Note 1. Operations and Summary of Significant Accounting Policies

The following is a summary of certain accounting policies followed in the preparation of these financial statements. The policies conform to generally accepted accounting principles and have been consistently applied in the preparation of the financial statements:

A. Nature of Business – The Company owns and licenses the N-Viro Process, a patented technology to treat and recycle wastewater sludges and other bio-organic wastes, utilizing certain alkaline by-products produced by the cement, lime, electric utilities and other industries. Revenue and the related accounts receivable are due from companies acting as independent agents or licensees, principally municipalities.

B. Use of Estimates – The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

C. Principles of Consolidation – The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

D. Cash and Cash Equivalents – The Company has cash on deposit primarily in one financial institution which, at times, may be in excess of FDIC insurance limits.

For purposes of the statements of cash flows, the Company considers all certificates of deposit with initial maturities of 90 days or less to be cash equivalents.

Restricted cash consists of: two certificates of deposit and corresponding accrued interest which are held as collateral against the Company's line-of-credit; one certificate of deposit and corresponding accrued interest which is held as collateral with a performance bond on behalf of one of the Company's licensees; one certificate of deposit and corresponding accrued interest which is held as collateral on behalf of the Florida Department of Agriculture for the Company's soil distribution license.

E. Accounts Receivable – The Company extends unsecured credit to customers under normal trade agreements, which require payment within 30 days. Accounts greater than 90 days past due amounted to $67,344 and $61,698 of receivables for the years ended December 31, 2011 and 2010, respectively. The Company's policy is not to accrue and record interest income on past due trade receivables. The Company does bill the customer finance charges on past due accounts and records the interest income when collected. Credit is generally granted on an unsecured basis. Periodic credit evaluations of customers are conducted and appropriate allowances are established.

Management estimates an allowance for doubtful accounts, which was $70,000 as of both December 31, 2011 and 2010. The estimate is based upon management's review of delinquent accounts and an assessment of the Company's historical evidence of collections.

F. Property and Equipment – Property, machinery and equipment are stated at cost less accumulated depreciation. Depreciation has been computed primarily by the straight-line method over the estimated useful lives of the assets. Generally, useful lives are five to fifteen years. Leasehold improvements are capitalized and amortized over the lesser of the life of the lease or the estimated useful life of the asset. Depreciation expense amounted to $514,748 and $416,172 in 2011 and 2010, respectively. Management has reviewed property and equipment for impairment when events and circumstances indicate that the assets might be impaired and the carrying values of those assets may not be recoverable. Management believes the carrying amount is not impaired based upon estimated future cash flows.

G. Intangible Assets – Patent costs and territory rights are recorded at cost and then amortized by the straight-line method over their estimated useful lives (periods ranging from one and one-half to seventeen years; weighted-average amortization periods for patents/related intangibles and territory rights were 14.2 and 15.8 years at December 31, 2011 and 2010, respectively). Amortization expense amounted to $23,276 and $26,691 in 2011 and 2010, respectively. Estimated amortization expense, based on these patent costs and territory rights at December 31, 2011, for each of the ensuing five years is as follows: 2012 - $13,000; 2013 - $13,000; 2014 - $13,000; 2015 - $12,000; 2016 - $9,000. Management has reviewed intangible assets for impairment when events and circumstances indicate that the assets might be impaired and the carrying values of those assets may not be recoverable.

The Company has capitalized the cost of acquiring certain customer licenses and contracts as part of the acquisition of Florida N-Viro on December 31, 2006. Amortization expense amounted to $1,719 in 2011 and $6,259 in 2010. Estimated amortization expense, based on these capitalized license and contracts at December 31, 2011, for each of the ensuing five years is as follows: 2012 - $1,700; 2013 - $1,700; 2014 - $1,700; 2015 - $1,700; 2016 - $500.

H. Revenue Recognition – Facility management revenue and royalty fees are recognized under contracts where the Company or licensees utilize the N-Viro Process to treat sludge, either pursuant to a fixed-price contract or based on volumes of sludge processed. Revenue is recognized as services are performed.

Alkaline admixture sales, alkaline admixture management service revenue and N-Viro SoilTM revenue are recognized upon shipment.

License and territory fees are generated by selling the right to market or use the N-Viro Process in a specified territory. The Company's policy is to record revenue for the license agreements when all material services relating to the revenue have been substantially performed, conditions related to the contract have been met and no material contingencies exist. We do not recognize revenue on any non-domestic license or territory fee contracts until the cash is received, assuming all other tests of revenue recognition are met. Canada is excluded from this definition of non-domestic. Research and development revenue is recognized as work is performed and billed to the contracting entity in accordance with the contract.

The Company records the amount of shipping and handling costs billed to customers as revenue. The cost incurred for shipping and handling has been included in the cost of sales.

I. Loss Per Common Share – Loss per common share has been computed on the basis of the weighted-average number of common shares outstanding during each period presented. For the years ended December 31, 2011 and 2010, the effects of 2,924,985 and 2,273,300 stock options outstanding, respectively, 1,444,585 and 1,147,350 warrants to purchase common stock, respectively, and, debentures that are convertible to 227,500 and 360,000 shares of common stock, respectively, are excluded from the diluted per share calculation because they would be antidilutive.

J. Stock Options – The Company records share-based compensation expense using a fair-value based method of measurement that results in compensation costs for essentially all awards of stock-based compensation to employees. Compensation costs are recognized over the requisite period or periods that services are rendered.

K. New Accounting Standards – There are no Accounting Standards Updates expected to have a significant effect on the Company's consolidated financial position or results of operations.

L. Income Taxes – Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the current period plus or minus the change during the period in deferred tax assets and liabilities.

The accounting for uncertain tax positions requires the Company to evaluate each income tax position using a two step process which includes a determination as to whether it is more likely than not that the income tax position will be sustained, based upon technical merit and upon examination by the taxing authorities. At December 31, 2011 and 2010, there were no uncertain tax positions that required accrual. None of the Company's federal or state income tax returns are currently under examination by the Internal Revenue Service (“IRS”) or state authorities. However, fiscal years 2008 and later remain subject to examination by the IRS and respective states.

M. Supplemental Disclosure of Non-Cash Activity:

	2011	2010
Common Stock issued for commissions on debentures	$ -	$5,500
Burnham Hill Consulting - commission not due on cancellation of license of VC Energy agreement	18,000	-
VC Energy - issuance of common stock warrants	-	604,150
Deemed dividend on extension of outstanding stock warrants	132,642	611,854
SLD Consulting - value of stock issued on consulting agreement	-	334,400
SAMI - value of stock issued on public relations agreement	210,307	304,500
Rakgear - value of stock issued on consulting agreement	73,000	-
Conversion of debentures to Common Stock	-	90,204
	$433,949	$1,950,608

N. Segment Information – During 2011, the Company determined that it currently operates in one segment based on the financial information upon which the chief operating decision maker regularly assesses performance and allocates resources. The chief operating decision maker is the Chief Executive Officer.