creek homes, $0.2 million relating to Trails of HSB lots, and $0.1 million relating to a Flintrock Falls home for the three months ended September 30, 2023. For the nine months ended September 30, 2023, the Company recorded impairment charges of $3.9 million relating to the Darkhorse lots, $3.2 million relating to the Pacific Ridge apartments, $2.5 million relating to the Wyndstone apartments, $1.5 million relating to the Summit Rock lots and homes, $0.8 million relating to the Cimarron Hills homes, $0.4 million relating to Sienna Creek homes, $0.2 million relating to a Bunker Ranch home, $0.2 million relating to Trails of HSB lots, and $0.1 million relating to a Flintrock Falls home. No impairment charges were recorded for the comparable periods in 2022. For the year ended December 31, 2022, the Company recorded impairment charges of $1.2 million and $2.4 million relating to the Winding Lane lots and Pacific Ridge apartments, respectively. These charges are recorded in cost of sales and real estate as presented in Note 5. The Company did not identify any other real estate that qualified for an impairment charge.

Revenue and Cost Recognition

FASB ASC Topic 606, Revenue from Contracts with Customers (“ASC 606”), establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity’s contracts to provide goods or services to customers.

In accordance with ASC 606, revenue is recognized when a customer obtains control of the promised good or service. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these goods or services. The provision of ASC 606 includes a five-step process by which the Company
determines revenue recognition, depicting the transfer of goods or services to customers in amounts reflecting the payment to which the Company expects to be entitled in exchange for those goods or services.

ASC 606 requires the Company to apply the following steps: (1) identify the contract with the customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, performance obligations are satisfied.

A detailed breakdown of the five-step process for revenue recognitions is as follows:

Homes, Developed Lots, and Entitled Land

1. Identify the contract with a customer.

The Company signs an agreement with a buyer to purchase the parcel of entitled land, developed lots that have completed infrastructure, or completed homes.

2. Identify the performance obligations in the contract.

Performance obligations of the Company include delivering entitled land, developed lots, and completed homes to the customer, which are required to meet certain specifications outlined in the contract.

3. Determine the transaction price.

The transaction price is fixed and specified in the contract. Any subsequent change orders or price changes are required to be approved by both parties.

4. Allocation of the transaction price to performance obligations in the contract.

The parcel, lots, and homes are separate performance obligations for which the specific price is in the contract.

5. Recognize revenue when (or as) the entity satisfies a performance obligation.

The Company recognizes revenue when title is transferred. The Company does not have any further material performance obligations once title is transferred.

Fee Build

1. Identify the contract with a customer.

The Company signs an agreement with a customer to construct the required infrastructure so that houses can be developed on the lots.

2. Identify the performance obligations in the contract.

Performance obligations of the Company include delivering developed lots which are required to meet certain specifications that are outlined in the contract.

3. Determine the transaction price.

The transaction price is fixed and specified in the contract. Any subsequent change orders or price changes are required to be approved by both parties.

4. Allocation of the transaction price to performance obligations in the contract.

The nature of the industry involves a number of uncertainties that can affect the current state of the contract. Variable considerations are the estimates made due to a contract modification in the contractual service. Change orders, claims, extras, or back charges are common in contractual services activity as a form of variable consideration. If there is going to be a contract modification, judgment by management will need to be made to determine if the variable consideration is enforceable. The following factors are considered in determining if the variable consideration is enforceable:

1.The customer’s written approval of the scope of the change order;
2.Current contract language that indicates clear and enforceable entitlement relating to the change order;
3.Separate documentation for the change order costs that are identifiable and reasonable; and
4.The Company’s experience in negotiating change orders, especially as it relates to the specific type of contract and change order being evaluated.

Once the Company receives a contract, it generates a budget of projected costs for the contract based on the contract price. If the scope of the contract during the contractual period needs to be modified, the Company files a change order. The Company does not continue to perform services until the change modification is agreed upon with documentation by both the Company and the customer. There are few times that claims, extras, or back charges are included in the contract.

If there are multiple performance obligations to the contract, the costs must be allocated appropriately and consistently to each performance obligation. In the Company’s experience, usually only one performance obligation is stated per contract. If there are multiple services provided for one customer, the Company has a policy of splitting out the services over multiple contracts.

5. Recognize revenue when (or as) the entity satisfies a performance obligation.

The Company uses the total costs incurred on the project relative to the total expected costs to satisfy the performance obligation. The input method involves measuring the resources consumed, labor hours expended, costs incurred, time lapsed, or machine hours used relative to the total expected inputs to the satisfaction of the performance obligation. Costs incurred prior to actual contract (i.e., design, engineering, procurement of material, etc.) should not be recognized as the Company does not have control of the good/service provided. When the estimate on a contract indicates a loss or claims against costs incurred reduce the likelihood of recoverability of such costs, the Company records the entire estimated loss in the period the loss becomes known. Project contracts typically provide for a schedule of billings or invoices to the customer based on the Company’s job to date percentage of completion of specific tasks inherent in the fulfillment of its performance obligation(s). The schedules for such billings usually do not precisely match the schedule on which costs are incurred. As a result, contract revenue recognized in the statement of operations can and usually does differ from amounts that can be billed or invoiced to the customer at any point during the contract. Amounts by which cumulative contract revenue recognized on a contract as of a given date exceed cumulative billings and unbilled receivables to the customer under the contract are reflected as a current contract asset in the Company’s balance sheet. Amounts by which cumulative billings to the customer under a contract as of a given date exceed cumulative contract revenue recognized on the contract would be reflected as a current contract liability in the Company’s balance sheet. (See Note 17. Uncompleted Contracts.)

Revenues from contracts with customers are summarized by category as follows for the three and nine months ended September 30, 2023 and 2022:

For the Three Months Ended
September 30,
For the Nine Months Ended
September 30,
2023202220232022
Homes$117,900 $4,693,900 $8,816,600 $25,758,100 
Developed Lots4,231,000 — 8,571,300 9,080,000 
Entitled Land— 3,400,000 — 7,880,000 
Multi-family1,078,700 27,200 16,535,200 27,200 
Fee Build108,700 3,623,500 638,800 7,825,300 
Construction Materials— 3,900 — 45,400 
Total Revenue$5,536,300 $11,748,500 $34,561,900 $50,616,000 

Disaggregation of Revenue from Contracts with Customers:

The following table disaggregates the Company’s revenue based on the timing of satisfaction of performance obligations for the three and nine months ended September 30, 2023 and 2022:
For the Three Months Ended September 30,
For the Nine Months Ended September 30,
 2023202220232022
Performance obligations satisfied at a point in time$5,427,600 $8,125,000 $33,923,100 $42,790,700 
Performance obligations satisfied over time108,700 3,623,500 638,800 7,825,300 
Total Revenue$5,536,300 $11,748,500 $34,561,900 $50,616,000 

Rental Income

Rental income attributable to residential leases has been evaluated under FASB ASC Topic 842, Leases. Rental income is recorded when due from residents and recognized monthly as it was earned. Residential apartment leases may include lease income related to such items as utility recoveries, parking rent, storage rent and pet rent that the Company treats as a single lease component because the amenities cannot be leased on their own and the timing and pattern of revenue recognition are the same. Leases entered into between a resident and a property for the rental of an apartment unit are generally six months to one year, and typically renewed on a month-to-month basis after the initial term.

Rental income is included as a part of sales on the statement of operations and within the multi-family segment presented in Note 16. Segments. Rental income was $1.1 million and $0.03 million for the three months ended September 30, 2023 and 2022, respectively. Rental income was $2.3 million and $0.03 million for the nine months ended September 30, 2023 and 2022, respectively.

Security deposits related to the residential apartment leases are maintained in a checking account, separate from the Company's operating account, in accordance with Washington State laws. These security deposits are recorded within cash and customer deposit liabilities within accounts payable and accrued expenses.

Cost of Sales

Land acquisition costs are typically allocated to each lot based on the size of the lot in relation to the size of the total project or market value in relation to total purchase price. Development costs and capitalized interest are allocated to lots sold based on the same criteria.

Fee build costs are charged to cost of sales as incurred. See the revenue recognition criteria above.

Costs relating to the handling of recycled construction materials and converting items into usable construction materials for resale are charged to cost of sales as incurred.

Rental expenses, relating to our multi-family rental revenue, are charged to cost of sales as incurred.

Advertising

Advertising expenses, which are expensed as incurred and included in operating expenses, were $0.1 million and $0.1 million for the three months ended September 30, 2023 and 2022, respectively. Advertising expenses were $0.3 million and $0.2 million for the nine months ended September 30, 2023 and 2022, respectively.

Income Taxes

Deferred income tax assets and liabilities are determined based on the estimated future tax effects of net operating loss, credit carryforwards, and temporary differences between the tax basis of assets and liabilities and their respective financial reporting amounts measured at the current enacted tax rates. Management applies the criteria established under FASB ASC Topic 740, Income Taxes, to determine whether any valuation allowances are needed each year.

The Company calculated the effective tax rate for the nine months ended September 30, 2023 and 2022 based on the actual effective tax rate for the year-to-date period.

The Company recognizes a tax benefit for an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by taxing authorities based on the technical merits of the position. There are no uncertain tax positions as of September 30, 2023 and December 31, 2022.
On August 16, 2022, the Inflation Reduction Act of 2022 (“IRA”) was signed into law. The IRA includes a 15% Corporate Alternative Minimum Tax (“Corporate AMT”) for tax years beginning after December 31, 2022. The Company does not expect the Corporate AMT to have a material impact on its condensed consolidated financial statements. Additionally, the IRA imposes a 1% excise tax on net repurchases of stock by certain publicly traded corporations. The excise tax is imposed on the value of the net stock repurchased or treated as repurchased. The new law will apply to stock repurchases occurring after December 31, 2022. The IRA also extended the federal tax credit for building new energy-efficient homes delivered from January 1, 2022 (retroactively) through December 31, 2032, as well as modifies and increases it starting in 2023. The federal tax credits in 2022 reflected the impact of the extension under the IRA.

Recent Accounting Pronouncements

On June 16, 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurements of Credit Losses on Financial Instruments (“ASU 2016-13”), which changes the impairment model for most financial assets. This update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying premise of the update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be effected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. Pursuant to ASU No. 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842), ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2022 for small reporting companies, non-SEC filers, and all other companies. The adoption of ASU 2016-13 did not have a material impact on the Company's condensed financial statements.

On March 12, 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (ASC 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. ASC 848 contains optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform. The amendments in this update are elective and apply to all entities, subject to meeting certain criteria, that have contracts, hedging relationships, and other transactions that reference London Interbank Offered Rate (LIBOR) or another reference rate expected to be discontinued because of reference rate reform. The expedients and exceptions provided by the amendments do not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022, except for hedging relationships existing as of December 31, 2022, for which an entity has applied certain optional expedients that are retained through the end of the hedging relationship. In December 2022, ASU 2022-06 was issued which was effective upon issuance, defers the sunset date of this prior guidance from December 31, 2022 to December 31, 2024, after which entities will no longer be permitted to apply the relief guidance in Topic 848. The adoption of ASU 2020-04 and ASU 2022-06 did not have a material impact on the Company’s condensed financial statements.

On May 3, 2021, the FASB released ASU No. 2021-04, Compensation – Earning Per Share (Topic 260), Debt - Modifications and Extinguishments (subtopic 470-50), Compensation - Stock Compensation (Topic 718), Contracts in Entity’s Own Equity (Subtopic 815-40), Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options. The FASB issued this update to clarify and reduce diversity in an issuer’s accounting for modifications or exchanges of freestanding equity-classified written call options (for example warrants) that remain equity classified after modification or exchange. The standard is effective for fiscal years beginning after December 15, 2021. The Company adopted ASU 2021-04 on January 1, 2022, however the adoption did not have an impact on the Company’s condensed financial statements.

In July 2023, the FASB released ASU No. 2023-03, Presentation of Financial Statements (Topic 205), Income Statement—Reporting Comprehensive Income (Topic 220), Distinguishing Liabilities from Equity (Topic 480), Equity (Topic 505), and Compensation—Stock Compensation (Topic 718): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 120, SEC Staff Announcement at the March 24, 2022 EITF Meeting, and Staff Accounting Bulletin Topic 6.B, Accounting Series Release 280—General Revision of Regulation S-X: Income or Loss Applicable to Common Stock (SEC Update). The FASB issued this update to describe and clarify the amendments as listed above. The Company assessed the amendments related to this update, specifically for Topics 205, 505 and 718 and noted that ASU No. 2023-03 does not have an impact on the Company’s condensed financial statements.

In July 2023, the SEC adopted the final rule under SEC Release No. 33-11216, Cybersecurity Risk Management, Strategy, Governance, and Incident Disclosure, requiring disclosure of material cybersecurity incidents on Form 8-K and periodic disclosure of a registrant’s cybersecurity risk management, strategy and governance in annual reports. Regulation S-K Item 6 disclosure requirements under this rule will be effective for us in the fourth quarter of 2023. Incident disclosure
requirements in Form 8-K will be effective for us on June 15, 2024. We are still evaluating for any impact on our financial statement disclosures from the adoption of this final rule.

Impairment of Property and Equipment

The Company reviews fixed assets for impairment whenever events or circumstances indicate that the carrying value of such assets may not be fully recoverable. Impairment is present when the sum of estimated undiscounted future cash flow expected to result from use of the assets is less than carrying value. If impairment is present, the carrying value of the impaired asset is reduced to its fair value. Fair value is determined based on discounted cash flow or appraised values, depending on the nature of the assets. As of September 30, 2023 and December 31, 2022, there were no impairment losses recognized for fixed assets.