NOTE A

—

THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

The Company, founded in

1993,

develops and markets proprietary fingerprint identification biometric technology and software solutions enterprise-ready identity access management solutions to commercial, government and education customers throughout the United States and internationally. The Company was a pioneer in developing automated, finger identification technology that supplements or compliments other methods of identification and verification, such as personal inspection identification, passwords, tokens, smart cards, ID cards, PKI, credit cards, passports, driver's licenses, OTP or other form of possession or knowledge-based credentialing. Additionally, advanced BIO-key® technology has been, and is, used to improve both the accuracy and speed of competing finger-based biometrics.

Going Concern and Basis of Presentation

We have historically financed our operations through access to the capital markets by issuing secured and convertible debt securities, convertible preferred stock, common stock, and through factoring receivables. We currently require approximately

$735,000

per month to conduct our operations, a monthly amount that we have been unable to consistently achieve through revenue generation. During

2020,

we generated approximately

$2,837,000

of revenue, which is below our average monthly requirements. During

2020,

we raised approximately

$24,000,000

from financing activities and at

December 31, 2020

had approximately

$17,000,000

in cash. As of the date of this report, the Company has enough cash for

twelve

eighteen

months of operations, and therefore, there is

longer uncertainty in our going concern status.

Effective

November 20, 2020,

the Company implemented a reverse stock split of its outstanding common stock at a ratio of

-for-

All share figures and results are reflected on a post-split basis.

Summary of Significant Accounting Policies

A summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows:

Principles

of Consolidation

The accompanying consolidated financial statements include the accounts of BIO-key International, Inc. and its wholly-owned subsidiaries (collectively, the “Company”). Intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

Our consolidated financial statements are prepared in accordance with GAAP as set forth in the Financial Accounting Standards Board's (FASB) Accounting Standards Codification (ASC) and consider the various staff accounting bulletins and other applicable guidance issued by the U.S. Securities and Exchange Commission (SEC). These accounting principles require us to make certain estimates, judgments and assumptions. The Company believes that the estimates, judgments and assumptions upon which it relies are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenues and expenses during the periods presented. Certain significant accounting policies that contain subjective management estimates and assumptions include those related to revenue recognition, accounts receivable, inventory, intangible assets and long-lived assets, and income taxes. To the extent there are material differences between these estimates, judgments or assumptions and actual results, its consolidated financial statements will be affected. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does

not

require management's judgment in its application. There are also areas in which management's judgment in selecting among available alternatives would

not

produce a materially different result.

Revenue Recognition

In accordance with ASC

606,

revenue is recognized when a customer obtains control of promised goods or services. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these services. To achieve this core principle, the Company applies the following

five

steps:

●

Identify the contract with a customer

●

Identify the performance obligations in the contract

●

Determine the transaction price

●

Allocate the transaction price to performance obligations in the contract

●

Recognize revenue when or as the Company satisfies a performance obligation

All of the Company's performance obligations, and associated revenues, are generally transferred to customers at a point in time, with the exception of support and maintenance, and professional services, which are generally transferred to the customer over time.

Software licenses

Software license revenue consist of fees for perpetual and subscription licenses for

one

or more of the Company's biometric fingerprint solutions or identity access management solutions. Revenue is recognized at a point in time once the software is available to the customer for download. Software license contracts are generally invoiced in full on execution of the arrangement.

Hardware

Hardware revenue consists of fees for associated equipment sold with or without a software license arrangement, such as servers, locks and fingerprint readers. Customers are

not

obligated to buy

third

party hardware from the Company, and

may

procure these items from a number of suppliers. Revenue is recognized at a point in time once the hardware is shipped to the customer. Hardware items are generally invoiced in full on execution of the arrangement.

Support and Maintenance

Support and maintenance revenue consists of fees for unspecified upgrades, telephone assistance and bug fixes. The Company satisfies its support and maintenance performance obligation by providing “stand-ready” assistance as required over the contract period. The Company records deferred revenue (contract liability) at time of prepayment until the contracts term occurs. Revenue is recognized over time on a ratable basis over the contract term. Support and maintenance contracts are up to

one

five

years in length and are generally invoiced in advance at the beginning of the term. Support and Maintenance revenue for subscription licenses is carved out of the total license cost at

18%

and recognized on a ratable basis over the license term.

Professional Services

Professional services revenues consist primarily of fees for deployment and optimization services, as well as training. The majority of the Company's consulting contracts are billed on a time and materials basis, and revenue is recognized based on the amount billable to the customer in accordance with practical expedient ASC

606

18.

For other professional services contracts, the Company utilizes an input method and recognizes revenue based on labor hours expended to date relative to the total labor hours expected to be required to satisfy its performance obligation.

Contracts with Multiple Performance Obligations

Some contracts with customers contain multiple performance obligations. For these contracts, the Company accounts for individual performance obligations separately if they are distinct. The transaction price is allocated to the separate performance obligations on a relative standalone selling price basis. The standalone selling prices are determined based on overall pricing objectives, taking into consideration market conditions and other factors, including the value of the contracts, the cloud applications sold, customer demographics, geographic locations, and the number and types of users within the contracts.

The Company considered several factors in determining that control transfers to the customer upon shipment of hardware and availability of download of software. These factors include that legal title transfers to the customer, the Company has a present right to payment, and the customer has assumed the risks and rewards of ownership.

Accounts receivable from customers are typically due within

days of invoicing. The Company does

not

record a reserve for product returns or warranties as amounts are deemed immaterial based on historical experience.

Costs to Obtain and Fulfill a Contract

Costs to obtain and fulfill a contract are predominantly sales commissions earned by the sales force and are considered incremental and recoverable costs of obtaining a contract with a customer. These costs are deferred and then amortized over a period of benefit determined to be

four

years. These costs are included as capitalized contract costs on the balance sheet. The period of benefit was determined by taking into consideration customer contracts, technology, and other factors based on historical evidence. Amortization expense is included in selling, general and administrative expenses in the accompanying consolidated statements of operations.

Deferred Revenue

Deferred revenue includes customer advances and amounts that have been paid by customer for which the contractual maintenance terms have

not

yet occurred. The majority of these amounts are related to maintenance contracts for which the revenue is recognized ratably over the applicable term, which generally is

months. Contracts greater than

months are segregated as long term deferred revenue. Maintenance contracts include provisions for unspecified when-and-if available product updates and customer telephone support services. At

December 31, 2020

and

2019,

amounts in deferred revenue were approximately

$702,000

and

$359,000,

respectively.

Business Combinations

In accordance with ASC

805,

Business Combinations

(ASC

805

), the Company recognizes the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. Determining these fair values requires management to make significant estimates and assumptions, especially with respect to intangible assets.

The Company recognizes identifiable assets acquired and liabilities assumed at their acquisition date fair value. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net acquisition date fair value of the assets acquired and the liabilities assumed and represents the expected future economic benefits arising from other assets acquired that are

not

individually identified and separately recognized. While the Company uses its best estimates and assumptions as part of the purchase price allocation process to accurately value assets acquired and liabilities assumed at the acquisition date, its estimates are inherently uncertain and subject to refinement. Assumptions

may

be incomplete or inaccurate, and unanticipated events or circumstances

may

occur, which

may

affect the accuracy or validity of such assumptions, estimates or actual results. As a result, during the measurement period, which

may

be up to

one

year from the acquisition date, the Company records adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill to the extent that it identifies adjustments to the preliminary purchase price allocation. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to the consolidated statements of operations.

Goodwill and acquired intangible assets

Goodwill is

not

amortized, but is evaluated for impairment annually, or whenever events or changes in circumstances indicate that the carrying value

may

not

be recoverable. The Company has determined that there is a single reporting unit for the purpose of conducting this goodwill impairment assessment. For purposes of assessing potential impairment, the Company estimates the fair value of the reporting unit, based on the Company's market capitalization, and compares this amount to the carrying value of the reporting unit. If the Company determines that the carrying value of the reporting unit exceeds its fair value, an impairment charge would be required. The annual goodwill impairment test will be performed as of

December

31st

of each year. To date, the Company has

not

identified any impairment to goodwill.

Intangible assets acquired in a business combination are recorded at their estimated fair values at the date of acquisition. The Company amortizes acquired definite-lived intangible assets over their estimated useful lives based on the pattern of consumption of the economic benefits or, if that pattern cannot be readily determined, on a straight-line basis.

Cash Equivalents

Cash equivalents consist of liquid investments with original maturities of

three

months or less. At

December 31, 2020

and

2019,

cash equivalents consisted of a money market account.

Accounts Receivable

Accounts receivable are carried at original amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful receivables by regularly evaluating individual customer receivables and considering a customer's financial condition, credit history, and current economic conditions. Accounts receivable are written off when deemed uncollectible.

As a result of the payment delays for a large customer, the Company has reserved

$1,720,000

December 31, 2020

and

2019,

which represents

100%

of the remaining balance owed under the contract. Recoveries of accounts receivable previously written off are recorded when received. The Company made a license sale to a Chinese reseller in

December 2018.

Revenue was recognized in accordance with ASC

606

in the amount of

$1.1

million in

2018.

As of

December 31, 2019,

the

second

payment for

$555,555

was still outstanding and payable. The Company wrote off directly to bad debt expense

$555,555

that was promised to be paid in

March 2019,

but

not

received.

Accounts receivable at

December 31, 2020

and

2019

consisted of the following:

	December 31,
	2020			2019

Accounts receivable - current	$	561,834		$	139,785
Accounts receivable - non current		1,720,000			1,720,000
		2,281,834			1,859,785

Allowance for doubtful accounts - current		(13,785	)		(13,785	)
Allowance for doubtful accounts - non current		(1,720,000	)		(1,720,000	)
		(1,733,785	)		(1,733,785	)

Accounts receivable, net of allowances for doubtful accounts	$	548,049		$	126,000

The allowance for doubtful accounts for the years ended

December 31, 2020

and

2019

is as follows:

	Balance at Beginning of Year		Charged to Costs and Expenses		Deductions From Reserves		Balance at End of Year
Year Ended December 31, 2020
Allowance for Doubtful Accounts	$	1,733,785	$	-	$	-	$	1,733,785
Year Ended December 31, 2019
Allowance for Doubtful Accounts	$	1,733,785	$	-	$	-	$	1,733,785

Bad debt expenses (if any) are recorded in selling, general, and administrative expense.

Equipment and Leasehold Improvements,

Intangible Assets and

Depreciation and Amortization

Equipment and leasehold improvements are stated at cost. Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets to operations over the estimated service lives, principally using straight-line methods. Leasehold improvements are amortized over the shorter of the life of the improvement or the lease term, using the straight-line method.

The estimated useful lives used to compute depreciation and amortization for financial reporting purposes are as follows:

	Years
Equipment and leasehold improvements
Equipment (years)	3	-	5
Furniture and fixtures (years)	3	-	5
Software (years)		3
Leasehold improvements	life or lease term

Intangible assets other than goodwill consist of patents, trade name, proprietary software, and customer relationships. Patent costs are capitalized until patents are awarded. Upon award, such costs are amortized using the straight-line method over their respective economic lives. If a patent is denied, all costs are charged to operations in that year. Trade names, proprietary software, and customer relationships are amortized over the economic useful life.

Impairment or Disposal of Long Lived Assets, including Intangible Assets

The Company reviews long-lived assets, including intangible assets subject to amortization, whenever events or changes in circumstances indicate that the carrying amount of such an asset

may

not

be recoverable. Recoverability of these assets is measured by comparison of their carrying amount to the future undiscounted cash flows the assets are expected to generate. If such assets are considered impaired, the impairment to be recognized is equal to the amount by which the carrying value of the assets exceeds their fair value determined by either a quoted market price, if any, or a value determined by utilizing a discounted cash flow technique. In assessing recoverability, the Company must make assumptions regarding estimated future cash flows and discount factors. If these estimates or related assumptions change in the future, the Company

may

be required to record impairment charges. Intangible assets with determinable lives are amortized over their estimated useful lives, based upon the pattern in which the expected benefits will be realized, or on a straight-line basis, whichever is greater. The Company recorded an impairment charge in

2019

with respect to the FingerQ Resalable Software License Rights. Refer to Note I – Resalable License Rights for additional information.

10.

Advertising Expense

The Company expenses the costs of advertising as incurred. Advertising expenses for

2020

and

2019

were approximately

$494,000

and

$317,000,

respectively.

11.

Research and Development Expenditures

Research and development expenses include costs directly attributable to the conduct of research and development programs primarily related to the development of our software products and improving the efficiency and capabilities of our existing software. Such costs include salaries, payroll taxes, employee benefit costs, materials, supplies, depreciation on research equipment, services provided by outside contractors, and the allocable portions of facility costs, such as rent, utilities, insurance, repairs and maintenance, depreciation and general support services. All costs associated with research and development are expensed as incurred.

12.

Earnings Per Share of Common Stock (

“

EPS

”

)

The Company's EPS is calculated by dividing net income (loss) applicable to common stockholders by the weighted-average number of common shares outstanding during the reporting period. Diluted EPS includes the effect from potential issuances of common stock, such as stock issuable pursuant to the conversion of preferred stock, exercise of stock options and warrants, when the effect of their inclusion is dilutive.

13.

Accounting for Stock-Based Compensation

The Company accounts for share based compensation in accordance with the provisions of ASC

718

10,

“Compensation — Stock Compensation,” which requires measurement of compensation cost for all stock awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The majority of its share-based compensation arrangements vest over either a

three

four

year vesting schedule. The Company expenses its share-based compensation under the ratable method, which treats each vesting tranche as if it were an individual grant. The fair value of stock options is determined using the Black-Scholes valuation model, and requires the input of highly subjective assumptions. These assumptions include estimating the length of time employees will retain their vested stock options before exercising them (the “expected option term”), the estimated volatility of its common stock price over the option's expected term, the risk-free interest rate over the option's expected term, and the Company's expected annual dividend yield. Changes in these subjective assumptions can materially affect the estimate of fair value of stock-based compensation and consequently, the related amount recognized as an expense in the consolidated statements of operations. As required under the accounting rules, the Company reviews its valuation assumptions at each grant date and, as a result, the Company is likely to change its valuation assumptions used to value employee stock-based awards granted in future periods. The values derived from using the Black-Scholes model are recognized as expense over the service period, net of estimated forfeitures (the number of individuals that will ultimately

not

complete their vesting requirements). The estimation of stock awards that will ultimately vest requires significant judgment. The Company considers many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience. Actual results, and future changes in estimates,

may

differ substantially from current estimates. Options and warrants to outsiders are accounted for under ASC

718.

The following table presents share-based compensation expenses included in the Company's consolidated statements of operations:

	Year ended December 31,
	2020		2019

Selling, general and administrative	$	705,971	$	828,981
Research, development and engineering		86,124		118,739
	$	792,095	$	947,720

Valuation Assumptions for Stock Options

For

2020

and

2019,

28,440

and

30,167

stock options were granted, respectively. The fair value of each option was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

	Year ended December 31,
	2020			2019
Weighted average Risk free interest rate		0.30	%		2.33	%
Expected life of options (in years)		4.50			4.50
Expected dividends		0	%		0	%
Weighted average Volatility of stock price		115	%		84	%

The stock volatility for each grant is determined based on the review of the experience of the weighted average of historical daily price changes of the Company's common stock over the expected option term. The expected term was determined using the simplified method for estimating expected option life, which qualify as “plain-vanilla” options; and the risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the option.

14.

Derivative Liabilities

In connection with the issuances of equity instruments or debt, the Company

may

issue options or warrants to purchase common stock. In certain circumstances, these options or warrants

may

be classified as liabilities, rather than as equity. In addition, the equity instrument or debt

may

contain embedded derivative instruments, such as conversion options or listing requirements, which in certain circumstances

may

be required to be bifurcated from the associated host instrument and accounted for separately as a derivative liability instrument. The Company early-adopted the new provisions issued

July 2017,

for derivative liability instruments under FASB ASU

2017

11,

Earnings Per Share (Topic

260

), Distinguishing Liabilities from Equity (Topic

480

) and Derivatives and Hedging (Topic

815

): I. Accounting for Certain Financial Instruments with Down Round Features; II. Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Non-controlling Interests with a Scope Exception. Under ASU

2017

11,

down round features do

not

meet the criteria for derivative accounting and

liability is to be recorded until an actual issuance of securities triggers the down-round feature. Prior to these provisions, the liabilities were recorded without the actual issuance of the securities triggering the down-round feature.

15.

Income Taxes

The provision for, or benefit from, income taxes includes deferred taxes resulting from the temporary differences in income for financial and tax purposes using the liability method. Such temporary differences result primarily from the differences in the carrying value of assets and liabilities. Future realization of deferred income tax assets requires sufficient taxable income within the carryback, carryforward period available under tax law. The Company evaluates, on a quarterly basis whether, based on all available evidence, if it is probable that the deferred income tax assets are realizable. Valuation allowances are established when it is more likely than

not

that the tax benefit of the deferred tax asset will

not

be realized. The evaluation, as prescribed by ASC

740

10,

“Income Taxes,” includes the consideration of all available evidence, both positive and negative, regarding historical operating results including recent years with reported losses, the estimated timing of future reversals of existing taxable temporary differences, estimated future taxable income exclusive of reversing temporary differences and carryforwards, and potential tax planning strategies which

may

be employed to prevent an operating loss or tax credit carryforward from expiring unused. Because of the Company's historical performance and estimated future taxable income, a full valuation allowance has been established.

The Company accounts for uncertain tax provisions in accordance with ASC

740

05,

“Accounting for Uncertainty in Income Taxes.” The ASC clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements. The ASC prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The ASC provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

. Leases

In accordance with ASC

842,

Lease

s (ASC

842

), the Company records a right-of-use (ROU) asset and a lease liability on the balance sheet for all leases with terms longer than

months and classifies them as either operating or finance leases.

At the inception of an arrangement, the Company determines whether the arrangement is or contains a lease based on the unique facts and circumstances present and the classification of the lease including whether the contract involves the use of a distinct identified asset, whether the Company obtains the right to substantially all the economic benefit from the use of the asset, and whether the Company has the right to direct the use of the asset. Leases with a term greater than

one

year are recognized on the balance sheet as ROU assets, lease liabilities and, if applicable, long-term lease liabilities. The Company has elected

not

to recognize on the balance sheet leases with terms of

one

year or less under practical expedient in paragraph ASC

842

For contracts with lease and non-lease components, the Company has elected

not

to allocate the contract consideration, and to account for the lease and non-lease components as a single lease component.

Lease liabilities and their corresponding ROU assets are recorded based on the present value of lease payments over the expected lease term. The implicit rate within our operating leases are generally

not

determinable and, therefore, the Company uses the incremental borrowing rate at the lease commencement date to determine the present value of lease payments. The determination of the Company's incremental borrowing rate requires judgment. The Company determines the incremental borrowing rate for each lease using our estimated borrowing rate, adjusted for various factors including level of collateralization, term and currency to align with the terms of the lease. The operating lease ROU asset also includes any lease prepayments, offset by lease incentives.

An option to extend the lease is considered in connection with determining the ROU asset and lease liability when it is reasonably certain we will exercise that option. An option to terminate is considered unless it is reasonably certain we will

not

exercise the option.

17.

Recent Accounting Pronouncements

June 2016,

the FASB issued ASU

2016

13,

Financial Instruments-Credit Losses

(Topic

326

), referred to herein as ASU

2016

13,

which significantly changes how entities will account for credit losses for most financial assets and certain other instruments that are

not

measured at fair value through net income. ASU

2016

replaces the existing incurred loss model with an expected credit loss model that requires entities to estimate an expected lifetime credit loss on most financial assets and certain other instruments. Under ASU

2016

credit impairment is recognized as an allowance for credit losses, rather than as a direct write-down of the amortized cost basis of a financial asset. The impairment allowance is a valuation account deducted from the amortized cost basis of financial assets to present the net amount expected to be collected on the financial asset. Once the new pronouncement is adopted by the Company, the allowance for credit losses must be adjusted for management's current estimate at each reporting date. The new guidance provides

threshold for recognition of impairment allowance. Therefore, entities must also measure expected credit losses on assets that have a low risk of loss. For instance, trade receivables that are either current or

not

yet due

may

not

require an allowance reserve under currently generally accepted accounting principles, but under the new standard, the Company will have to estimate an allowance for expected credit losses on trade receivables under ASU

2016

13.

ASU

2016

is effective for annual periods, including interim periods within those annual periods, beginning after

December 15, 2022

for smaller reporting companies. Early adoption is permitted. The Company is currently assessing the impact ASU

2016

will have on its consolidated financial statements.

Management does

not

believe that any other recently issued, but

not

yet effective, accounting standard if currently adopted would have a material effect on the accompanying consolidated financial statements.