1. Description of Business and Significant Accounting Policies

Tengasco, Inc. is a Delaware corporation ("Tengasco" or the "Company").

The Company is in the business of exploration and production of oil and natural gas. The Company's primary area of oil exploration and production is in Kansas. The Company's primary area of natural gas exploration and production is the Swan Creek Field in Tennessee.

The Company's wholly-owned subsidiary, Tengasco Pipeline Corporation ("TPC"), owns and operates a 65 mile intrastate pipeline which it constructed to transport natural gas from the Company's Swan Creek Field to customers in Kingsport, Tennessee.

The Company's wholly-owned subsidiary, Manufactured Methane Corporation ("MMC") operates treatment and delivery facilities using the latest developments in available treatment technologies for the extraction of methane gas from nonconventional sources for delivery through the nations existing natural gas pipeline system, including the Company's TPC pipeline system in Tennessee for eventual sale to natural gas customers.

Principles of Consolidation

The accompanying consolidated financial statements are presented in accordance with accepted accounting principles generally accepted in the United States ("U.S. GAAP"). The consolidated financial statements include the accounts of the Company, and its wholly-owned subsidiaries after elimination of all significant intercompany transactions and balances.

Use of Estimates

The accompanying consolidated financial statements are prepared in conformity with U.S. GAAP which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant estimates include reserve quantities and estimated future cash flows associated with proved reserves, which significantly impact depletion expense and potential impairments of oil and natural gas properties, income taxes and the valuation of deferred tax assets, stock-based compensation and commitments and contingencies. We analyze our estimates based on historical experience and various other assumptions that we believe to be reasonable. While we believe that our estimates and assumptions used in preparation of the consolidated financial statements are appropriate, actual results could differ from those estimates.

Revenue Recognition

Revenues are recognized based on actual volumes of oil, natural gas, methane gas, and electricity sold to purchasers at a fixed or determinable price, when delivery has occurred and title has transferred, and collectability is reasonably assured. Crude oil is stored and at the time of delivery to the purchasers, revenues are recognized. Natural gas meters are placed at the customer's location and usage is billed each month. There were no material natural gas imbalances at December 31, 2012 or 2011. Methane gas and electricity sales meters are located at the tailgate of the Company's Methane Facility and sales are billed each month.

Cash and Cash Equivalents

Cash and cash equivalents include temporary cash investments with a maturity of ninety days or less at date of purchase. The Company has elected to enter into a sweep account arrangement allowing excess cash balances to be used to temporarily pay down the credit facility, thereby, reducing overall interest cost.

Restricted Cash

As security required by Tennessee oil and gas regulations, the Company placed $120,500 in a Certificate of Deposit to cover future asset retirement obligations for the Company's Tennessee wells. At December 31, 2012 and 2011, this amount was recorded in the Consolidated Balance Sheets under "Restricted cash".

In addition, during the 4^thquarter of 2012, the Company placed $386,000 as collateral for a bond to appeal a civil penalty related to issuance of an "Incidence of Non-Compliance" by the Bureau of Ocean Energy Management ("BOEM") concerning one of the Hoactzin wells operated by the Company pursuant to the Management Agreement. At December 31, 2012, this amount was recorded in the Consolidated Balance Sheets under "Restricted cash". (See Note 9. Commitments and Contingencies)

Inventory

Inventory consists of crude oil in tanks and is carried at lower of cost or market value. The cost component of the oil inventory is calculated using the average per barrel cost which includes production costs and taxes, allocated general and administrative costs, and allocated interest cost. The market component is calculated using the average December oil sales price for the Company's Kansas properties. In addition, the Company also carried equipment and materials to be used in its Kansas operation and is carried at the lower of cost or market value. The cost component of the equipment and materials inventory represents the original cost paid for the equipment and materials. The market component is based on estimated sales value for similar equipment and materials at the end of each year. At December 31, 2012 and 2011, inventory consisted of the following (in thousands):


	December 31,
		2012		2011
Oil – carried at cost	$	650	$	679
Equipment and materials – carried at cost		752		144
Total inventory	$	1,402	$	823

Oil and Gas Properties

The Company follows the full cost method of accounting for oil and gas property acquisition, exploration, and development activities. Under this method, all costs incurred in connection with acquisition, exploration and development of oil and gas reserves are capitalized. Capitalized costs include lease acquisitions, seismic related costs, certain internal exploration costs, drilling, completion, and estimated asset retirement costs. The capitalized costs of oil and gas properties, plus estimated future development costs relating to proved reserves and estimated asset retirement costs, which are not already included net of estimated salvage value, are amortized on the unit-of-production method based on total proved reserves. The Company has determined its reserves based upon reserve reports provided by LaRoche Petroleum Consultants Ltd. in 2012, 2011, 2010, and 2009. The costs of unproved properties are excluded from amortization until the properties are evaluated, subject to an annual assessment of whether impairment has occurred. The Company had $0.457 million and $0.268 million in unevaluated properties as of December 31, 2012 and 2011, respectively. Proceeds from the sale of oil and gas properties are accounted for as reductions to capitalized costs unless such sales cause a significant change in the relationship between costs and the estimated value of proved reserves, in which case a gain or loss is recognized.

At the end of each reporting period, the Company performs a "ceiling test" on the value of the net capitalized cost of oil and gas properties. This test compares the net capitalized cost (capitalized cost of oil and gas properties, net of accumulated depreciation, depletion and amortization and related deferred income taxes) to the present value of estimated future net revenues from oil and gas properties using an average price (arithmetic average of the beginning of month prices for the prior 12 months) and current cost discounted at 10% plus cost of properties not being amortized and the lower of cost or estimated fair value of unproven properties included in the cost being amortized (ceiling). (See Note. 4 Oil and Gas Properties)

Asset Retirement Obligation

An asset retirement obligation associated with the retirement of a tangible long-lived asset is recognized as a liability in the period incurred, with an associated increase in the carrying amount of the related long-lived asset, our oil and natural gas properties. The cost of the tangible asset, including the asset retirement cost, is depleted over the useful life of the asset. The asset retirement obligation is recorded at its estimated fair value, measured by reference to the expected future cash outflows required to satisfy the retirement obligation discounted at our credit-adjusted risk-free interest rate. Accretion expense is recognized over time as the discounted liability is accreted to its expected settlement value. Accretion expense is recorded as a "Production costs and taxes" in the Consolidated Statements of Operations. If the estimated future cost of the asset retirement obligation changes, an adjustment is recorded to both the asset retirement obligation and the long-lived asset. Revisions to estimated asset retirement obligations can result from changes in retirement cost estimates, revisions to estimated inflation rates and changes in the estimated timing of abandonment.

Pipeline Facilities

The pipeline was placed into service in 2001. The pipeline is being depreciated over its estimated useful life of 30 years. The Company reviews the carrying value of the pipeline for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. In cases where undiscounted expected future cash flows are less than the carrying value, an impairment loss is recognized equal to an amount by which the carrying value exceeds the fair value of assets. The factors considered by management in performing this assessment include current operating results, trends, and prospects, as well as the effects of obsolescence, demand, competition, and other economic factors. During 2010 and 2012, there were indicators the pipeline may be impaired and the Company performed an assessment of the carrying value as of December 31, 2010 and December 31, 2012 based on expected future cash flows. The assessments resulted in the Company recording an impairment of approximately $5.0 million or $3.3 million net of tax for the year ended December 31, 2010 and $5.2 million or $3.4 million net of tax for the year ended December 31, 2012. At December 31, 2011 management determined there were no indicators of impairment, therefore, there is no impairment charge for the year ended December 31, 2011. The Company's pipeline facilities are classified as an asset held for sale the related operations are classified as discontinued operations in the accompanying financial statements. (See Note 7. Assets Held for Sale and Discontinued Operations)

Manufactured Methane Facilities

The methane facilities were placed into service on April 1, 2009. The methane facilities are being depreciated over an estimated useful life of 32 years and 9 months beginning at the time it was placed in service. This useful life is based on the estimated landfill closure date of December 2041. (See Note 5. Methane Project)

In June 2012, the Company received a payment in the amount of approximately $1.0 million from the United States Department of the Treasury for a cash payment in lieu of tax credits relating to the methane facilities. The payment to the Company was authorized under Section 1603 of Division B of the American Recovery and Reinvestment Act of 2009. The grant amount was calculated pursuant to provisions applicable to a "landfill gas project," defined in this statute as a project generating electricity from landfill gas. The Company may not take investment tax credits for this facility as a result of accepting the cash payment, and is subject to annual reporting of the status of the project and recapture of all or a portion of the payment in the event the project were to be assigned to an ineligible nonprofit or governmental entity, during the five year period following the date of the award. The Company does not anticipate that the payment will be subject to recapture. Pursuant to the terms of the implementing federal regulations, the cash payment awarded is not treated as taxable income, but does reduce the taxable basis of the project by half of the grant amount. However, the book carrying amount of the property was reduced by the full amount of the payment.

Other Property and Equipment

Other property and equipment is carried at cost. The Company provides for depreciation of other property and equipment using the straight-line method over the estimated useful lives of the assets which range from two to seven years. Net gains or losses on other property and equipment disposed of are included in operating income in the period in which the transaction occurs. (See Note 6. Other Property and Equipment)

Stock-Based Compensation

The Company records stock-based compensation to employees based on the estimated fair value of the award at grant date. We recognize expense on a straight line basis over the requisite service period. For stock-based compensation that vests immediately, the Company recognizes the entire expense in the quarter in which the stock-based compensation is granted. The Company recorded compensation expense of $0.05 million in 2012, $0.2 million in 2011 and $0.1 million in 2010.

Accounts Receivable

Accounts receivable consist of uncollateralized joint interest owner obligations due within 30 days of the invoice date, uncollateralized accrued revenues due under normal trade terms, generally requiring payment within 30 days of production, and other miscellaneous receivables. No interest is charged on past-due balances. Payments made on accounts receivable are applied to the earliest unpaid items. We review accounts receivable periodically and reduce the carrying amount by a valuation allowance that reflects our best estimate of the amount that may not be collectible. No such allowance was considered necessary at December 31, 2012 or 2011. At December 31, 2012 and 2011, accounts receivable consisted of the following (in thousands):


	December 31,
		2012		2011
Revenue	$	1,517	$	1,412
Joint interest		65		112
Other		26		55
Total accounts receivable	$	1,608	$	1,579

Income Taxes

Income taxes are reported in accordance with U.S. GAAP, which requires the establishment of deferred tax accounts for all temporary differences between the financial reporting and tax bases of assets and liabilities, using currently enacted federal and state income tax rates. In addition, deferred tax accounts must be adjusted to reflect new rates if enacted into law. Management routinely assesses the ability to realize our deferred tax assets and reduces such assets by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be recognized.

At December 31, 2012, federal net operating loss carryforwards amounted to approximately $21.8 million which expire between 2019 and 2031. The total deferred tax asset was $9.4 million and $10.2 million at December 31, 2012 and 2011, respectively.

Realization of deferred tax assets is contingent on the generation of future taxable income. As a result, management considers whether it is more likely than not that all or a portion of such assets will be realized during periods when they are available, and if not, management provides a valuation allowance for amounts not likely to be recovered.

Management periodically evaluates tax reporting methods to determine if any uncertain tax positions exist that would require the establishment of a loss contingency. A loss contingency would be recognized if it were probable that a liability has been incurred as of the date of the financial statements and the amount of the loss can be reasonably estimated.

The amount recognized is subject to estimates and management's judgment with respect to the likely outcome of each uncertain tax position. The amount that is ultimately incurred for an individual uncertain tax position or for all uncertain tax positions in the aggregate could differ from the amount recognized.

Although management considers our valuation allowance and loss contingency as of December 31, 2012 and 2011 adequate, material changes in these amounts may occur in the future based on tax audits and changes in legislation.

Concentration of Credit Risk

Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and accounts receivable. Cash and cash equivalents are maintained at financial institutions and, at times, balances may exceed federally insured limits. We have never experienced any losses related to these balances.

The Company's primary business activities include oil and gas sales to a limited number of customers in the states of Kansas and Tennessee. The related trade receivables subject the Company to a concentration of credit risk.

The Company sells a majority of its crude oil primarily to one customer in Tennessee and two customers in Kansas. Additionally, the Company presently sells all gas from the Swan Creek Field and the Methane Facility to one customer. In addition, the Company sells the electricity generated at the Methane Facility to a local utility. Although management believes that customers could be replaced in the ordinary course of business, if the present customers were to discontinue business with the Company, it may have a significant adverse effect on the Company's projected results of operations.

Revenue from the top three purchasers accounted for 84.0%, 14.3%, and 2.2% of total revenues for year ended December 31, 2012. Revenue from the top three purchasers accounted for 83.5%, 13.9% and 1.9% of total revenues for the year ended December 31, 2011. Revenue from the top three purchasers accounted for 80.0%, 16.6% and 2.3% of total revenues for the year ended December 31, 2010.

Earnings per Common Share

We report basic earnings per common share, which excludes the effect of potentially dilutive securities, and diluted earnings per common share which include the effect of all potentially dilutive securities unless their impact is anti-dilutive. The following are reconciliations of the numerators and denominators of our basic and diluted earnings per share, (in thousands except for share and per share amounts):


	For the years ended December 31,
		2012			2011			2010

Income (numerator):
Net income from continuing operations	$	4,244		$	4,966		$	1,911
Net loss from discontinued operations	$	(4,311	)	$	(286	)	$	(3,656	)
Weighted average shares (denominator):
Weighted average shares - basic		60,778,356			60,701,660			60,415,859
Dilution effect of share-based compensation,
treasury method		376,275			387,323			241,133
Weighted average shares - dilutive		61,154,631			61,088,983			60,656,992
Earnings (loss) per share – Basic and Dilutive:
Continuing Operations	$	0.07		$	0.08		$	0.03
Discontinued Operations	$	(0.07	)	$	(0.00	)	$	(0.06	)

Fair Value of Financial Instruments

The carrying amounts of financial instruments including cash and cash equivalents, accounts receivable, accounts payables, accrued liabilities and long term debt approximates fair value as of December 31, 2012 and 2011. (See Note 10. Fair Value Measurements)

Derivative Financial Instruments

The Company uses derivative instruments to manage our exposure to commodity price risk on sales of oil production. The Company does not enter into derivative instruments for speculative trading purposes. The Company presents the fair value of derivative contracts on a net basis where the right to offset is provided for in our counterparty agreements. (See Note 11. Derivatives)

Reclassifications

Certain prior year amounts have been reclassified to conform to current year presentation with no effect on net income.

Discontinued Operations

During 2012, the Company committed to a plan to sell the Swan Creek and Pipeline assets. At December 31, 2012, the Company was in the process of negotiating this sale and on March 1, 2013, the Company entered into an agreement to sell the Company's Swan Creek and Pipeline assets for $1.5 million. Final closing of this transaction is contingent upon customary due diligence as well as certain regulatory and easement holder approvals. The Company has elected to classify the Pipeline assets as "Non-current assets held for sale" in the Consolidated Balance Sheets for the years ended December 31, 2012 and 2011. The related results of operations have been classified as "Net loss from discontinued operations in the Consolidated Statements of Operations for the years ended December 31, 2012, 2011, and 2010. The related cash flows have been classified as "Net cash (used in) operating activities – discontinued operations", "Net cash (used in) investing activities – discontinued operations", and Net cash (used in) financing activities – discontinued operations". As the Swan Creek assets represent only a small portion of the Company's full cost pool, these assets will remain in oil and gas properties and related operations and will continue to be classified in continuing operations. Unless otherwise indicated, the information in these notes relate to the Company's continuing operations. Information related to the assets held for sale and discontinued operations is included in "Note 7. Assets Held for Sale and Discontinued Operations".