Significant Accounting Policies

6 Months Ended

Jun. 30, 2011

Significant Accounting Policies

Significant Accounting Policies

NOTE 3-SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

The preparation of financial statements in conformity with United States generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. The more significant estimates relate to revenue recognition, contractual allowances and uncollectible accounts, intangible assets, accrued liabilities, derivative liabilities, income taxes, litigation and contingencies. Estimates are based on historical experience and on various other assumptions that the Company believes to be reasonable under the circumstances, the results of which form the basis for judgments about results and the carrying values of assets and liabilities. Actual results and values may differ significantly from these estimates.

Concentration of Credit Risk

Financial instruments which subject the Company to potential credit risk consist of its cash and cash equivalents and accounts receivable. The Company places its cash and cash equivalents with one high credit quality financial institution. Deposits may exceed the amount of insurance provided; however, these deposits typically are redeemable upon demand and, therefore, the Company believes the financial risks associated with these financial instruments are minimal. The Company has not experienced any losses to date on its deposits.

The Company performs ongoing credit evaluations of its customers, and generally does not require collateral on its accounts receivable. The Company estimates the need for allowances for potential credit losses based on historical collection activity and the facts and circumstances relevant to specific customers and records a provision for uncollectible accounts when collection is uncertain. The Company has not experienced significant credit related losses to date.

The Company currently relies on various outside contract manufacturers in China to supply electric vehicles and products for its customers and management believes that other contract manufactures could provide similar services and intends to transition its manufacturing to Jonway's facilities in Sanmen, China. However, if these Chinese companies are unable to supply electric vehicles and the Company is unable to transition manufacturing to Jonway's facilities or find alternative sources for these product and services, the Company might not be able to fill existing backorders and/or sell more electric vehicles. Any significant manufacturing interruption could have a material adverse effect on the Company's business, financial condition and results of operations.

Revenue Recognition

The Company records revenues for non-Jonway sales when all of the following criteria have been met:

·                       Persuasive evidence of an arrangement exists. The Company generally relies upon sales contracts or agreements, and customer purchase orders to determine the existence of an arrangement.

·                       Sales price is fixed or determinable. The Company assesses whether the sales price is fixed or determinable based on the payment terms and whether the sales price is subject to refund or adjustment.

·                       Delivery has occurred. The Company uses shipping terms and related documents, or written evidence of customer acceptance, when applicable, to verify delivery or performance. The Company's customary shipping terms are FOB shipping point.

·                       Collectability is reasonably assured.  The Company assesses collectability based on creditworthiness of customers as determined by our credit checks and their payment histories. The Company records accounts receivable net of allowance for doubtful accounts and estimated customer returns.

The Company records revenues for Jonway sales only upon the occurrence of all of the following conditions:

·                       The Company has received a binding purchase order from the customer or distributor authorized by a representative empowered to commit the purchaser (evidence of a sale);

·                       The purchase price has been fixed, based on the terms of the purchase order;

·                       The Company has delivered the product from its factory to a common carrier acceptable to the customer; and

·                       The Company deems the collection of the amount invoiced probable.

The Company provides no price protection. Sales are recognized net of promotional discounts, rebates and return        allowances.

Shipping and Handling costs

Shipping and handling costs have been included in cost of goods sold.

Research and Development

Research and product development costs are expensed as incurred.

Stock-based Compensation

The Company accounts for stock-based compensation under the provisions of FASB ASC Topic 718, Compensation—Stock Compensation ("ASC 718"), which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors based on estimated fair values on the grant date. The Company adopted ASC 718 (previously Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards No. 123(R) on January 1, 2006 using the modified prospective method. The Company estimates the fair value of stock-based awards on the date of grant using the Black-Scholes-Merton option pricing model (the "Black-Scholes model"). The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods using the straight-line method. We estimate forfeitures at the time of grant and revise our estimate in subsequent periods if actual forfeitures differ from those estimates. See Note 4 "Stock-Based Compensation" for a complete discussion of our equity compensation programs and the fair value assumptions used to determine our stock-based compensation expense.

The Company accounts for stock-based compensation awards and warrants granted to non-employees in accordance with FASB ASC Topic 505-50, Equity-Based Payments to Non-Employees ("ASC 505-50"). Under ASC 505-50, the Company determines the fair value of the warrants or stock-based compensation awards granted as either the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. If the fair value of equity instruments issued is used, it is measured using the stock price and other measurement assumptions as of the earlier of either (1) the date at which commitment for performance by the counterparty to earn the equity instruments is reached, or (2) the date at which the counterparty's performance is complete.

Income Taxes

The Company uses the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. To the extent a deferred tax asset cannot be recognized under the preceding criteria, allowances are established. At June 30, 2011 and 2010, all deferred tax assets, without offsetting liabilities in the same jurisdiction, were fully reserved.

Net Loss per Share Attributable to Common Stockholders

                Basic and diluted net loss per share is computed by dividing consolidated net loss attributable to ZAP by the weighted-average number of common shares outstanding during the period. The Company's potentially dilutive shares, which include outstanding common stock options convertible debt and warrants, have not been included in the computation of diluted net loss per share for all periods presented as the result would be anti-dilutive. Such potentially dilutive shares are excluded when the effect would be to reduce a net loss per share. There were outstanding options and warrants exercisable to purchase 100.7 million and 94 million shares of ZAP common stock at June 30, 2011 and 2010, respectively. ZAP also had outstanding debt, which is convertible into 84,265,000 shares of ZAP common stock or a number of shares of Jonway stock owned by ZAP to be determined in accordance with the Note with CEVC dated January 12, 2011.

Cash and Cash Equivalents

The Company invests its excess cash in short-term investments with various banks and financial institutions. Short-term investments are cash equivalents, as they are part of the cash management activities of the Company and are comprised of investments having maturities of three months or less when purchased.  The Company considers all highly liquid investments with an original maturity of three months or less from the date of purchase to be cash equivalents

Restricted Cash

The Company has cash restricted in connection with the issuance by Jonway's automobile dealers of bank notes instead of cash payment for Jonway's mature payables, due to Jonway's lack of cash in the three months ended June 30, 2011.  To issue these notes, the banks require a deposit of approximately 40-60% of the amount of the note and to have the full amount of the note on the note's due date, which is usually 6 months from issuance.

Due to Related Party

Based on a contract by and among the Sanmen Branch of Zhejiang UFO Automobile Manufacturing Co., Ltd. ("Zhejiang UFO"), Jonway Group and Jonway dated as of January 1, 2006, Zhejiang UFO has authorized Jonway to operate its Sanmen Branch to assemble and sell UFO branded SUVs for a period of 10 years starting from January 1, 2006.

According to the contract, Jonway shall pay Zhejiang UFO a variable contractual fee which is calculated based on the number of SUVs that the Sanmen Branch assembles every year, at the following rates:

The first 3,000 vehicles	$44 per vehicle
Vehicles from 3,001 to 5,000	$30 per vehicle
Vehicles over 5,000	$22 per vehicle

Zhejiang UFO is considered a related party because the Wang Family, who are shareholders of Jonway, have certain non-controlling equity interests in Zhejiang UFO.  The balance due from Jonway at June 30, 2011 is $2.7 million.

Marketable Securities

The Company has an investment in a related party that is comprised of marketable equity securities, which are classified as available-for-sale and recorded at fair value, the value of which fluctuates with the stock market value.   The securities are shares of stock in Samyang Optics Co., Ltd., which shares are traded on the Korean stock exchange.  ZAP's ownership is not material to Samyang Optics Co., Ltd. Net unrealized holding gains and losses, net of tax, are reported as a separate component of shareholders' deficit, except where holding losses are determined to be "other-than-temporary", whereby the losses are reported in gains and losses on investments in the consolidated statement of operations.  Gains and losses on disposals of marketable equity securities are determined using the specific identification method.  The market value of these securities declined $230,000 in the three months ended June 30, 2011 and $517,000 for the six months ended June 30, 2011.

Notes Receivable

Notes receivable balances consist of bank notes issued by Jonway's automobile dealers instead of cash payment for Jonway's mature payables, due to Jonway's lack of cash in the three months ended June 30, 2011.

Fair Value of Financial Instruments

The Company measures its financial assets and liabilities at fair value. The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties. For certain of the Company's financial instruments, including cash equivalents, accounts receivable, accounts payable and accrued liabilities, the carrying amount approximates fair value because of the short maturities. The fair value of debt is not determinable due to the terms of the debt and the lack of a comparable market for such debt.  These tiers include:

Level 1: Observable inputs such as quoted prices in active markets;

Level 2: Inputs other than quoted prices in active markets that are directly or indirectly observable;

Level 3: Unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions and methodologies that result in management's best estimate of fair value.

The change in fair value of derivative liabilities is classified in other income (expense) in the Company's statement of operations.  The fair value of the Company's derivative liabilities related to stock purchase warrants was determined using the Black-Scholes option pricing model – a Level 3 input.

Derivative Financial Instruments

The Company generally does not use derivative financial instruments to hedge exposures to cash flow or market risks. However, certain other financial instruments, such as warrants, are classified as liabilities when either (a) the holder possesses rights to net-cash settlement or (b) physical or net-share settlement is not within the control of the Company. In such instances, net-cash settlement is assumed for financial accounting and reporting, even when the terms of the underlying contracts do not provide for net-cash settlement. Such financial instruments are initially recorded at fair value and subsequently adjusted to fair value at the close of each reporting period.

The Company accounts for derivative instruments and debt instruments in accordance with the interpretative guidance of ASC 815 ("Derivatives and Hedging").   It is necessary for the Company to make certain assumptions and estimates to value derivatives and debt instruments.

During the three months ended June 30, 2011, certain derivative liabilities were converted into 233,192 shares of ZAP stock.

The following table set forth a summary of changes in the fair value of Level 3 liabilities for the three months ended June 30, 2011 (in thousands):

	Balance		Exercise			Change in		Balance
	3/31/2011		of warrants			fair value		6/30/2011
Derivative Liabilities	$	201	$	(70	)	$	10	$	0

                The Company does not have any non-financial assets or liabilities that it measures at fair value.

Beneficial Conversion Feature

The Company accounts for potentially beneficial conversion features under Emerging Issues Task Force No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios and EITF Issue No. 00-27, Application of Issue 98-5 to Certain Convertible Instruments. On January 12, 2011, the Company issued $19 million of Convertible debt to CEVC which is convertible into 84.3 million shares of ZAP Stock or a number of shares of Jonway stock owned by ZAP to be determined in accordance with the note. At the time of each of this issuance, the value of the common stock into which the note is convertible had a fair value greater than the proceeds for such issuance. Accordingly, the Company has recorded a beneficial conversion feature of $8.6 million. The amount of the conversion feature was limited where the warrants issued in conjunction with the CEVC note were valued at $10.3 million plus the conversion feature would not exceed $19 million

Allowance for Doubtful Accounts

The Company provides an allowance for doubtful accounts when management estimates collectibles to be uncertain. Accounts receivable are continually reviewed to determine which, if any, accounts are doubtful of collection. In making the determination of the appropriate allowance amount, the Company considers current economic and industry conditions, relationships with each significant customer, overall customer credit-worthiness and historical experience. The allowance for doubtful accounts was approximately $19,000 and $27,000 at June 30, 2011 and December 31, 2010, respectively for ZAP's U.S. operations.  Zhenjiang Jonway Automobile Co., Ltd. ("Jonway") primarily sells vehicles to its qualified dealers. An on-going credit evaluation of its customers' financial condition is performed. Jonway maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. As a result of this analysis no allowance for doubtful accounts was determined to be required at June 30, 2011.

                Inventories

Inventories consist primarily of vehicles, both gas and electric, parts and supplies, and finished goods and are carried at the lower of cost (first-in, first-out basis) or market (net realizable value or replacement cost). The Company maintains reserves for estimated excess, obsolete and damaged inventory based on projected future shipments using historical selling rates, and taking into account market conditions, inventory on-hand, purchase commitments, product development plans and life expectancy, and competitive factors. If markets for the Company's products and corresponding demand were to decline, then additional reserves may be deemed necessary. Any changes to the Company's estimates of its reserves are reflected in cost of goods sold within the statement of operations during the period in which such changes are determined by management.

Property and Equipment

Property and equipment consists of land, building and improvements, machinery and equipment, office furniture and equipment, vehicles, and leasehold improvements. Property and equipment is stated at cost, net of accumulated depreciation and amortization, and is depreciated or amortized using straight-line and accelerated methods over the asset's estimated useful life. Costs of maintenance and repairs are charged to expense as incurred; significant renewals and betterments are capitalized

Long-lived Assets

Long-lived assets are comprised of property and equipment and intangible assets. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. An estimate of undiscounted future cash flows produced by the asset, or by the appropriate grouping of assets, is compared to the carrying value to determine whether impairment exists. If an asset is determined to be impaired, the loss is measured based on quoted market prices in active markets, if available. If quoted market prices are not available, the estimate of fair value is based on various valuation techniques, including a discounted value of estimated future cash flow and fundamental analysis. The Company reports an asset to be disposed of at the lower of its carrying value or its estimated net realizable value.

Intangible Assets

Intangible assets consist of trade names, developed technology, in process research and development and customer relationships (including client contracts). For financial statement purposes, identifiable intangible assets with a defined life are being amortized using the straight-line method over the estimated useful lives of seven years for developed technology and eight years for the customer relationships. Costs incurred by the Company in connection with trademark applications and approvals from governmental agencies, including legal fees and trademark fees and specific testing costs, are expensed as incurred. Purchased intangible costs of completed developments are capitalized and amortized over an estimated economic life of the asset commencing on the acquisition date. Costs subsequent to the acquisition date are expensed as incurred.

Product warranty costs

The Company provides 30 to 90 day warranties on its personal electric products, including the ZAPPY3 and the Zapino scooters, six month warranties for the Xebra®, the ZAPTRUCK XL, the ZAPVAN Shuttle vehicles, and a six month warranty for Xebra® vehicles repaired by ZAP pursuant to its product recall.  The Company records the estimated cost of the product warranties at the time of sale using the estimated costs of products warranties based on historical results. The estimated cost of warranties has not been significant to date. Should actual failure rates and material usage differ from our estimates, revisions to the warranty obligation may be required.

The Company provides a 2-year or 60,000 kilometer mileage warranty for its Jonway SUV products. The Company records the estimated cost of the product warranties at the time of sale using the estimated cost of product warranties based on historical results. The estimated cost of warranties has not been significant to date. Should actual failure rates and material usage differ from our estimates, revisions to the warranty obligation may be required

                 Common Stock

At the ZAP Annual Meeting held on June 20, 2011, the shareholders approved the following proposed resolutions that affect our common stock:

• an amendment to increase the authorized shares of common stock from 400 million to 800 million;
• an amendment to our charter to effect a reverse stock split within a range of one-for-four or one–for-eight with the ultimate ratio to be determined by our Board of Directors; and
• an amended and restated 2008 equity plan to, among other things, increase the number of shares of common stock available for issuance under the plan to a total of 40 million shares.

Comprehensive loss

Comprehensive loss represents the net loss for the period plus the results of certain changes to shareholders' equity that are not reflected in the consolidated statements of operations. The Company's comprehensive loss consists of net losses, foreign currency cumulative translation adjustments and unrealized net losses on investments.  Comprehensive loss was as follows (in thousands):

	Three months ended June 30,				Six months ended June 30,
	2011		2010		2011		2010
			Restated				Restated
Consolidated net loss	$	(13,715)	$	(2,482)	$	(23,613)	$	(5,342)
Increase in foreign cumulative translation adjustment		365		—		669		—
Decrease in net unrealized gains on available-for-sale securities		(230)		—		(517)		—
Comprehensive loss		(13,580)		(2,482)		(23,461)		(5,342)
Comprehensive loss attributable to non controlling interest		(1,134)		—		(3,034)		—
Comprehensive loss attributable to ZAP	$	(12,446)	$	(2,482)	$	(20,427)	$	(5,342)

                Quantitative and Qualitative Disclosures about Market Risk

ZAP foreign currency exchange risks are as follows:

The financial position and results of operations of our Chinese subsidiary Jonway are measured using Chinese Renminbi (RMB) as the functional currency.  The financial position and results of operations of our Chinese subsidiary are reported in United States dollars (USD) and included in our consolidated financial statements.  Our exposure to foreign currency fluctuation is mitigated, in part, by the fact that we incur certain operating costs in the same foreign currencies in which revenues are denominated.  The foreign currency transaction gain (loss) is attributable to the impact of foreign currency exchange rate changes on intercompany debt balances and on receivable and payables denominated in a currency other than a subsidiary's functional currency.  ZAP benefits from a weaker dollar and is adversely affected by a stronger dollar relative to major currencies worldwide.  Accordingly, changes in exchange rates, and in particular a strengthening of the US dollar, may negatively affect the company's consolidated revenues or operating costs and expenses as expressed in U.S. Dollars.  Adjustments resulting from the process of translating foreign functional currency financial statements into US dollars are included in accumulated other comprehensive income (loss) a separate component of  common shareholders equity.