NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Basis of Presentation

The accompanying condensed financial statements have been prepared by Gulf Resources, Inc. a Delaware corporation and its subsidiaries (collectively, the “Company”), without audit, in accordance with the instructions to Form 10-Q and, therefore, do not necessarily include all information and footnotes necessary for a fair statement of its financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States (“US GAAP”). The balance sheet at December 31, 2010 is derived from the audited balance sheet at that date which is not presented herein.

In the opinion of management, the unaudited financial information for the quarter ended and six-month period ended June 30, 2011 presented reflects all adjustments, which are only normal and recurring, necessary for a fair statement of results of operations, financial position and cash flows. These condensed financial statements should be read in conjunction with the financial statements included in the 2010 Form 10-K. Operating results for the interim periods are not necessarily indicative of operating results for an entire fiscal year.

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the amounts that are reported in the financial statements and accompanying disclosures. Although these estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future, actual results may be different from the estimates. The Company also exercises judgments in the preparation of these condensed financial statements in the areas including classification of leases and related party transactions. 

(b) Nature of the Business

The Company manufactures and trades bromine and crude salt through its wholly-owned subsidiary, Shouguang City Haoyuan Chemical Company Limited ("SCHC"), and manufactures chemical products for use in the oil industry and paper manufacturing industry through its wholly-owned subsidiary, Shouguang Yuxin Chemical Industry Co., Limited ("SYCI") in The People’s Republic of China (“PRC”).

As of June 30, 2011 and December 31, 2010, allowance for doubtful accounts were nil. No allowances for doubtful accounts were charged to the income statement for the three-month and six-month periods ended June 30, 2011 and 2010.

(d) Concentration of Credit Risk

The Company is exposed to credit risk in the normal course of business, primarily related to accounts receivable and cash and cash equivalents. Substantially all of the Company’s cash and cash equivalents are maintained with financial institutions in the PRC, namely, Industrial and Commercial Bank of China Limited and China Merchants Bank Company Limited, which are not insured or otherwise protected. The Company placed $59,688,124 and $68,444,480 with these institutions as of June 30, 2011 and December 31, 2010, respectively. The Company has not experienced any losses in such accounts in the PRC.

Concentrations of credit risk with respect to accounts receivable exists as the Company sells a substantial portion of its products to a limited number of customers. However, such concentrations of credit risks are limited since the Company performs ongoing credit evaluations of its customers’ financial condition and due to the generally short payment terms. The balances of accounts receivable as of June 30, 2011 and December 31, 2010 are all amounts outstanding for less than three months.

(e) Property, Plant and Equipment

Property, plant and equipment are stated at cost less accumulated depreciation and any impairment losses. Expenditures for new facilities or equipment and expenditures that extend the useful lives of existing facilities or equipment are capitalized and depreciated using the straight-line method at rates sufficient to depreciate such costs over the estimated productive lives.

Mineral rights are recorded at cost less accumulated depreciation and any impairment losses. Mineral rights are amortized ratably over the term of the lease, or the equivalent term under the units of production method, whichever is shorter.

(e) Property, Plant and Equipment – Continued

Construction in progress primarily represents direct costs of construction of plant, machinery and equipment. Costs incurred are capitalized and transferred to property and equipment upon completion, at which time depreciation commences. Cost of repairs and maintenance is expensed as incurred.

The Company’s depreciation and amortization policies on property, plant and equipment other than mineral rights and construction in progress, are as follows:

		Useful life (in years)
Buildings (including salt pans)		15 - 20
Plant and machinery		5 - 8
Motor vehicles		5
Furniture, fixtures and equipment		8

For the three-month period ended June 30, 2011, the Company changed the estimated useful life of certain protection shell/brick of transmission channels and ducts included in plant and machinery from 8 years to 5 years, resulting in an increase of depreciation in the amount of $548,859 for the three-month period ended June 30, 2011.

Property, plant and equipment under capital leases are depreciated over their expected useful lives on the same basis as owned assets, or where shorter, the term of the lease, which is 20 years.

(f) Retirement Benefits

Pursuant to the relevant laws and regulations in the PRC, the Company participates in a defined contribution retirement plan for its employees arranged by a governmental organization. The Company makes contributions to the retirement scheme at the applicable rate based on the employees’ salaries. The required contributions under the retirement plans are charged to the consolidated income statement on an accrual basis when they are due. The Company’s contributions totaled $105,537 and $132,964 for the three-month periods ended June 30, 2011 and 2010, respectively, and totaled $226,912 and $242,966 for the six-month periods ended June 30, 2011 and 2010, respectively.

(g) Mineral Rights

The Company follows the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 805 that certain mineral rights are considered tangible assets and that mineral rights should be accounted for based on their substance. Mineral rights are included in property, plant and equipment.

(h) Revenue Recognition

The Company recognizes revenue, net of value-added tax, when persuasive evidence of an arrangement exists, delivery of the goods has occurred, customer acceptance has been obtained, which means the significant risks and ownership have been transferred to the customer, the price is fixed or determinable and collectability is reasonably assured.

(i) Shipping and Handling Fees and Costs

The Company does not charge its customers for shipping and handling. The Company classifies shipping and handling costs for purchase of raw materials as part of the cost of net revenue. For the three-month periods ended June 30, 2011 and 2010, shipping and handling costs were $167,657 and $164,440, respectively. For the six-month periods ended June 30, 2011 and 2010, shipping and handling costs were $281,228 and $285,311, respectively.

(j) Exploration Cost

Exploration costs, which included the cost of researching appropriate places to drill and the cost of actual drilling of potential natural brine resources, were charged to the income statement as incurred. For the three-month and six-month periods ended June 30, 2011, the Company incurred exploration cost in the amount of $3,867,286 in Sichuan province, PRC, for the drilling of exploratory wells and its associated facilities in order to confirm and measure the resources of natural brine in the areas of drilling. The exploratory wells are still under construction and expected to complete by end of 2011.

(k) Cash and Cash Equivalents

Cash and cash equivalents consist of all cash balances and highly liquid investments with original maturities of three months or less. Because of short maturity of these investments, the carrying amounts approximate their fair values.

(l) Impairment or Disposal of Long-lived Assets

In accordance with ASC 360-10-35 “Impairment or Disposal of Long-lived Assets”, long-lived assets to be held and used are analyzed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable or that the useful lives of those assets are no longer appropriate. The Company evaluates at each balance sheet date whether events and circumstances have occurred that indicate possible impairment.

The Company determines the existence of such impairment by measuring the expected future cash flows (undiscounted and without interest charges) and comparing such amount to the carrying amount of the assets. An impairment loss, if one exists, is then measured as the amount by which the carrying amount of the asset exceeds the discounted estimated future cash flows. Assets to be disposed of are reported at the lower of the carrying amount or fair value of such assets less costs to sell. Asset impairment charges are recorded to reduce the carrying amount of the long-lived asset that will be sold or disposed of to their estimated fair values. Charges for the asset impairment reduce the carrying amount of the long-lived assets to their estimated salvage value in connection with the decision to dispose of such assets.

For the three-month and six-month periods ended and as of June 30, 2011, the Company made impairment of long-lived assets for the relocation of Factory No. 4 and idle plant and machinery in the amount of $3,873,087. The Company determined that there was no impairment of long-lived assets as of December 31, 2010.

(m) Income Taxes

The Company accounts for income taxes in accordance with the Income Taxes Topic of the FASB ASC, which requires the use of the liability method of accounting for deferred income taxes. Under this method, deferred income taxes are recorded to reflect the tax consequences on future years of temporary differences between the tax basis of assets and liabilities and their reported amounts at each period end. If it is more likely than not that some portion or all of a deferred tax asset will not be realized, a valuation allowance is recognized. The guidance also provides criteria for the recognition, measurement, presentation and disclosures of uncertain tax positions. A tax benefit from an uncertain tax position may be recognized if it is “more likely than not” that the position is sustainable based solely on its technical merits.

(n) Leasing arrangements

Rentals payable under operating leases are charged to the statements of income on a straight line basis over the term of the relevant lease. For capital leases, the present value of future minimum lease payments at the inception of the lease is reflected as an asset and a liability in the statement of financial position. Amounts due within one year are classified as short-term liabilities and the remaining balance as long-term liabilities.

(o) Contingencies

The Company accrues for costs relating to litigation, including litigation defense costs, claims and other contingent matters, including liquidated damage liabilities, when such liabilities become probable and reasonably estimable. Such estimates may be based on advice from third parties or on management’s judgment, as appropriate. Revisions to accruals are reflected in earnings (loss) in the period in which different facts or information become known or circumstances change that affect the Company’s previous assumptions with respect to the likelihood or amount of loss. Amounts paid upon the ultimate resolution of such liabilities may be materially different from previous estimates.

(p) Basic and Diluted Net Income per Share of Common Stock

Basic earnings per common share are based on the weighted average number of shares outstanding during the periods presented. Diluted earnings per share are computed using weighted average number of common shares plus dilutive common share equivalents outstanding during the period. Anti-dilutive common stock equivalents which were excluded from the calculation of number of dilutive common stock equivalents amounted to 1,378,847 and 8,221 shares for the three-month periods ended June 30, 2011 and 2010, respectively, and amounted to 241,002 and 3,053 shares for the six-month periods ended June 30, 2011 and 2010, respectively.

The following table sets forth the computation of basic and diluted earnings per share:

	Three-Month Period Ended June 30,				Six-Month Period Ended June 30,
	2011		2010		2011		2010
Numerator
Net income	$	10,023,255	$	16,426,445	$	24,388,254	$	24,418,581

Denominator
Basic: Weighted-average common shares outstanding during the period		34,729,179		34,587,479		34,732,527		34,574,514
Add: Dilutive effect of stock options		4,009		151,188		395,746		176,200
Diluted		34,733,188		34,738,667		35,128,273		34,750,714

Net income per share
Basic	$	0.29	$	0.47	$	0.70	$	0.71
Diluted	$	0.29	$	0.47	$	0.69	$	0.70

(q) Foreign Currency Translations and Transactions

The Company’s operations in the PRC use the local currency, Renminbi (“RMB”), as their functional currency, whereas amounts reported in the accompanying condensed consolidated financial statements and disclosures are stated in the United States dollar (“USD” or “$”), the functional currency and the reporting currency of the Company.

As such, the Company uses the “current rate method” to translate its PRC operations from RMB into USD, as required under ASC 830 “Foreign Currency Matters”. The assets and liabilities of its PRC operations are translated into USD using the rate of exchange prevailing at the balance sheet date. The capital accounts are translated at the historical rate. Adjustments resulting from the translation of the balance sheets of the Company’s PRC subsidiaries from RMB into USD are recorded in stockholders’ equity as part of accumulated comprehensive income. The consolidated statement of income and comprehensive income is translated at average rates during the reporting period. Gains or losses resulting from transactions in currencies other than the functional currencies are recognized in net income for the reporting periods. The consolidated statement of cash flows is translated at average rates during the reporting period, with the exception of issuance of shares and payment of dividends which are translated at historical rates.

(r) New Accounting Pronouncements

No accounting standards and guidance with an effective date during the six-month period ended June 30, 2011 or issued during 2011 had or expected to have a significant impact on the Company’s condensed consolidated financial statements.