2. Accounting Policies

Estimates and Assumptions

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

Fiscal Year

The Company's year ends on the Saturday nearest to December 31.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. All intercompany accounts and transactions are eliminated.

Cash Equivalents and Concentrations of Credit Risk

Highly liquid investments purchased with a maturity of three months or less are considered cash equivalents. The Company has deposits that exceed amounts insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000, but the Company does not consider this a significant concentration of credit risk based on the strength of the financial institution.

Foreign Currency Translation

For foreign operations balance sheet accounts are translated at the current year-end exchange rate; income statement accounts are translated at the average exchange rate for the year. Resulting translation adjustments are made directly to a separate component of shareholders' equity – "Accumulated other comprehensive income (loss) – Foreign currency translation". Foreign currency exchange transaction gains and losses are not material in any year.

The Eastern Company

Recognition of Revenue and Accounts Receivable

Revenue and accounts receivable are recognized when persuasive evidence of an arrangement exists, the price is fixed and determinable, delivery has occurred, and there is a reasonable assurance of collection of the sales proceeds. The Company obtains written purchase authorizations from its customers for a specified amount of product at a specified price and delivery occurs at the time of shipment. Credit is extended based on an evaluation of each customer's financial condition; collateral is not required. Accounts receivable are recorded net of applicable allowances. No customer exceeded 10% of total accounts receivable at year end 2012. At year end of 2011 only one customer had an outstanding accounts receivable balance that exceeded 10% of total accounts receivable.

Allowance for Doubtful Accounts

The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The Company reviews the collectibility of its receivables on an ongoing basis taking into account a combination of factors. The Company reviews potential problems, such as past due accounts, a bankruptcy filing or deterioration in the customer's financial condition, to ensure the Company is adequately accrued for potential loss. Accounts are considered past due based on when payment was originally due. If a customer's situation changes, such as a bankruptcy or creditworthiness, or there is a change in the current economic climate, the Company may modify its estimate of the allowance for doubtful accounts. The Company will write off accounts receivable after reasonable collection efforts have been made and the accounts are deemed uncollectible. Write-offs have been within management's estimates.

Inventories

Inventories are valued at the lower of cost or market. Cost is determined by the last-in, first-out (LIFO) method in the U.S. ($21,580,351 for U.S. inventories at December 29, 2012) and by the first-in, first-out (FIFO) method for inventories outside the U.S. ($7,804,429 for inventories outside the U.S. at December 29, 2012). Current cost exceeds the LIFO carrying value by approximately $6,302,000 at December 29, 2012 and $6,281,000 at December 31, 2011. There was no material LIFO quantity liquidation in 2012, 2011 or 2010.

Property, Plant and Equipment and Related Depreciation

Property, plant and equipment (including equipment under capital lease) are stated at cost. Depreciation ($3,210,324 in 2012, $3,155,717 in 2011 and $3,265,832 in 2010) is computed generally using the straight-line method based on the following estimated useful lives of the assets: Buildings 10 to 39.5 years; Machinery and equipment 3 to 10 years.

Goodwill, Intangibles and Impairment of Long-Lived Assets

Patents are recorded at cost and are amortized using the straight-line method over the lives of the patents. Technology and licenses are recorded at cost and are generally amortized on a straight-line basis over periods ranging from 5 to 17 years. Non-compete agreements and customer relationships are being amortized using the straight-line method over a period of 5 years. Amortization expense in 2012, 2011 and 2010 was $229,476, $551,499 and $676,807, respectively. Total amortization expense for each of the next five years is estimated to be as follows: 2013 - $215,000; 2014 - $215,000; 2015 - $215,000; 2016 - $215,000; and 2017 - $215,000. Trademarks are not amortized as their lives are deemed to be indefinite.

The gross carrying amount and accumulated amortization of amortizable intangible assets:

	Industrial Hardware Segment		Security Products Segment		Metal Products Segment		Total		Weighted-Average Amortization Period (Years)
2012 Patents and developed technology
Gross Amount:	$	2,732,307	$	1,021,409	$	5,839	$	3,759,555		15.8
Accumulated amortization:		1,652,199		447,732		5,667		2,105,598
Net 2012 per Balance Sheet	$	1,080,108	$	573,677	$	172	$	1,653,957

2011 Gross Amount:
Patents and developed technology	$	2,714,900	$	1,062,652	$	5,839	$	3,783,391		15.5
Customer relationships		45,825		1,921,811		—		1,967,636		5.0
Non-compete agreements		30,000		90,735		—		120,735		5.0
Total Gross Intangibles	$	2,790,725	$	3,075,198	$	5,839	$	5,871,762		11.7

2011 Accumulated Amortization:
Patents and developed technology	$	1,528,007	$	495,218	$	5,323	$	2,028,548
Customer relationships		36,660		1,921,811		—		1,958,471
Non-compete agreements		24,000		90,735		—		114,735
Total Gross Amortization	$	1,588,667	$	2,507,764	$	5,323	$	4,101,754

Net 2011 per Balance Sheet	$	1,202,058	$	567,434	$	516	$	1,770,008

In the event that facts and circumstances indicate that the carrying value of long-lived assets, including definite life intangible assets, may be impaired, an evaluation is performed to determine if a write-down is required. No events or changes in circumstances have occurred to indicate that the carrying amount of such long-lived assets held and used may not be recovered.

During the third quarter of 2012 the Company elected to change its annual impairment testing of goodwill and trademarks from the second quarter of its fiscal year to the fourth quarter of its fiscal year. The Company discussed this change in accounting principle with its Independent Registered Public Accounting Firm and attached their Preference Letter as an exhibit to the Form 10-Q for the quarter ending September 29, 2012. The Company completed a qualitative assessment in the second quarter of 2012 and determined it is more likely than not that no impairment of goodwill existed at that time. The Company performed another qualitative assessment as of the end of fiscal 2012 and determined it is more likely than not that no impairment of goodwill existed at the end of 2012. The Company will perform annual qualitative assessments in subsequent years as of the end of each fiscal year. Additionally, the Company will perform interim analysis whenever conditions warrant.

Goodwill or trademarks would be considered impaired whenever our historical carrying amount exceeds the fair value. Goodwill and trademarks were not impaired in 2012, 2011 or 2010. Should we reach a different conclusion in the future, additional work would be performed to determine the amount of the non-cash impairment charge to be recognized. The maximum future impairment of goodwill or trademarks that could occur is the amount recognized on our balance sheet.

The following is a roll-forward of goodwill for 2012 and 2011:

	Industrial Hardware Segment			Security Products Segment		Metal Products Segment		Total
2012
Beginning balance	$	2,071,393		$	11,833,816	$	—	$	13,905,209
Foreign exchange		28,390			—		—		28,390
Ending balance	$	2,099,783		$	11,833,816	$	—	$	13,933,599

2011
Beginning balance	$	2,100,174		$	11,833,816	$	—	$	13,933,990
Foreign exchange		(28,781	)		—		—		(28,781	)
Ending balance	$	2,071,393		$	11,833,816	$	—	$	13,905,209

Cost of Goods Sold

Cost of goods sold reflects the cost of purchasing, manufacturing and preparing a product for sale. These costs generally represent the expenses to acquire or manufacture products for sale (including an allocation of depreciation and amortization) and are primarily comprised of direct materials, direct labor as well as overhead which includes indirect labor, facility and equipment costs, inbound freight, receiving, inspection, purchasing, warehousing and any other costs related to the purchasing, manufacturing or preparation of a product for sale.

Shipping and Handling Costs

Shipping and handling costs are included in cost of goods sold.

Selling, General and Administrative Expenses

Selling, general and administrative expenses include all operating costs of the Company that are not directly related to the cost of purchasing, manufacturing and preparing a product for sale. These expenses generally represent the cost of selling or distributing the product once it is available for sale as well as administrative expenses for support functions and related overhead.

Product Development Costs

Product development costs, charged to expense as incurred, were $814,096 in 2012, $825,778 in 2011 and $739,251 in 2010.

Advertising Costs

The Company expenses advertising costs as incurred. Advertising costs were $442,300 in 2012, $386,908 in 2011 and $446,899 in 2010.

Income Taxes

The Company accounts for uncertain tax positions pursuant to the provisions of FASB Accounting Standards Codification ("ASC") 740 which clarifies the accounting for uncertainty in income taxes recognized in a company's financial statements. These provisions detail how companies should recognize, measure, present and disclose uncertain tax positions that have or are expected to be taken. As such, the financial statements will reflect expected future tax consequences of uncertain tax positions presuming the taxing authorities' full knowledge of the position and all relevant facts. See Note 7 Income Taxes.

The Company and its U.S. subsidiaries file a consolidated federal income tax return.

Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.

Earnings per Share

The denominators used in the earnings per share computations follow:

	2012		2011		2010
Basic:
Weighted average shares outstanding		6,216,931		6,178,664		6,104,711

Diluted:
Weighted average shares outstanding		6,216,931		6,178,664		6,104,711
Dilutive stock options		16,444		37,529		87,308
Denominator for diluted earnings per share		6,233,375		6,216,193		6,192,019

There were no anti-dilutive stock options in 2012, 2011 or 2010.

Derivatives

The Company does not maintain any derivatives as of the date of this report.

Stock Based Compensation

The Company accounts for stock based compensation pursuant to the fair value recognition provisions of ASC 718. No stock options were granted in 2012, 2011 or 2010, and, since all outstanding options were fully vested in each year presented, there was no impact on the financial statements.

Fair Value of Financial Instruments

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The company utilizes a fair value hierarchy, which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. The fair value hierarchy has three levels of inputs that may be used to measure fair value:

Level 1

Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted

assets or liabilities.

Level 2

Quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly, for

substantially the full term of the asset or liability.

Level 3

Prices or valuation techniques that require inputs that are both significant to the fair value measurement and

unobservable.

The carrying amounts of financial instruments (cash and cash equivalents, accounts receivable, accounts payable and debt) as of December 29, 2012 and December 31, 2011, approximate fair value. Fair value was based on expected cash flows and current market conditions.

Reclassification

Certain prior year amounts have been reclassified to conform to the current year presentation.