Description of Operations and Summary of Significant Accounting Policies

12 Months Ended

Dec. 31, 2012

Accounting Policies [Abstract]

Description of Operations and Summary of Significant Accounting Policies

1.     Description of Operations and Summary of Significant Accounting Policies

Description of Operations

Mendocino Brewing Company, Inc., (“the Company” or “MBC”), was formed in 1983 in California, and has two operating subsidiaries: Releta Brewing Company, LLC, (“Releta”), and United Breweries International (UK) Limited (“UBIUK”). In the United States (“US”), MBC and its subsidiary, Releta, operate two breweries that produce beer and malt beverages for the specialty “craft” segment of the beer market. The breweries are located in Ukiah, California and Saratoga Springs, New York. The majority of sales for Mendocino Brewing Company in the US are in California. The Company brews several brands, of which Red Tail Ale is the flagship brand. In addition, the Company performs contract brewing for several other brands, and MBC holds the license to distribute Kingfisher Lager Beer in the US and Canada. Generally, product shipments are made directly from the breweries to the wholesalers or distributors in accordance with state and local laws.

The Company’s United Kingdom (“UK”) subsidiary, UBIUK, is a holding company for Kingfisher Beer Europe Limited (“KBEL”) which, prior to March 30, 2011, was known as UBSN Limited (“UBSN”). KBEL is a distributor of alcoholic beverages, mainly Kingfisher Lager Beer, in the United Kingdom and Europe. The distributorship is located in Maidstone, Kent in the UK.

Subsequent Events

The Company evaluates events that occur subsequent to the balance sheet date of periodic reports, but before financial statements are issued for periods ending on such balance sheet dates, for possible adjustment to such financial statements or other disclosure. This evaluation generally occurs through the date at which the Company’s financial statements are electronically prepared for filing with the Securities and Exchange Commission (“SEC”).

Principles of Consolidation

The consolidated financial statements present the accounts of Mendocino Brewing Company, Inc., and its wholly-owned subsidiaries, Releta and UBIUK. All material intracompany and inter-company balances, profits and transactions have been eliminated.

Basis of Presentation and Organization

The financial statements for the years ended December 31, 2012 and 2011 have been prepared in accordance with accounting principles generally accepted in the United States. The financial statements and notes are representations of the management and the Board of Directors, who are responsible for their integrity and objectivity.

Reclassifications

Certain items in the financial statements for the prior year have been reclassified to conform to the current year presentation. These reclassifications had no effect on net income or equity.

Cash and Cash Equivalents, Short- and Long-Term Investments

For purposes of cash flows, the Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.

Foreign Operations

Approximately 22% of the Company’s assets are located in the UK. Although this country is considered economically stable and the Company has experienced no notable burden from foreign exchange transactions, export duties, or government regulations, it is always possible that unanticipated events in foreign countries could disrupt the Company’s operations.

Trade Accounts Receivable and Allowance for Doubtful Accounts

Trade accounts receivable are stated at the invoiced amount and are the amount the Company expects to collect. Sales are made to approved customers on an open account basis, subject to established credit limits, and generally no collateral is required. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable; however, changes in circumstances relating to accounts receivable may result in a requirement for additional allowances in the future.

Allowance for Doubtful Accounts

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Management considers the following factors when determining the collectibility of specific customer accounts: customer credit-worthiness, past transaction history with the customer, current economic and industry trends and changes in customer payment terms. Past due balances over 90 days and other higher risk amounts are reviewed individually for collectibility. If the financial condition of the Company’s customers were to deteriorate, adversely affecting their ability to make payments, additional allowances would be required. Based on management’s assessment, the Company provides for estimated uncollectible amounts through a charge to earnings and a credit to a valuation allowance. Balances that remain outstanding after the Company has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable. As of December 31, 2012 and 2011, the Company maintained a reserve of $207,800 and $240,200 of potentially doubtful accounts receivable, respectively.

Inventories

Inventories are stated at the lower of average cost, which approximates the first-in, first-out method, or market (net realizable value). The Company regularly reviews its inventories for the presence of obsolete product attributed to age, seasonality and quality. Inventories that are considered obsolete are written off or adjusted to carrying value.

Prepaid Expenses and Other Assets

Prepaid expenses and other assets generally consist of deposits, other receivables, and prepayments for future services. Prepayments are expensed when the services are received.

Property and Equipment

Property and equipment are stated at cost and depreciated or amortized using the straight-line method over the assets’ estimated useful lives. Leasehold improvements are amortized over the shorter of the life of the improvement or the life of the related lease. The Company uses other depreciation methods (generally, accelerated depreciation methods) for tax purposes where appropriate. Costs of maintenance and repairs are charged to expense as incurred; significant renewals and betterments are capitalized. When property and equipment are retired, sold, or otherwise disposed of, the asset’s carrying amount and related accumulated depreciation are removed from the accounts and any gain or loss is included in the statement of operations.

Estimated useful lives of property and equipment are as follows:

Building	40 years
Machinery and equipment	3 - 40 years
Equipment under capital lease	3 - 10 years
Leasehold improvements	5 - 10 years
Vehicles	3 - 5 years
Furniture and fixtures	5 - 10 years

Assets Held under Capital Leases

Assets held under capital leases are recorded at the lower of the net present value of the minimum lease payments or the fair value of the leased asset at the inception of the lease. Amortization expense is computed using the straight-line method over the shorter of the estimated useful lives of the assets or the period of the related lease.

Impairment of Long-Lived Assets

The Company assesses the impairment of its long-lived assets periodically in accordance with the provisions of Accounting Standards Codification (ASC) 360, (Accounting for the Impairment and Disposal of Long-Lived Assets). The Company reviews the carrying value of property and equipment and any other long-lived assets for impairment annually or 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. Long-lived assets that management commits to sell or abandon are reported at the lower of carrying amount or fair value less cost to sell. During the year ended December 31, 2012, the Company recorded no impairment losses and during the year ended December 31, 2011 the Company recorded impairment losses of $17,600 related to long-lived assets.

Deferred Financing Costs

Costs relating to obtaining financing are capitalized and amortized over the term of the related debt. When a loan is paid in full, any unamortized financing costs are removed from the related accounts and charged to operations. Deferred financing costs of $311,300 related to loans repaid in June 2011 were fully amortized as of June 30, 2011. Deferred financing costs related to new borrowing made in June 2011 were $225,000. Amortization of deferred financing costs charged to operations was $45,000 and $55,200 for the years ended December 31, 2012 and 2011, respectively.

Income Taxes

The Company accounts for income taxes in accordance with ASC 750 which requires an asset and liability approach for financial accounting and reporting for income taxes and allows recognition and measurement of deferred tax assets based upon the likelihood of realization of tax benefits in future years. Under the asset and liability approach, deferred taxes are provided for the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. 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. Deferred tax assets are recognized for deductible temporary differences and operating loss, and tax credit carryforwards. A valuation allowance is established to reduce the deferred tax asset if it is more likely than not that the related tax benefits will not be realized.

The Company periodically assesses uncertain tax positions that the Company has taken or expects to take on a tax return (including a decision whether to file or not to file a return in a particular jurisdiction). The Company evaluated its tax positions and determined that there were no uncertain tax benefits for the years ending December 31, 2012 and 2011.

Revenue Recognition

The Company recognizes revenue from the brewing and distribution operations in accordance with ASC 605. The Company recognizes revenue from product sales, net of discounts.

The Company recognizes revenue only when all of the following criteria have been met:

● Persuasive evidence of an arrangement exists;

● Delivery has occurred or services have been rendered;

● The fee for the arrangement is fixed or determinable; and

● Collectibility is reasonably assured.

“Persuasive Evidence of an Arrangement” – The Company documents all terms of an arrangement in a written contract or purchase order signed by the customer prior to recognizing revenue.

“Delivery Has Occurred or Services Have Been Performed” – The Company delivers the products prior to recognizing revenue or performs services as per contractual terms. Product is considered delivered upon delivery to a customer’s designated location and services considered performed upon completion of Company’s contractual obligations.

“The Fee for the Arrangement is Fixed or Determinable” – Prior to recognizing revenue, an amount is either fixed or determinable under the terms of the written contract. The price is negotiated at the outset of the arrangement and is not subject to refund or adjustment during the initial term of the arrangement.

“Collectibility is Reasonably Assured” – The Company determines that collectibility is reasonably assured prior to recognizing revenue. Collectibility is assessed on a customer-by-customer basis based on criteria outlined by management. The Company does not enter into arrangements unless collectibility is reasonably assured at the outset. Existing customers are subject to ongoing credit evaluations based on payment history and other factors. If it is determined during the arrangement that collectibility is not reasonably assured, revenue is recognized on a cash basis.

The Company records certain consideration paid to customers for services or placement fees as a reduction in revenue rather than as an expense. The Company reports these items on the statement of operations as a reduction in revenue and as a corresponding reduction in marketing and selling expenses.

Revenues from the brewpub and gift store are recognized when sales have been completed.

Excise Taxes

The federal government levies excise taxes on the sale of alcoholic beverages, including beer. For brewers producing less than 2.0 million barrels of beer per calendar year, the federal excise tax is $7 per barrel on the first 60,000 barrels of beer removed for consumption or sale during a calendar year, and $18 per barrel for each barrel in excess of 60,000. Individual states also impose excise taxes on alcoholic beverages in varying amounts, which have also been subject to change. Sales as presented in the Company’s statements of operations, reflect the amount invoiced to the Company’s wholesalers and other customers. Excise taxes due to federal and state agencies are not collected from the Company’s customers, but rather are the responsibility of the Company. Net sales, as presented in the Company’s statements of operations, are reduced by applicable federal and state excise taxes. In the UK, excise taxes are paid by the manufacturer and not by the Company.

Discounts

To further promote retail sales of its products and in response to local competitive conditions, the Company regularly offers price discounts to distributors and retailers in most of its markets. Sales for the years 2012 and 2011, as presented in the Company’s statements of operations, are reduced by $1,330,800 and $1,523,000 respectively, related to such discounts.

Chargebacks and Sales Reserves

The Company has estimated reserves for chargebacks for promotional expenses by distributors. The Company estimates its reserves by utilizing historical information and current contracts. In estimating chargeback reserves, the Company analyzes actual chargeback amounts and applies historical chargeback rates to estimates potential chargeback. The Company routinely assesses its experience with distributors and adjusts the reserves accordingly. If actual chargebacks and other rebates are greater than the Company’s estimates, additional reserves may be required. Revisions to estimates are charged to income in the period in which the facts that give rise to the revision become known.

Seasonality

Sales of the Company’s products are somewhat seasonal, with the first and fourth quarters historically being the slowest and the rest of the year generating stronger sales. The volume of sales may also be affected by weather conditions. Because of the seasonality of the Company’s business, results for any one quarter are not necessarily indicative of the results that may be achieved for the full fiscal year.

Taxes Collected From Customers

Taxes collected from customers and remitted to tax authorities are sales tax collected from our retail customers. State and federal excise taxes on beer shipments are the responsibility of the company and included in our selling price. Excise taxes on shipments are shown in a separate line item in the consolidated statement of operations as reduction of gross sales. Sales taxes collected from customers are recognized as a liability, with the liability subsequently reduced when the taxes are remitted to the tax authority. Total sales taxes collected from customers and remitted to tax authorities were not material in 2012 and 2011.

Delivery Costs

In accordance with ASC 605, (Shipping and Handling Fees and Costs) the company reports pass-through freight costs on beer shipped to independent beer wholesalers in cost of sales. Reimbursements of these costs by wholesalers are reported in sales.

Non-pass-through costs incurred by the Company to deliver beer to wholesalers are included in marketing, distribution and administrative expenses. These costs are considered marketing related because in addition to product delivery, wholesalers provide marketing and other customer service functions to customers including product display, shelf space management, distribution of promotional materials, and product rotation. Shipping costs included in marketing expense totaled $914,200 and $854,800, for the years ended December 31, 2012 and 2011, respectively.

Basic and Diluted Income per Share

The basic earnings per share is computed by dividing the earnings attributable to common stockholders by the weighted average number of common shares outstanding during the period. In 2011, the effect of any potentially dilutive securities would have been anti-dilutive. Therefore, the conversion of the related party notes has been excluded from the calculation of net earnings per share for the year ended December 31, 2011. Basic net earnings per share exclude the dilutive effect of stock options or warrants and convertible notes. The computations of basic and dilutive net earnings per share are as follows:

	Year Ended December 31
	2012		2011
Net income	$	558,400		49,400
Weighted average common shares outstanding		12,611,133		12,481,913
Basic net income per share	$	0.04		0.00
Interest expense on convertible notes	$	91,300		-
Income for purpose of computing diluted net income per share	$	649,700		-
Incremental shares from assumed exercise of dilutive securities		2,288,102		-
Dilutive potential common shares		14,899,235		12,481,913
Diluted net earnings per share	$	0.04		0.00

Foreign Currency Translation

The Company has subsidiaries located in the UK, where the local currency, UK Pound Sterling, is the functional currency. Financial statements of these subsidiaries are translated into U.S. dollars using period-end exchange rates for assets and liabilities and average exchange rates during the period for revenues and expenses. Cumulative translation adjustments associated with net assets or liabilities are reported in non-owner changes in equity. Any exchange rate gains or losses related to foreign currency transactions are recognized in the income statement as incurred, in the same financial statement caption as the underlying transaction, and are not material for any year shown.

Cash at UBIUK was translated at exchange rates in effect at December 31, 2012 and 2011, and its cash flows were translated at the average exchange rates for the years then ended. Changes in cash resulting from the translations are presented as a separate item in the statements of cash flows.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America includes having the Company make estimates and assumptions affecting the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. The amounts estimated could differ from actual results. Significant estimates include, allowance for doubtful accounts, depreciation and amortization periods, and the future utilization of deferred tax assets.

Advertising

Advertising costs are expensed as incurred and were $900,700 and $1,116,300 for the years ended December 31, 2012 and 2011, respectively.

Fair Value of Financial Instruments

Fair Value

The fair value of the Company’s financial instruments reflects the amounts that the Company estimates to receive in connection with the sale of an asset or paid in connection with the transfer of a liability in an orderly transaction between market participants at the measurement date (exit price). For financial assets and liabilities that are periodically re-measured to fair value, the Company discloses a fair value hierarchy that prioritizes the use of inputs used in valuation techniques into the following three levels:

Level 1 – quoted prices in active markets for identical assets and liabilities.

Level 2 – observable inputs other than quoted prices in active markets for identical assets and liabilities.

Level 3 – unobservable inputs.

At December 31, 2012 and 2011, the Company had no financial assets or liabilities that required periodic re-measurement at fair value.

The recorded value of certain financial assets and liabilities, which consist primarily of cash and cash equivalents, accounts receivable, other current assets, accounts payable and accrued expenses, approximate the fair value of the respective assets and liabilities at December 31, 2012 and December 31, 2011 based upon the short-term nature of the assets and liabilities. Based on borrowing rates currently available to the Company for loans with similar terms, the carrying value of short and long term notes payable approximate fair value.

Comprehensive Income

Comprehensive income is composed of the Company’s net income and changes in equity from all other non-stockholder sources. The changes from these non-stockholder sources are reflected as a separate item in the statements of operations and comprehensive income.

Reportable Segments

The Company manages its operations through two business segments: (i) brewing operations, tavern and tasting room operations in the US and Canada (the “North American Territory”) and (ii) distributor operations in Europe (including Austria, Belgium, Denmark, Ireland, Italy, the Netherlands, France, Finland, Germany, Greece, Iceland, Liechtenstein, Luxembourg, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom) (the “Foreign Territory”). The Company evaluates performance based on net operating profit. Where applicable, portions of the administrative function expenses are allocated between the operating segments. The operating segments do not share manufacturing or distribution facilities. In the event any materials and/or services are provided to one operating segment by the other, the transaction is valued according to the Company’s transfer policy, which approximates market price. The costs of operating the manufacturing plants are captured discretely within each segment. The Company’s property, plant and equipment, inventory, and accounts receivable are captured and reported discretely within each operating segment.

Recent Accounting Pronouncements

In December 2011, the FASB amended its guidance related to the disclosure of offsetting assets and liabilities. The amended guidance will require disclosures for entities with financial instruments and derivatives that are either offset on the balance sheet or subject to a master netting arrangement. The provisions of the amended guidance will be effective for the Company beginning in the first quarter of 2013. The Company does not expect its adoption will have a material impact on the Company’s results of operations, financial position or cash flows.

In July 2012, the FASB issued ASU No. 2012-02, Intangibles-Goodwill and Other (Topic 350) which simplifies the impairment test for indefinite-lived intangible assets other than goodwill. ASU No. 2012-02 gives the option to first assess qualitative factors to determine if it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amounts as a basis for determining whether it is necessary to perform a quantitative valuation test. ASU No. 2012-02 is effective for fiscal years and interim periods beginning on or after September 15, 2012. The Company conducted its annual impairment assessment as of October 1, which included adoption of this guidance. The adoption of this guidance on October 1, 2012 did not have a significant impact on the Company’s consolidated financial position, results of operations or cash flows.

In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income requiring new disclosures regarding reclassification adjustments from accumulated other comprehensive income (“AOCI”). ASU No. 2013-02 requires disclosure of amounts reclassified out of AOCI in its entirety, by component, on the face of the statement of operations or in the notes. The standard is effective for fiscal years beginning after December 15, 2012. The Company does not believe that the adoption of this guidance will have a material impact on the Company’s consolidated financial statements. The Company plans to adopt this guidance beginning in the first quarter of 2013.

Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force (“EITF”), the American Institute of Certified Public Accountants (“AICPA”), and the SEC did not or are not believed by management to have a material impact on the Company’s present or future financial statements.