. SIGNIFICANT ACCOUNTING POLICIES

●	Management estimates and reporting

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us 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 reported amounts of revenues and expenses during the periods presented. Actual results could differ from those estimates. Assets and liabilities with reported amounts based on significant estimates include inventory (slow-moving), property and equipment (useful lives, impairment), goodwill, accrued liabilities (expected sales returns, gift card breakage) and deferred income tax.

●	Principles of consolidation

Our consolidated financial statements include the accounts of Tandy Leather Factory, Inc. and its active wholly owned subsidiaries, The Leather Factory, L.P. (a Texas limited partnership), Tandy Leather Company, L.P. (a Texas limited partnership),The Leather Factory of Canada, Ltd. (a Canadian corporation), Tandy Leather Factory UK Limited (a UK corporation), Tandy Leather Factory Australia Pty. Limited (an Australian corporation), and Tandy Leather Factory España, S.L. (a Spanish corporation). All intercompany accounts and transactions have been eliminated in consolidation.

●	Foreign currency translation and transactions

Foreign currency translation adjustments arise from activities of our foreign subsidiaries. Results of operations are translated into U.S. dollars using the average exchange rates during the period, while assets and liabilities are translated using period-end exchange rates. Foreign currency translation adjustments of assets and liabilities are recorded in stockholders’ equity. Gains and losses resulting from foreign currency transactions are reported in the statements of income under the caption “Other (Income) Expense”, net, for all periods presented. We recognized foreign currency transaction gains of

$28,000,

$30,000,

and

$19,000,

2018,

2017,

and

2016,

respectively.

●	Revenue recognition

Our revenue is earned from sales of merchandise and generally occur via

two

methods: (

) at the store counter, and (

) shipment by common carrier. Sales at the counter are recorded and title passes as transactions occur. Otherwise, sales are recorded and title passes when the merchandise is shipped to the customer. Shipping terms are normally FOB shipping point. Sales tax and comparable foreign tax is excluded from revenue, while shipping charged to our customers is included in revenue.

Prior to

November 2018,

we offered an unconditional satisfaction guarantee to all customers and accepted all product returns. Net sales represent gross sales less negotiated price allowances, product returns, and allowances for defective merchandise. Beginning in

November 2018,

we changed our policy for returns to allow merchandise to be returned under most circumstances up to

days after purchase. At

December 31, 2018,

we have established a sales return reserve of

$184,000

based on historical customer return behavior, included in Accrued Expenses and Other Liabilities, while an estimated value of the merchandise expected to be returned of

$111,000

has been included in Inventory in the accompanying Consolidated Balance Sheet.

Historically, the sale of gift cards has

not

been material to our financial condition, results of operations or cash flows. As such, prior to

January 1, 2018,

gift cards were recognized as sales in the period the gift card was sold. Effective

January 1, 2018,

in conjunction with the adoption of Accounting Standards Codification

606,

"Revenue from Contracts with Customers" ("ASC

606"

), we began recording a gift card liability on the date we issue a gift card to a customer, of which

$168,311

was recognized on

January 1, 2018

as the cumulative effect of an accounting change. We record revenue and reduce the gift card liability as the customer redeems the gift card. In addition, for gift card breakage, we recognize a proportionate amount for the expected unredeemed gift cards over the expected customer redemption period, which is

one

year. At

December 31, 2018,

our gift card liability, included in accrued expenses and other liabilities, totaled

$195,901.

●	Disaggregated r evenue

In the following table, revenue is disaggregated by our major customer groups for the years ended

December 31:

	2018		2017		2016
RETAIL (end users, consumers, individuals)		61%		59%		56%
NON-RETAIL (hospitals, organizations, distributors, and businesses)		39%		41%		44%
		100%		100%		100%

For

2018,

2017

and

2016,

North America represents approximately

96%,

95%,

and

95%,

respectively, of total sales; as such, we believe that revenue by customer group more closely aligns with our North America segment than our International segment. Note

also contains additional disaggregated revenue information by segment and geographic area.

●

Discounts

We maintain

four

price levels on a consistent basis: retail, wholesale, business, and distributor. Sales are reported after deduction of discounts. We do

not

pay slotting fees or make other payments to resellers.

●	Operating e xpense

Operating expenses include all selling, general and administrative costs, including wages and benefits, rent and occupancy costs, depreciation, advertising, store operating expenses, outbound freight charges (to ship merchandise to customers), and corporate office costs.

●	Property and equipment, net of accumulated depreciation and amortization

Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which are

three

ten

years for equipment and machinery,

seven

fifteen

years for furniture and fixtures,

five

years for vehicles, and

forty

years for buildings and related improvements. Leasehold improvements are amortized over the lesser of the life of the lease or the useful life of the asset. Repairs and maintenance costs are expensed as incurred.

●

Inventory

Inventory is stated at the lower of cost (

first

-in,

first

out) or net realizable value. The calculation of cost includes merchandise purchases, the costs to bring the merchandise to our Texas distribution center, warehousing and handling expenditures, and distributing and delivering merchandise to stores. These costs include depreciation of long-lived assets utilized in acquiring, warehousing and distributing inventory. Carrying values of inventory are analyzed and, to the extent that the cost of inventory exceeds the expected selling prices less reasonable costs to sell, provisions are made to reduce the carrying amount of the inventory.

We regularly review all inventory items to determine if there are damaged goods (e.g. for leather, excessive scars or damage from UV light), to determine what items should be eliminated from the product line (e.g. item is slow moving, supplier is unable provide acceptable quality or quantity, and to maintain freshness in the product line) and to ensure that all necessary pricing actions are taken to adequately value our inventory at the lower of cost or net realizable value by recording permanent markdowns on our on-hand inventory.

Since the determination of net realizable value of inventory involves both estimation and judgment with regard to market values and reasonable costs to sell, differences in these estimates could result in ultimate valuations that differ from the recorded asset.

The majority of inventory purchases and commitments are made in U.S. dollars in order to limit the Company’s exposure to foreign currency fluctuations.

Goods shipped to us are recorded as inventory owned by us when the risk of loss shifts to us from the supplier.

Inventory is physically counted at substantially all locations at least

two

-to-

four

times annually, at which time actual results are reflected in the financial statements.

●	Impairment of long-lived assets

We evaluate long-lived assets for indicators of impairment whenever events or changes in circumstances indicate their carrying amounts

may

not

be recoverable. Additionally, for store assets, we evaluate the performance of individual stores for indicators of impairment including material declines in operational and financial performance or planned changes in the use of assets, such as store relocation or store closure. Such stores are selected for further evaluation of the recoverability of their carrying amounts. The evaluation of long-lived assets is performed at the lowest level of identifiable cash flows, which is at the individual store level. Impairment is determined when estimated future undiscounted cash flows associated with an asset are less than the asset’s carrying value resulting in an impairment charge equal to the difference between the asset’s carrying value and fair value. This evaluation requires management to make judgments relating to future cash flows, growth rates and economic and market conditions. Fair value of an asset is estimated using a valuation method such as discounted cash flow or a relative, market-based approach. During the quarter ended

December 31, 2018,

as part of an overall strategic review initiated in conjunction with changes in management, we performed a comprehensive evaluation of the historical sales performance, profitability and cash flow contribution of our individual stores, and assessed the recoverability of the carrying value of each store’s property and equipment. As part of that evaluation, we recorded impairment losses of

$285,500,

all of which relates to

four

underperforming stores in our North America segment and was determined on the basis of estimated future cash flows. This impairment charge is included in operating expenses on the accompanying Consolidated Statements of Comprehensive Income. There were

impairment charges in

2017

and

2016.

●	Earnings per share

Basic earnings per share are computed based on the weighted average number of common shares outstanding during the period. Diluted earnings per share includes, to the extent inclusion of such shares would be dilutive to earnings per share, the effect of outstanding options and warrants, computed using the treasury stock method.

	201 8		201 7		201 6
BASIC
Net income	$	1,963,828	$	4,451,751	$	6,402,259

Weighted average common shares outstanding		9,185,203		9,242,092		9,301,867

Earnings per share – basic	$	0.21	$	0.48	$	0.69

DILUTED
Net income	$	1,963,828	$	4,451,751	$	6,402,259

Weighted average common shares outstanding		9,185,203		9,242,092		9,301,867
Effect of restricted stock awards and assumed exercise of stock options		459		14,718		19,691
Weighted average common shares outstanding, assuming dilution		9,185,662		9,256,810		9,321,558

Earnings per share - diluted	$	0.21	$	0.48	$	0.69

Outstanding options and restricted stock awards excluded as anti-dilutive		657,717		17,632		31,477

For additional disclosures regarding the restricted stock awards and the employee stock options, see Note

10.

The net effect of converting stock options and restricted stock grants to purchase

12,779,

19,169

and

90,085

shares of common stock at option prices less than the average market prices has been included in the computations of diluted EPS for the years ended

December 31, 2018,

2017,

and

2016,

respectively.

●	Goodwill and other intangibles

Goodwill represents the excess of the purchase price over the fair value of net assets acquired in a business combination. Goodwill is required to be evaluated for impairment on an annual basis, absent indicators of impairment during the interim. Application of the goodwill impairment test requires exercise of judgment, including the estimation of future cash flows, determination of appropriate discount rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value and/or goodwill impairment for each reporting unit. Goodwill is

not

amortized, but is evaluated at least annually for impairment. We completed our annual goodwill impairment analysis as of

December 31

for each of the years ended

December 31, 2018,

2017,

and

2016

and determined that

adjustment to the carrying value of goodwill was required.

The only change in our goodwill for

2018

and

2017

resulted from foreign currency translation gains (losses) of

$8,184

and

$6,748,

respectively.

Our intangible assets and related accumulated amortization consisted of the following:

	As of December 31, 201 8
	Gross		Accumulated Amortization		Net
Trademarks, Copyrights	$	554,369	$	546,702	$	7,667
Non-Compete Agreements		175,316		166,483		8,833
	$	729,685	$	713,185	$	16,500

	As of December 31, 201 7
	Gross		Accumulated Amortization		Net
Trademarks, Copyrights	$	554,369	$	545,897	$	8,472
Non-Compete Agreements		175,316		164,566		10,750
	$	729,685	$	710,463	$	19,222

Amortization of intangible assets (excluding goodwill) of

$2,722

2018,

$1,618

2017,

and

$6,442

2016

was recorded in operating expenses. The weighted average amortization period is

years for trademarks and copyrights. Based on the current amount of intangible assets subject to amortization, we estimate amortization expense to be less than

$3,000

annually over the next

five

years.

●	Fair value of financial i nstruments

We measure fair value as an exit price, which is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As a basis for considering such assumptions, accounting standards establish a

three

-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:

Level

– observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level

– include other inputs that are directly or indirectly observable in the marketplace.

Level

– significant unobservable inputs which are supported by little or

market activity.

Classification of the financial asset or liability within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

Our principal financial instruments held consist of certificates of deposit, accounts receivable, accounts payable, and long-term debt. The carrying value of certificates of deposit, accounts receivable and accounts payable approximate their fair value due to the relatively short-term nature of the accounts. The terms of the long-term debt are considered reasonable for this type of financing; therefore, the carrying amount approximates fair value.

●	Income taxes

We account for income taxes using the asset and liability method. Under this method, the amount of taxes currently payable or refundable is accrued, and deferred tax assets and liabilities are recognized for the estimated future tax consequences of temporary differences that currently exist between the tax basis and the financial reporting basis of our assets and liabilities.

Deferred tax assets and liabilities are measured using the enacted tax rates in effect in the years when those temporary differences are expected to reverse. The effect on deferred taxes from a change in tax rate is recognized through continuing operations in the period that includes the enactment date of the change. Changes in tax laws and rates could affect recorded deferred tax assets and liabilities in the future.

A tax benefit from an uncertain tax position

may

be recognized when it is more-likely-than-

not

that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Income tax position must meet a more-likely-than-

not

recognition threshold to be recognized.

We recognize tax liabilities for uncertain tax positions and adjust these liabilities when our judgment changes as a result of the evaluation of new information

not

previously available. Due to the complexity of some of these uncertainties, the ultimate resolution

may

result in a payment that is materially different from the current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense and the effective tax rate in the period in which new information becomes available.

may

be subject to periodic audits by the Internal Revenue Service and other taxing authorities. These audits

may

challenge certain of our tax positions, such as the timing and amount of deductions and allocation of taxable income to the various jurisdictions.

●	Share-based compensation

We have

one

stock option plan that expired in

March 2017.

This plan permitted annual stock option grants to non-employee directors with an exercise price equal to the fair market value of the shares at the date of grant. These options vest and become exercisable

six

months from the option grant date. Under this plan,

stock options were awarded in

2015

or after, therefore, we did

not

recognize any share based compensation expense for these options during those periods.

The Company’s stock-based compensation relates to restricted stock awards. Accounting guidance requires measurement and recognition of compensation expense at an amount equal to the grant date fair value. Compensation expense is recognized for service-based restricted stock awards on a straight-line basis or ratably over the requisite service period, based on the closing price of the Company’s stock on the date of grant. The time-based awards typically vest ratably over the requisite service period provided that the participant is employed on the vesting date. The performance-based shares vest, if at all, upon the Company satisfying certain performance targets. The Company records compensation expense for these awards with a performance condition when it is probable that the condition will be achieved. The compensation expense ultimately recognized, if any, related to these performance-based awards will equal the grant date fair value for the number of shares for which the performance condition has been satisfied.

●	Comprehensive income

Comprehensive income includes net income and certain other items that are recorded directly to Stockholders’ Equity. The Company’s only source of other comprehensive income is foreign currency translation adjustments.

●	Shipping and handling costs

Costs to ship products from our stores to our customers are included in operating expenses on the statements of income. These costs totaled approximately

$1,818,000,

$1,965,000,

and

$1,982,000

for the years ended

December 31, 2018,

2017,

and

2016,

respectively.

●	Advertising

Advertising costs include the cost of print, digital, direct mail, community events, trade shows, and our ecommerce platform. With the exception of catalog costs, advertising costs are expensed as incurred. Catalog costs are capitalized and expensed over the estimated useful life of the particular catalog in question, which is typically

twelve

months. Such capitalized costs are included in other current assets and totaled

$239,000

and

$203,000

December 31, 2018

and

2017,

respectively. Total advertising expense was

$3,889,000

2018;

$4,956,000

2017;

and

$4,759,000

2016.

●	Cash flows presentation

For purposes of the statement of cash flows, we consider all highly liquid investments with initial maturities of

three

months or less from the date of purchase to be cash equivalents.

●

Revisions

The Company revised the Consolidated Statement of Cash Flows for the years ended

December 31, 2017

and

2016

to correct the presentation of exchange rate changes on cash. This revision resulted in an increase (decrease) in cash provided by operating activities and corresponding increase/decrease to effect of exchange rate changes on cash in the amount of (

$853,822

) and

$181,891

for the years ended

December 31, 2017

and

2016,

respectively. These revisions do

not

impact the Consolidated Balance Sheets, the Consolidated Statements of Comprehensive Income, or the Consolidated Statements of Stockholders' Equity. The Company has concluded that the effect of this revision is

not

material to any of our previously issued financial statements.