CHINA DU KANG CO. LTD. - FORM 10-Q

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

FINANCIAL REPORT

At June 30, 2012 and December 31, 2011 and

For the Three and Six Months Ended June 30, 2012 and 2011

INDEX

		PAGE


	CONSOLIDATED BALANCE SHEETS	2

	CONSOLIDATED STATEMENTS OF OPERATIONS	3

	CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME	4

	CONSOLIDATED STATEMENTS OF CASH FLOWS	5

	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS	6-33

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	June 30,			December 31,
	2012			2011
	(unaudited)
ASSETS
Current Assets:
Cash and cash equivalents	$	570,026		$	968,370
Accounts receivable, net (Note 4)		563,382			270,276
Others receivable		77,587			2,427
Prepaid expenses (Note 5)		2,038,069			678,528
Inventories (Note 6)		5,947,393			5,335,136
Total current assets		9,196,457			7,254,737

Property, Plant and Equipment, net (Note 7)		4,320,146			4,451,669
Intangible assets, net (Note 8)		2,026,907			2,034,235
Long-term investment		1,898,880			1,885,399

Total Assets	$	17,442,390		$	15,626,040

LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable	$	1,498,511		$	1,215,285
Accrued expenses (Note 9)		439,274			352,964
Others payable		132,198			125,599
Taxes payable (Note 10)		709,498			661,296
Deferred revenue		3,739,335			2,785,391
Employee security deposit		45,889			45,564
Lease liability-current (Note 15)		117,904			123,087
Total Current Liabilities		6,682,609			5,309,186

Long-term Liabilities:
Lease liability-long-term (Note 15)		797,560			847,420
Total Long-term Liabilities		797,560			847,420
Total Liabilities		7,480,169			6,156,606

Commitments and Contingencies (Note 15)		-			-

Shareholders' Equity:
China Du Kang Co., Ltd. Shareholders' Equity
Preferred stock, par value $0.001, 5,000,000 shares authorized;
no shares issued and outstanding as of
June 30, 2012 and December 31, 2011		-			-
Common stock, par value $0.001, 250,000,000 shares authorized;
100,113,791 shares issued and outstanding as of
86,000,000 shares issued and outstanding as of September 30, 2008
June 30, 2012 and December 31, 2011		100,114			100,114
Additional paid-in capital		27,385,386			27,385,386
Accumulated deficit		(21,894,053	)		(22,292,346	)
Accumulated other comprehensive income		(753,628	)		(821,700	)
Total China Du Kang Co., Ltd. Shareholders' equity (deficit)		4,837,819			4,371,454
Noncontrolling Interest		5,124,402			5,097,980
Total Shareholders' Equity (Deficit)		9,962,221			9,469,434
Total Liabilities and Shareholders' Equity (Deficit)	$	17,442,390		$	15,626,040

See Notes to Consolidated Financial Statements

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

	For the Three Months Ended						For the Six Months Ended
	June 30,						June 30,
	2012			2011			2012			2011
	(unaudited)			(unaudited)			(unaudited)			(unaudited)
Revenues
Sales of Liquor	$	722,681		$	258,941		$	1,337,058		$	686,620
License Fees		212,209			242,636			424,531			526,453
Gross Profit		934,890			501,577			1,761,589			1,213,073

Costs of Revenues
Costs of Liquor Sold		446,413			215,546			905,848			555,684
Costs of License Fees		-			-			-			-
Total Costs of Sales		446,413			215,546			905,848			555,684

Gross Profit		488,477			286,031			855,741			657,389

Operating Expenses

Selling Expenses
Advertising expenses		13,474			66,480			26,083			72,387
Travel and entertainment		10,141			3,312			17,793			5,046
Total Selling Expenses		23,615			69,792			43,876			77,433

General and administrative expenses
Payroll		106,477			72,667			177,830			150,955
Employee benefit and pension		27,763			21,646			49,380			40,726
Depreciation and amortization expenses		30,772			38,279			62,142			83,928
Professional fees and consultancy fees		44,871			31,122			97,401			56,226
Office expenses		83,710			13,047			104,692			28,889
Vehicle expenses		11,227			9,702			19,009			18,978
Travel and entertainment		55,559			7,053			63,467			18,082
Other general and administrative expenses		9,164			(31,615	)		9,164			2,257
Total General and Administrative Expenses		369,543			161,901			583,085			400,041

Total Operating Expenses		393,158			231,693			626,961			477,474

Income (Loss) from Operation		95,319			54,338			228,780			179,915

Other Income (Expenses)
Interest income		1,588			1,483			2,811			3,003
Interest expenses		(8,035	)		(19,930	)		(16,083	)		(38,473	)
Imputed interest		-			(260,838	)		-			(523,335	)
Governmental subsidy		-			-			260,849			-
Other income (expense)		(143	)		(1,444	)		111			(1,344	)
Total other income (expenses)		(6,590	)		(280,729	)		247,688			(560,149	)

Income (Loss) before Provision for Income Tax		88,729			(226,391	)		476,468			(380,234	)

Provision for Income Tax		(29,425	)		(33,721	)		(51,778	)		(80,306	)

Net Income (Loss)		59,304			(260,112	)		424,690			(460,540	)

Less: Net income attributable to noncontrolling interest		(14,186	)		12,038			26,397			43,869

Net Income (Loss) attributable to
China Du Kang Co., Ltd.	$	73,490		$	(272,150	)	$	398,293		$	(504,409	)

Basic and Fully Diluted Earnings per Share	$	0.00		$	(0.00	)	$	0.00		$	(0.01	)

Weighted average shares outstanding		100,113,791			100,113,791			100,113,791			100,113,791

See Notes to Consolidated Financial Statements

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF COMPRESENTATIVE INCOME

	For the Three Months Ended						For the Six Months Ended
	June 30,						June 30,
	2012			2011			2012		2011
	(unaudited)			(unaudited)			(unaudited)		(unaudited)

Net income	$	59,304		$	(260,112	)	$	424,690	$	(460,540	)
Other comprehensive income, net of tax:
Effects of foreign currency conversion		8,474			(118,840	)		68,097		(164,544	)
Total other comprehensive, not of tax		8,474			(118,840	)		68,097		(164,544	)
Comprehensive income		67,778			(378,952	)		492,787		(625,084	)
Comprehensive income attributable to
the noncontrolling interest		(14,131	)		14,201			26,422		46,773
Comprehensive income attributable to
China Du Kang Co., Ltd.	$	81,909		$	(393,153	)	$	466,365	$	(671,857	)

See Notes to Consolidated Financial Statements

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

	For the Six Months Ended
	June 30,
	2012			2011
	(unaudited)			(unaudited)
Cash Flows from Operating Activities

Net income (loss) including noncontrolling interest	$	424,690		$	(460,540	)
Adjustments to reconcile net income (loss)
including noncontrolling interest to net cash
provided (used) by operating activities:
Imputed interest		-			523,335
Depreciation		267,137			182,075
Amortization		21,852			23,820
Changes in operating assets and liabilities:
(Increase) in accounts receivable		(290,914	)		(60,295	)
(Increase)/Decrease in others receivable		(75,074	)		71,929
(Increase)/Decrease in prepaid expenses		(1,353,467	)		(412,076	)
(Increase)/Decrease in inventories		(573,741	)		(1,043,221	)
Increase in accounts payable		274,321			126,912
Increase/(Decrease) in accrued expenses		83,720			128,163
Increase in other payable		5,699			10,191
Increase in taxes payable		43,453			60,112
(Decrease) in deferred revenue		933,254			623,321
(Decrease) in lease liabilities		(61,897	)		(63,771	)
Net cash (used) by operating activities		(300,967	)		(290,045	)

Cash Flows from Investing Activities

Purchase of fixed assets		19,639			(124,427	)
Purchase of land use right		-			(1,965,706	)
Net cash (used) by investing activities		19,639			(2,090,133	)

Cash Flows from Financing Activities

Proceeds from related parties		-			1,657,609
Repayments to related parties		-			(9,939	)
Net cash provided by financing activities		-			1,647,670

Increase (decrease) in cash		(281,328	)		(732,508	)
Effects of exchange rates on cash		(117,015	)		74,671
Cash at beginning of period		968,370			1,994,126
Cash at end of period	$	570,027		$	1,336,289

Supplemental Disclosures of Cash Flow Information:
Cash paid (received) during year for:
Interest	$	16,083		$	27,862
Income taxes	$	-		$	-

See Notes to Consolidated Financial Statements

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1-

BASIS OF PRESENTATION

The accompanying unaudited financial statements of China Du Kang Co., Ltd. and subsidiaries, (the “Company” or "China Du Kang") were prepared pursuant to the rules and regulations of the United States Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. Management of the Company (“Management”) believes that the following disclosures are adequate to make the information presented not misleading. These financial statements should be read in conjunction with the audited financial statements and the notes for the year ended December 31, 2011.

These unaudited financial statements reflect all adjustments, consisting only of normal recurring adjustments that, in the opinion of Management, are necessary to present fairly the financial position and results of operations of the Company for the periods presented. Operating results for the three and six months ended June 30, 2012, are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.

Note 2-

ORGANIZATION AND BUSINESS BACKGROUND

China Du Kang Co., Ltd (“China Du Kang” or the “Company”) was incorporated in the State of Nevada on January 16, 1987. Currently, throught its wholely owned subsidiary, Hong Kong Merit Enterprise Limited (“Merit”),the Company is engaged in the business of production and distribution of distilled spirit with the brand name of “Baishui Dukang”in the People's Republic of China ("PRC"). The Company also licenses the brand name to other liquor manufactures and liquor stores in PRC. The Company's structure is summarized in the following chart.

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2-

ORGANIZATION AND OPERATIONS (continued)

		China Du Kang Co., Ltd. ("China Du Kang") Incorporated in the State of Nevada on January 16, 1987
			Acquiring 100% equity interest on 2/11/2008
		Hong Kong Merit Enterprise Limited “Merit" Incorporated in Hong Kong on September 8, 2006
			Acquiring 100% equity interest on 1/22/2008
		Shaanxi Huitong Food Development Co., Inc. “Huitong” Incorporated in Shaanxi Province, PRC on August 9, 2007
			Acquiring 98.24% equity interest on 12/26/2007
			The equity interest changed to 83.47% on October 1, 2011
		Shaanxi Xidenghui Technology Stock Co., Ltd. “Xidenghui” Incorporated in Shaanxi Province, PRC on March 29, 2001
	Acquiring 90.51% equity interest on 5/15/2002		Acquiring 70% equity interest on 11/12/2007

Shaanxi Baishui Dukang Liquor Co., Ltd. “Baishui Dukang” Incorporated in Shaanxi Province, PRC on March 1, 2002				Shaanxi Baishui Dukang Liquor Brand Management Co., Ltd. “Brand Management” Incorporated in Shaanxi Province, PRC on November 12, 2007

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3-

SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States of America ("US GAAP"). This basis of accounting differs from that used in the statutory accounts of the Company, which are prepared in accordance with the "Accounting Principles of China " ("PRC GAAP"). Certain accounting principles, which are stipulated by US GAAP, are not applicable in the PRC GAAP. The difference between PRC GAAP accounts of the Company and its US GAAP consolidated financial statements is immaterial.

The consolidated financial statements include the accounts of the Company and all its majority-owned subsidiaries which require consolidation. Inter-company transactions have been eliminated in consolidation.

Certain amounts in the prior year's consolidated financial statements and notes have been revised to conform to the current year presentation.

Use of Estimates

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

Subsequent Events

The Company evaluated subsequent events through the date of issuance of these financial statements. We are not aware of any significant events that occurred subsequent to the balance sheet date but prior to the filing of this report that would have a material impact on our consolidated financial statements.

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3-

SIGNIFICANT ACCOUNTING POLICIES (continued)

Foreign Currencies Translation

The Company maintains its books and accounting records in PRC currency "Renminbi" ("RMB"), which is determined as the functional currency. Transactions denominated in currencies other than RMB are translated into RMB at the exchange rates quoted by the People’s Bank of China (“PBOC”) prevailing at the date of the transactions. Monetary assets and liabilities denominated in currencies other than RMB are translated into RMB using the applicable exchange rates quoted by the PBOC at the balance sheet dates. Exchange differences are included in the statements of changes in owners' equity. Gain and losses resulting from foreign currency transactions are included in operations.

The Company’s financial statements are translated into the reporting currency, the United States Dollar (“US$”). Assets and liabilities of the Company are translated at the prevailing exchange rate at each reporting period end. Contributed capital accounts are translated using the historical rate of exchange when capital is injected. Income and expense accounts are translated at the average rate of exchange during the reporting period. Translation adjustments resulting from translation of these consolidated financial statements are reflected as accumulated other comprehensive income (loss) in the consolidated statements of changes in shareholders’ equity.

The exchange rates used for foreign currency translation were as follows (USD$1 = RMB):

Period Covered	Balance Sheet Date	Average Rates

Six months ended June 30, 2012	6.31970	6.32550
Six months ended June 30, 2011	6.46400	6.54818
Year ended December 31, 2011	6.36470	6.47351
Year ended December 31, 2010	6.61180	6.77875

Statement of Cash Flows

In accordance with FASB ASC 230, “Statement of Cash Flows”, cash flows from the Company’s operations is calculated based upon the functional currency. As a result, amounts related to assets and liabilities reported on the statement of cash flows may not necessarily agree with changes in the corresponding balances on the balance sheet.

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3-

SIGNIFICANT ACCOUNTING POLICIES (continued)

Revenue Recognition

The Company recognizes revenue when the earnings process is complete, both title and the risks and rewards of ownership are transferred or services have been rendered and accepted, the selling price is fixed or determinable, and collectability is reasonably assured.

(1) Sales of Liquor

The Company generally sells liquor to liquor distributors with which the Company executed an exclusive distributor contract, pursuant to which the distributor cannot act as a distributor for any other products of the third party. The Company recognizes liquor sales revenue when the significant risks and rewards of ownership have been transferred pursuant to PRC law, including such factors as when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, sales and value-added tax laws have been complied with, and collectability is reasonably assured. The Company generally recognizes revenue from sales of liquor when its products are shipped.

The Company does not provide an unconditional right of return, price protection or any other concessions to our customers. Sales returns and other allowances have been immaterial in our operation.

(2) License Fees

(a) License fees from liquor manufactures

We authorize liquor manufacturers who comply with our requirements to use certain sub brand names of “Baishui Dukang” to process the production of liquor and to sell to customers within the designated area in a certain period of time. The amount of license fee varies based on the sales territory and the number of sub brand names. We generally collect the entire license fee when the license agreement is executed, and then recognize license fee revenue over the beneficial period described by the agreement, as the revenue is realized or realizable and earned.

(b) License fees from liquor stores

We also authorize liquor stores who comply with our requirements to exclusively sell certain sub brand names of “Baishui Dukang” products within the designated area in a certain period of time. The amount of license fee varies based on the sales territory and the number of sub brand names. We generally collect the entire license fee when the agency agreement is executed, and then recognize license fee revenue over the beneficial period described by the agreement, as the revenue is realized or realizable and earned.

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3-

SIGNIFICANT ACCOUNTING POLICIES (continued)

Deferred Revenue

Deferred revenue consists of prepayments to the Company for products that have not yet been delivered to the customers and franchise fees received upfront for services have not yet been rendered and accepted. Payments received prior to satisfying the Company’s revenue recognition criteria are recorded as deferred revenue.

Cost of License Fees

Costs of franchise fees principally include the costs to prepare the franchise contracts and the payroll to employees who are responsible for inspection and monitoring the franchisees. These expenses are immaterial and therefore included in the general and administrative expenses.

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand, deposits in banks with maturities of three months or less, and all highly liquid investments which are unrestricted as to withdrawal or use, and which have original maturities of three months or less.

Others Receivable

Others receivable principally includes advance to employees who are working on projects on behalf of the Company. After the work is finished, they will submit expense reports with supporting documents to the accounting department. Upon being properly approved, the expenses are debited into the relevant accounts and the advances are credited out. Cash flows from these activities are classified as cash flows from operating activities.

Concentrations of Credit Risk

Financial instruments that subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents. The Company maintains its cash and cash equivalents with various financial institutions in the PRC which do not provide insurance for the amounts on deposit. The Company has not experienced any losses in such accounts and believes it is not exposed to significant credit risk in this area.

Fair Value of Financial Instruments

The carrying value of financial instruments including cash and cash equivalents, receivables, prepaid expenses, accounts payable, and accrued expenses, approximates their fair value due to the relatively short-term nature of these instruments.

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3-

SIGNIFICANT ACCOUNTING POLICIES (continued)

Inventories

Inventories are stated at the lower of cost or market value. Actual cost is used to value raw materials and supplies. Finished goods and work-in-progress are valued on the weighted-average-cost method. Elements of costs in finished good and work-in-progress include raw materials, direct labor, and manufacturing overhead.

Baishui Dukang, one of our subsidiaries, is engaged in the distillery business. Pursuant to the production requirement, all spirits that are newly distilled from sorghum, so call “liquor base”, must be barrel-aged for several years, so we bottle and sell only a portion of our liquor base inventory each year. We classify barreled liquor base as work-in-progress. Following industry practice, we classify all barreled liquor base as a current asset.

Property, Plant and Equipment

Property, plant and equipment are carried at cost. The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized.

When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the year of disposition.

Depreciation is calculated on a straight-line basis over the estimated useful life of the assets without residual value. The percentages or depreciable life applied are:

Building and warehouses	20 years
Machinery and equipment	7-10 years
Office equipment and furniture	5 years
Motor vehicles	5 years
Leased assets	Lease duration

Intangible Assets

Intangible assets are carried at cost. Amortization is calculated on a straight-line basis over the estimated useful life of the assets without residual value. The percentages or amortizable life applied are:

Land use right	50 years
Trade Mark	10 years

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3-

SIGNIFICANT ACCOUNTING POLICIES (continued)

Land Use Right

All land belongs to the State in PRC. Enterprises and individuals can pay the State a fee to obtain a right to use a piece of land for commercial purpose or residential purpose for an initial period of 50 years or 70 years, respectively. The land use right can be sold, purchased, and exchanged in the market. The successor owner of the land use right will reduce the amount of time which has been consumed by the predecessor owner.

The Company owns the right to use three pieces of land, approximately 657 acre, 2.4 acre, and 7.8 acre, located in Weinan City, Shaanxi Province for through February, 2051, March 2055, and May 2059. The costs of these land use rights are amortized over their prospective beneficial period, using the straight-line method with no residual value.

Valuation of Long-Lived assets

Long-lived assets and certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

Long-term Investment

On March 1, 2006, Xidenghui executed an investment agreement with Shaanxi Yichuan Nature Park Co., Inc., pursuant to which, Xidenghui agreed to invest cash of $1,596,254 (RMB 12,000,000) to establish a joint-venture named Shaanxi Yellow-river Bay Wenquan Lake Park Co., Ltd., F/K/A Shaanxi Yellow-river Wetlands Park Co., Ltd., and owns 7.9% equity ownership interest therein. Shaanxi Yellow-river Wetlands Park Co., Ltd. is engaged in the business of recreation and entertainment.

Xidenghui finished the investment contribution in September 2007. As the project is currently ongoing, the Management believes the amount invested approximates the fair value and uses the cost method to record the investment.

Advertising Costs

The Company expenses advertising costs as incurred or the first time the advertising takes place, whichever is earlier, in accordance with the FASB ASC 720-35, “Advertising Costs”. The advertising costs were $26,083, and $72,387 for the six months ended June 30, 2012 and 2011, respectively.

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3-

SIGNIFICANT ACCOUNTING POLICIES (continued)

Research and Development Costs

Research and development costs relating to the development of new products and processes, including significant improvements and refinements to existing products, are expensed when incurred in accordance with the FASB ASC 730, "Research and Development". Research and development costs were immaterial for the six months ended June 30, 2012 and 2011, respectively.

Value-added Tax ("VAT")

Sales revenue represents the invoiced value of goods, net of a value-added tax (VAT). All of the Company’s products that are sold in PRC are subject to a Chinese value-added tax at a rate of 17% of the gross sales price or at a rate approved by the Chinese local government. This VAT may be offset by VAT paid on purchase of raw materials included in the cost of producing the finished goods. The Company presents VAT on a net basis.

Sales Tax and Sales Tax Affixation

Brand Management derives license fees revenue, which is subject to sales tax and sales tax affixation in PRC. Sales tax rate is 5% of the gross sales, and sales tax affixation is approximately 10% of the sales tax, or 0.05% of the gross sales. The Company presents sales tax and sales tax affixation on a net basis. License fee revenue represents the invoiced amount, net of sales tax and sales tax affixation.

Excise Tax

Baishui Dukang produces and distributes distilled liquor, which is subject to excise tax in PRC. Excise tax rate is $0.14 (RMB1.00) per kilogram and 10%-20% of gross sales revenue. The Company presents excise tax on a net basis. Sales revenue from sales of liquor represents the invoiced value of liquor sold, net of excise tax.

Related Parties

A party is considered to be related to the Company if the party directly or indirectly or through one or more intermediaries, controls, is controlled by, or is under common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate families of principal owners of the Company and its management and other parties with which the Company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests. A party which can significantly influence the management or operating policies of the transacting parties or if it has an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests is also a related party.

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3-

SIGNIFICANT ACCOUNTING POLICIES (continued)

Due from/to Affiliates

Due from/to affiliates represent temporally short-term loans to/from affiliates, which are directly or indirectly, beneficially and in the aggregate, majority-owned and controlled by directors and principal shareholders of the Company. These loans are unsecured, non-interest bearing and have no fixed terms of repayment, therefore, deemed payable on demand. Cash flows from due from related parties are classified as cash flows from investing activities. Cash flows from due to related parties are classified as cash flows from financing activities.

Loans from Directors and Officers

Loans from directors and officers are temporally short-term loans from our directors and officers to finance the Company’s operation due to lack of cash resources. These loans are unsecured, non-interest bearing and have no fixed terms of repayment, therefore, deemed payable on demand. Cash flows from these activities are classified as cash flows from financing activates.

Imputed Interest

The Company has financed it business operation through short-term borrowings from various related parties. These short-term borrowings are non-secured, non-interest bearing with no fixed repayment date. The imputed interests are assessed as an expense to the business operation and an addition to the paid-in capital. The calculation is performed quarterly based on the average outstanding balance and the market interest rate. The interest rate used in the calculation of imputed interest for the six months ended June 30, 2011 was 6.375%. The imputed interest expense was $0 and $523,335 for the six months ended June 30, 2012 and 2011.

Pension and Employee Benefits

Full time employees of the PRC entities participate in a government mandated multi-employer defined contribution plan pursuant to which certain pension benefits, medical care, unemployment insurance, employee housing fund and other welfare benefits are provided to employees. Chinese labor regulations require the Company to accrue for these benefits based on certain percentages of the employees' salaries. The Management believes full time employees who have passed the probation period are entitled to such benefits. The total provisions for such employee benefits was $38,495 and $36,305 for the six months ended June 30, 2012 and 2011, respectively.

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3-

SIGNIFICANT ACCOUNTING POLICIES (continued)

Government Subsidies

The Company records government grants as current liabilities upon reception. A government subsidy revenue is recognized only when there is reasonable assurance that the Company has complied with all conditions attached to the grant. Government subsidies are generally exempt from income tax. The Company recognized government subsidy of $260,849 and $0 for the six months ended June 30, 2012 and 2011, respectively.

Income Taxes

The Company accounts for income tax in accordance with FASB ASC 740-10-25, which requires the asset and liability approach for financial accounting and reporting for income taxes. Deferred tax assets and liabilities are recognized for the 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. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance related to deferred tax assets is recorded when it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Although the PRC Income Tax Law allows the enterprises to offset their future net income with operating losses carried forward, an enterprise need approval from the local tax authority before it can claim such tax benefit, and the outcome of the application is generally uncertain. Therefore, the Management established a 100% valuation allowance for the operation losses carried forward and no deferred tax assets have been recorded.

Effective January 1, 2007, the Company adopted a new FASB guidance, which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. The new FASB guidance 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 new FASB guidance also provides guidance on de-recognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure, and transition. In accordance with the new FASB guidance, the Company performed a self-assessment and concluded that there were no significant uncertain tax positions requiring recognition in its consolidated financial statements.

The Company accounts for income taxes in interim periods in accordance with FASB ASC 740-270, "Interim Reporting". The Company has determined an estimated annual effect tax rate. The rate will be revised, if necessary, as of the end of each successive interim period during the Company's fiscal year to its best current estimate. The estimated annual effective tax rate is applied to the year-to-date ordinary income (or loss) at the end of the interim period.

The Company may from time to time be assessed interest or penalties by major tax jurisdictions. In the event it receives an assessment for interest and/or penalties, it will be classified in the financial statements as tax expense.

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3-

SIGNIFICANT ACCOUNTING POLICIES (continued)

Statutory Reserves

Pursuant to the applicable laws in PRC, PRC entities are required to make appropriations to three non-distributable reserve funds, the statutory surplus reserve, statutory public welfare fund, and discretionary surplus reserve, based on after-tax net earnings as determined in accordance with the PRC GAAP, after offsetting any prior years’ losses. Appropriation to the statutory surplus reserve should be at least 10% of the after-tax net earnings until the reserve is equal to 50% of the Company's registered capital. Appropriation to the statutory public welfare fund is 5% to 10% of the after-tax net earnings. The statutory public welfare fund is established for the purpose of providing employee facilities and other collective benefits to the employees and is non-distributable other than in liquidation. Beginning from January 1, 2006, enterprise is no more required to make appropriation to the statutory public welfare fund. The Company does not make appropriations to the discretionary surplus reserve fund.

Since the Company has been accumulating deficiency, no contribution has been made to statutory surplus reserve fund and statutory public welfare reserve fund to date. The company will be required to make contribution to the statutory surplus reserve fund and statutory public welfare reserve fund upon the achievement of positive retained earnings, which means elimination of accumulated deficit and making further positive net income.

Comprehensive Income

FASB ASC 220, “Comprehensive Income”, establishes standards for reporting and display of comprehensive income, its components and accumulated balances. Comprehensive income as defined includes all changes in equity during a period from non-owner sources. Accumulated comprehensive income, as presented in the accompanying statements of changes in owners' equity consists of changes in unrealized gains and losses on foreign currency translation. This comprehensive income is not included in the computation of income tax expense or benefit.

Segment Reporting

FASB ASC 820, “Segments Reporting”, establishes standards for reporting information about operating segments on a basis consistent with the Company’s internal organization structure as well as information about geographical areas, business segments and major customers in financial statements. The Company currently operates in two principal business segments.

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3-

SIGNIFICANT ACCOUNTING POLICIES (continued)

Earnings (Loss) Per Share

The Company reports earnings per share in accordance with FASB ASC 260, “Earnings Per Share” , which requires presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings (loss) per share is computed by dividing income (loss) available to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed similar to basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. There are no potentially dilutive securities outstanding (options and warrants) for the six months ended June 30, 2012 and 2011, respectively.

Fair Value of Measurements

Accounting principles generally accepted in the United States define fair value 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 at the measurement date. Additionally, the inputs used to measure fair value are prioritized based on a three-level hierarchy. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:

Level 1:		Unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2:		Input other than quoted market prices that are observable, either directly or indirectly, and reasonably available. Observable inputs reflect the assumptions market participants would use in pricing the asset or liability and are developed based on market data obtained from sources independent of the Company.

Level 3:		Unobservable inputs. Unobservable inputs reflect the assumptions that the Company develops based on available information about what market participants would use in valuing the asset or liability.

An asset or liability’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Availability of observable inputs can vary and is affected by a variety of factors. The Company uses judgment in determining fair value of assets and liabilities and Level 3 assets and liabilities involve greater judgment than Level 1 and Level 2 assets or liabilities.

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 3-

SIGNIFICANT ACCOUNTING POLICIES (continued)

Recent Accounting Pronouncements

In December 2011, the Financial Accounting Standards Board (“FASB”) released Accounting Standards Update No. 2011-12 (“ASU 2011-12”), Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. ASU 2011-12 defers only those changes in ASU 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. The provisions of ASU 2011-12 became effective in fiscal years beginning after December 15, 2011. The adoption of ASU 2011-12 did not materially impact our financial statements.

In September 2011, the Financial Accounting Standards Board (FASB) issued a revised standard on testing for goodwill impairment. The revised standard allows an entity to first assess qualitatively whether it is necessary to perform step one of the two-step annual goodwill impairment test. An entity is required to perform step one only if the entity concludes that it is more likely than not that a reporting unit’s fair value is less than its carrying amount, a likelihood of more than 50 percent. An entity can choose to perform the qualitative assessment on none, some, or all of its reporting units. Moreover, an entity can bypass the qualitative assessment for any reporting unit in any period and proceed directly to step one of the impairment test, and then perform the qualitative assessment in any subsequent period. The revised standard is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 and early adoption is permitted. The adoption of this new guidance did not have a material effect on the Company’s financial position, results of operations, and cash flows.

In June 2011, the FASB issued amended disclosure requirements for the presentation of comprehensive income. The amended guidance eliminates the option to present components of other comprehensive income (OCI) as part of the statement of changes in equity. Under the amended guidance, all changes in OCI are to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive financial statements. The changes are effective January 1, 2012. Early application is permitted. The adoption of this new guidance did not have a material effect on the Company’s financial position, results of operations, and cash flows.

In January 2011, the FASB temporarily deferred the disclosures regarding troubled debt restructurings which were included in the disclosure requirements about the credit quality of financing receivables and the allowance for credit losses which was issued in July 2010. In April 2011, the FASB issued additional guidance and clarifications to help creditors in determining whether a creditor has granted a concession, and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. The new guidance and the previously deferred disclosures are effective July 1, 2011 applied retrospectively to January 1, 2011. Prospective application is required for any new impairments identified as a result of this guidance. The adoption of this new guidance did not have a material effect on the Company’s financial position, results of operations, and cash flows.

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 4-

ACCOUNTS RECEIVABLE

Accounts receivable consists of the following:

	June 30,		December 31,
	2012		2011
	(unaudited)

Accounts receivable	$	563,382	$	270,276
Less: Allowance for doubtful accounts		-		-
Accounts receivable, net	$	563,382	$	270,276

Bad debt expense charged to operations was $0 and $0 for the six months ended June 30, 2012 and 2011, respectively.

Note 5-

PREPAID EXPENSES

Prepaid expenses consist of the following:

	June 30,		December 31,
	2012		2011
	(unaudited)

Machinery and parts	$	12,026	$	20,520
Construction projects		996,400		-
Raw materials and supplies		692,608		519,629
Packing and supply materials		304,090		138,379
Office expenses		32,945		-
Total	$	2,038,069	$	678,528

Note 6-

INVENTORIES

Inventories consist of following:

	June 30,		December 31,
	2012		2011
	(unaudited)

Finished goods	$	2,409,002	$	1,799,934
Work-in-progress		2,680,932		2,700,921
Raw materials		219,276		154,603
Supplies and packing materials		638,183		679,678
Total	$	5,947,393	$	5,335,136

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 7-

PROPERTY, PLANT AND EQUIPMENT

The following is a summary of property, plant and equipment:

	June 30,			December 31,
	2012			2011
	(unaudited)

Building and warehouses	$	3,177,085		$	3,274,587
Machinery and equipment		2,330,805			2,306,197
Office equipment and furniture		198,032			191,972
Motor vehicles		373,531			370,878
Leased assets		2,499,643			2,457,187
Total		8,579,096			8,600,821
Less: Accumulated depreciation		(4,636,273	)		(4,460,944	)
		3,942,823			4,139,877
Add: Construction in progress		377,323			311,792
Total property, plant and equipment, net	$	4,320,146		$	4,451,669

Depreciation expense charged to operations was $267,137 and $182,075 for the six months ended June 30, 2012 and 2011, respectively. Depreciation expense with respect to production equipment that was charged to cost of sales was $226,847 and $121,967 for the six months ended June 30, 2012 and 2011, respectively. The remainder, depreciation expense attributable to equipment used in administration, was $40,290 and $60,108 for the six months ended June 30, 2012 and 2011, respectively, and was included in general and administration expenses.

Note 8-

INTANGIBLE ASSETS

The following is a summary of intangible assets, less amortization:

	June 30,			December 31,
	2012			2011
	(unaudited)

Land use right	$	2,100,252		$	2,085,341
Trade Mark of "Xidenghui"		71,208			70,702
Trade Mark of "Baishui Du Kang"		26,110			25,924
Total intangible assets		2,197,570			2,181,967

Less: Accumulated amortization		(170,663	)		(147,732	)

Total intangible assets, net	$	2,026,907		$	2,034,235

Amortization expense charged to operations was $21,852 and $23,823 for the three months ended March 31, 2012 and 2011, respectively.

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 9-

ACCRUED EXPENSES

Accrued expenses consist of the following:

	June 30,		December 31,
	2012		2011
	(unaudited)

Accrued payroll	$	60,977	$	84,933
Accrued employee benefits		59,390		59,000
Accrued pension and employee benefit		171,874		138,643
Accrued office expenses		147,033		70,388
Total	$	439,274	$	352,964

Note 10-

TAXES PAYABLE

Taxes payable consists of the following:

	June 30,		December 31,
	2012		2011
	(unaudited)

Income tax	$	504,834	$	469,626
Sales tax and sales tax affixation		144,285		142,148
Excise taxes		19,458		44,694
Value-added Tax ("VAT")		40,365		2,429
Other taxes		556		2,399
Total taxes payable	$	709,498	$	661,296

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 11-

SALES OF LIQUOR TO RELATED PARTY

The Company generally sells liquor to liquor distributors. Some of these liquor distributors are our affiliates, which are directly or indirectly, beneficially and in the aggregate, majority-owned and controlled by directors and principal shareholders of the Company. The price will be different if we sell liquor to third parties. The amount sold to these affiliates follows:

		For the Three Months Ended				For the Six Months Ended
		June 30,				June 30,
Name of Related Party	Description	2012		2011		2012		2011
		(unaudited)		(unaudited)		(unaudited)		(unaudited)

Shaanxi Dukang Group Co., Ltd.	Affiliate 1	$	441,562	$	358,244	$	441,562	$	358,244
Shaanxi Baishui Shiye Co., Ltd.(F/K/A
Shaanxi Baishui Dukang Trade Co., Ltd.)	Affiliate 2		26,369		67,803		26,369		67,803
		$	467,931	$	426,047	$	467,931	$	426,047

In related to sales to related-parties, our subsidiaries have accounts receivable and deferred revenue from related-parties, as disclosed in the following:

Deferred revenue from related parties consists of the following:
		June 30,		December 31,
	Description	2012		2011
Name of Related Party		(unaudited)

Shaanxi Dukang Group Co., Ltd.	Affiliate 1	$	1,521,417	$	427,732
Shaanxi Baishui Shiye Co., Ltd.(F/K/A
Shaanxi Baishui Dukang Trade Co., Ltd.)	Affiliate 2		212,916		217,021
Total Deferred Revenue from Related-parties		$	1,734,333	$	644,753

The nature of the affiliation of each related party follows:

Affiliate 1--The CEO of the Company is a director of Shaanxi Dukang Group Co., Ltd. and has significant influence on the operations therein.

Affiliate 2--The CEO of the Company is the sole director of Shaanxi Baishui Shiye Co., Ltd. and has significant influence on the operations therein.

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 12-

SEGMENT REPORTING

The Company operates in two reportable business segments that are determined based upon differences in products and services. Summarized information by business segment for the three months ended March 31, 2012 and 2011 is as follows:

	For the Three Months Ended				For the Six Months Ended
	June 30,				June 30,
	2012		2011		2012		2011
	(unaudited)		(unaudited)		(unaudited)		(unaudited)
REVENUE
Sales of Liquor	$	722,681	$	258,941	$	1,337,058	$	686,620
License Fees		212,209		242,636		424,531		526,453

COST OF SALES
Sales of Liquor	$	446,413	$	215,546	$	905,848	$	555,684
License Fees		-		-		-		-

GROSS PROFITS
Sales of Liquor	$	276,268	$	43,395	$	431,210	$	130,936
License Fees		212,209		242,636		424,531		526,453

	June 30,		December 31,
	2012		2011
	(unaudited)

TOTAL ASSETS OF LIQUOR PRODUCTION AND DISTRIBUTION	$	13,912,410	$	12,139,862

TOTAL ASSETS OF BRAND NAME LICENSE	$	4,213,860	$	4,201,880

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 13-

CONCENTRATIONS AND CREDIT RISKS

The Company operates in the PRC and grants credit to its customers in this geographic region based on an evaluation of the customer's financial condition. Although the PRC is economically stable, it is always possible that unanticipated events in foreign countries could disrupt the Company’s operations.

Major Customers

The following major customers accounted for approximately 5% or more of the Company’s total sales, as summarized in the following:

		For the Six Months Ended June 30,
		2012					2011
		(unaudited)					(unaudited)

Major	Type of			Percentage of					Percentage of
Customer	Customer	Revenue		Total Revenue			Revenue		Total Revenue
Shaanxi Dukang Group Co., Ltd.	Distributor	$	400,151		22.72	%	$	358,244		50.35	%
Shaanxi Baishui Dukang Shiye Co., Ltd.	Distributor		45,801		2.60	%		67,803		9.53	%
Mr. Jincai Bai'	Licensee		-		-			43,203		6.07	%
Ms. Xiaoyan Shi	Agent		-		-			50,403		7.08	%
Mr. Anxian Xie	Agent		44,857		2.55	%		43,203		6.07	%
Mr. Changzhong Ji	Agent		44,857		2.55	%		-		-
Ms. Jie Cao	Agent		44,857		2.55	%		-		-
Ms. Xiaoli Du	Agent		-		-			36,002		5.06	%
Ms. Sue Dong	Agent		-		-			36,002		5.06	%
Total		$	580,523		32.95	%	$	634,860		89.23	%

Major Suppliers

The following major suppliers accounted for approximately 5% or more of the Company’s total purchase, as summarized in the following:

	For the Six Months Ended June 30,
	2012					2011
	(unaudited)					(unaudited)

Major			Percentage of					Percentage of
Suppliers	Purchase		Total Purchase			Purchase		Total Purchase
Hunan Dexing Taochi Co., Ltd.	$	12,718		10.92	%	$	-		-
Hunan Liling Liangyou Taochi Co., Ltd.		19,155		16.45	%		27,426		11.27	%
Hunan Fengling Liangyou China Co., Ltd.		-		-			-		-
Hunan Xinshiji Taochi Co., Ltd.		-		-			61,871		25.42	%
Shanxi Wenxiyingfa Glass Co., Ltd.		-		-			68,097		27.98	%
Sichuan Guangan Defeng Glass Co., Ltd.		-		-			13,879		5.70	%
Wenzhou Zhixin Wujin Glass Co., Ltd.		30,910		26.55	%		-		-
Yuncheng Aofeng Glass Co., Ltd.		47,893		41.14	%		50,799		20.87	%
Total	$	110,675		95.07	%	$	222,071		91.25	%

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 14-

NONCONTROLLING INTEREST

Balance of Noncontrolling Interest consists of the following:

	Subsidiary and Noncontrolling Interest percentage								Total
	Brand Management		Baishui Dukang			Xidenghui			Noncontrolling
		30.00%		9.49%			16.53%	(4)	Interest

Balance @ December 31, 2010	$	206,671	$	(61,636	)	$	(42,984	)	$	102,051

Noncontrolling Interest income (Loss)		130,183		(29,866	)		27,494			127,810

Debt Conversion		-		218,865			4,644,728			4,863,593

Other Comprehensive Income (Loss)-
effects of Foreign Currency Conversion		2,225		(509	)		2,809			4,526

Balance @ December 31, 2011	$	339,079	$	126,854		$	4,632,047		$	5,097,980

Noncontrolling Interest income (Loss)		22,650		3,747			-			26,397

Other Comprehensive Income (Loss)-
effects of Foreign Currency Conversion		22		3			-			25

Balance @ March 31, 2012	$	361,751	$	130,604		$	4,632,047		$	5,124,402

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 14-

NONCONTROLLING INTEREST (continued)

Noncontrolling interest income consists of the following:

	For the six months Ended June 30, 2012

Name of Subsidiary	Brand Management						Baishui Dukang					Xidenghui					Parent/Holding Company
		Total Income			Noncontrolling Interest Income		Total Income			Noncontrolling Interest Income		Total Income		Noncontrolling Interest Income			Total Income			Noncontrolling Interest Income
			100%			30%		100%			9.49%		100%		16.53%	(4)

Net Income (Loss)		$	75,501		$	22,650	$	39,483		$	3,747	$	309,841	$	51,217		$	(138	)	$	-

Income (Loss) from subsidiary
(equity method)			-			-		-			-		88,587		14,643			398,428			26,397

Total Income (Loss)			75,501			22,650		39,483			3,747		398,428		65,860			398,290			26,397

Adjustments to noncontrolling
interest to absorb accumulated deficit			-			-		-			-		-		(53,713	)		-			-

Less: Income (Loss) attributable to
noncontrolling interest			(22,650	)		-		(3,747	)		-		-		-			-			-

Income (Loss) attributable to Majority		$	52,851				$	35,736				$	398,428				$	398,290	(3)
Income (Loss) attributable to
noncontrolling interest					$	22,650				$	3,747			$	-					$	26,397

	For the six months Ended June 30, 2011

Name of Subsidiary	Brand Management						Baishui Dukang						Xidenghui						Parent/Holding Company
		Total Income			Noncontrolling Interest Income		Total Income			Noncontrolling Interest Income			Total Income			Noncontrolling Interest Income			Total Income			Noncontrolling Interest Income
			100%			30%		100%			9.49%			100%			1.76%

Net Income (Loss)		$	240,917		$	72,275	$	(204,126	)	$	(19,372	)	$	(497,209	)	$	(8,751	)	$	(118	)	$	-

Income (Loss) from subsidiary
(equity method)			-			-		-			-			(16,113	)		(284	)		(504,287	)		43,869

Total Income (Loss)			240,917			72,275		(204,126	)		(19,372	)		(513,322	)		(9,034	)		(504,405	)		43,869

Less: Income (Loss) attributable to
noncontrolling interest			(72,275	)		-		19,372			-			9,034			-			-			-

Income (Loss) attributable to Majority		$	168,642				$	(184,755	)				$	(504,287	)				$	(504,405	)
Income (Loss) attributable to
noncontrolling interest					$	72,275				$	(19,372	)				$	(9,034	)				$	43,869

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 14-

NONCONTROLLING INTEREST (continued)

Noncontrolling interest income consists of the following:

	For the Year Ended December 31, 2011

Name of Subsidiary	Brand Management						Baishui Dukang						Xidenghui						Parent/Holding Company
		Total Income			Noncontrolling Interest Income		Total Income			Noncontrolling Interest Income			Total Income			Noncontrolling Interest Income			Total Income			Noncontrolling Interest Income
			100%			30%		100%			9.49%			100%			16.53%	(4)

Net Income (Loss)		$	433,942		$	130,183	$	(314,709	)	$	(29,866	)	$	(814,314	)	$	2,943		$	(917	)	$	-

Income (Loss) from subsidiary
(equity method)			-			-		-			-			18,917			24,550			(822,891	)		127,810

Total Income (Loss)			433,942			130,183		(314,709	)		(29,866	)		(795,397	)		27,494			(823,808	)		127,810

Less: Income (Loss) attributable to
noncontrolling interest			(130,183	)		-		29,866			-			(27,494	)		-			-			-

Income (Loss) attributable to Majority		$	303,760				$	(284,843	)				$	(822,891	)				$	(823,808	)			(3)
Income (Loss) attributable to
noncontrolling interest					$	130,183				$	(29,866	)				$	27,494					$	127,810

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 14-

NONCONTROLLING INTEREST (continued)

(1) Prior to January 1, 2009, before we adopted ASC 810 (or FAS 160), if the current period loss attributed to the noncontrolling interest resulted in a deficit noncotrolling interest balance, the majority absorbed the current period loss up to the extent that brought the minority interest back to zero. Any subsequent period income attributed to such noncontrolling interest will first absorb the amount that was absorbed by the majority in the prior period, the balance, if any, will attribute to the noncontrolling interest.

(2) After we adopted ASC 810 on January 1, ASC 810-10-45-21 requires that the noncontrolling interest continue to be attributed its share of losses even if that attribution results in a deficit noncontrolling interest balance.

(3) The minor variance between the amount on the table and the amount on the consolidated statements of operations was due to the rounding of foreign currency translation.

(4) The non-controlling interest percentage increased from 1.76% to 16.53% on October 1, 2011, as some minority shareholders contributed their loans to Shaanxi Xidenghui Technology Stock Co., Ltd. to paid-in capital.

Note 15-

COMMITMENTS AND CONTINGENCIES

Lack of Insurance

The Company does not carry any business interruption insurance, products liability insurance or any other insurance policy except for a limited property insurance policy. As a result, the Company may incur uninsured losses, increasing the possibility that the investors would lose their entire investment in the Company.

The Company could be exposed to liabilities or other claims for which the Company would have no insurance protection. The Company does not currently maintain any business interruption insurance, products liability insurance, or any other comprehensive insurance policy except for property insurance policies with limited coverage. As a result, the Company may incur uninsured liabilities and losses as a result of the conduct of its business. There can be no guarantee that the Company will be able to obtain additional insurance coverage in the future, and even if it can obtain additional coverage, the Company may not carry sufficient insurance coverage to satisfy potential claims. If an uninsured loss should occur, any purchasers of the Company’s common stock could lose their entire investment.

Because the Company does not carry products liability insurance, a failure of any of the products marketed by the Company may subject the Company to the risk of product liability claims and litigation arising from injuries allegedly caused by the improper functioning or design of its products. The Company cannot assure that it will have enough funds to defend or pay for liabilities arising out of a products liability claim. To the extent the Company incurs any product liability or other litigation losses, its expenses could materially increase substantially. There can be no assurance that the Company will have sufficient funds to pay for such expenses, which could end its operations and the investors would lose their entire investment.

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 15-

COMMITMENTS AND CONTINGENCIES (continued)

Contingent Liability from Prior Operation

Prior to the merger with Hong Kong Merit Enterprise Limited on February 11, 2008, the Company has not been active since discontinuing its financial service operations by December 31,2007. Management believes that there are no valid outstanding liabilities from prior operations. If a creditor were to come forward and claim a liability, the Company has committed to contest such claim to the fullest extent of the law. No amount has been accrued in the financial statements for this contingent liability.

The Company’s assets are located in PRC and revenues are derived from operations in PRC.

In terms of industry regulations and policies, the economy of PRC has been transitioning from a planned economy to market oriented economy. Although in recent years the Chinese government has implemented measures emphasizing the utilization of market forces for economic reforms, the reduction of state ownership of productive assets and the establishment of sound corporate governance in business enterprises, a substantial portion of productive assets in PRC are still owned by the Chinese government. For example, all lands are state owned and are leased to business entities or individuals through governmental granting of Land Use Rights. The Chinese government also exercises significant control over PRC’s economic growth through the allocation of resources and providing preferential treatment to particular industries or companies. Uncertainties may arise with changing of governmental policies and measures.

The Company faces a number of risks and challenges not typically associated with companies in North America and Western Europe, since its assets exist solely in the PRC, and its revenues are derived from its operations therein. The PRC is a developing country with an early stage market economic system, overshadowed by the state. Its political and economic systems are very different from the more developed countries and are in a state of change. The PRC also faces many social, economic and political challenges that may produce major shocks and instabilities and even crises, in both its domestic arena and in its relationships with other countries, including the United States. Such shocks, instabilities and crises may in turn significantly and negatively affect the Company's performance.

Lease

On March 4, 2002, Baishui Dukang signed a lease agreement with Shaanxi Sanjiu Dukang Liquor Production Co., Ltd ("Sanjiu"), pursuant to which Baishui Dukang agreed to lease the liquor production facility of Sanjiu, including all the fixed assets and the piece of land that the fixed assets attached, for a period of 20 years, which was latterly extended to 30 year. On February 3, 2005, Sanjiu was acquired by Shannxi Baishui Dukang Liquor Development Co., Ltd, an affiliate of the Company. On April 30, 2005, Baishui Dukang signed a complementary lease agreement with Shannxi Baishui Dukang Liquor Development Co., Ltd, pursuant to which Baishui Dukang agreed to continue to lease the liquor production facility for the rest of the original 30-year period. Baishui Dukang also agreed to pay $362,450 (RMB 3,000,000) to the local government to continue the lease and to absorb the pension and unemployment insurance expenses of Sanjiu's original employees. All the pension and unemployment insurance payments were to be made directly to the local China Social Security Administration to satisfy all of the pension and unemployment insurance expenses that were required in connection with the original Sanjiu employees.

Pursuant to the lease agreement, Baishui Dukang is required to absorb the pension and unemployment insurance expenses of Sanjiu's original employees until they all reach their retirement age. Pursuant to the applicable laws in PRC, male employees retire when they reach 60 years old, while female employees retire when they reach 55 years old. Accordingly, Sanjiu’s original employees will gradually retire until Year 2032. The pension and unemployment insurance expenses are based on a certain percentage of the employees’ gross payroll. The percentage may be changed as the applicable law is amended. In practice, the expenses can be based on the local average salary published by the local government. Over the life of the lease, the Management anticipates the percentage will remain the same while the local average salary will increase 4% annually. The number of employees that we need to absorb their pension and unemployment insurance expenses will gradually decrease as Sanjiu’s original employees reach their retirement ages. To the best of our estimation, we anticipate the future payment for pension and unemployment insurance expenses for Sanjiu’s original employees as rental payment follows:

CHINA DU KANG CO., LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 15-

COMMITMENTS AND CONTINGENCIES (continued)

Lease (continued)

Estimated Pension and Unemployment Insurance Expenses

Year	Pension Insurance Expense					Unemployment Insurance Expense					Total		Present Value as of December 31, 2011 (the incremental interest rate is 8%)
	Province average salary (RMB)	Annual increase rate	Percentage	No. of employees	Estimated pension insurance expense (RMB)	City average salary (RMB)	Annual increase rate	Percentage	No. of employees	Estimated pension insurance expense	USD$1.00=RMB¥6.36470 @12/31/2011
	Province average salary (RMB)	Annual increase rate	Percentage	No. of employees	Estimated pension insurance expense (RMB)	City average salary (RMB)	Annual increase rate	Percentage	No. of employees	Estimated pension insurance expense	(RMB)	(USD)	(RMB)	(USD)
2012	14,909	4%	20%	301	897,502	11,876	4%	2.50%	301	89,370	986,872	155,054	783,411	123,087
2013	15,505	4%	20%	282	874,483	12,351	4%	2.50%	282	87,078	961,561	151,077	706,776	129,524
2014	16,125	4%	20%	268	864,312	12,846	4%	2.50%	268	86,065	950,377	149,320	646,811	118,535
2015	16,770	4%	20%	258	865,344	13,359	4%	2.50%	258	86,168	951,512	149,498	599,614	109,886
2016	17,441	4%	20%	244	851,123	13,894	4%	2.50%	244	84,752	935,875	147,041	546,074	100,074
2017	18,139	4%	20%	228	827,124	14,449	4%	2.50%	228	82,362	909,486	142,895	491,367	90,048
2018	18,864	4%	20%	215	811,162	15,027	4%	2.50%	215	80,772	891,935	140,138	446,189	81,769
2019	19,619	4%	20%	199	780,828	15,629	4%	2.50%	199	77,752	858,580	134,897	397,689	72,881
2020	20,404	4%	20%	173	705,963	16,254	4%	2.50%	173	70,297	776,260	121,963	332,925	61,012
2021	21,220	4%	20%	148	628,103	16,904	4%	2.50%	148	62,544	690,647	108,512	274,265	50,262
2022	22,068	4%	20%	135	595,849	17,580	4%	2.50%	135	59,332	655,182	102,940	240,909	44,149
2023	22,951	4%	20%	113	518,698	18,283	4%	2.50%	113	51,650	570,348	89,611	194,181	35,586
2024	23,869	4%	20%	102	486,933	19,015	4%	2.50%	102	48,487	535,420	84,123	168,787	30,932
2025	24,824	4%	20%	77	382,290	19,775	4%	2.50%	77	38,067	420,357	66,045	122,698	22,486
2026	25,817	4%	20%	52	268,497	20,566	4%	2.50%	52	26,736	295,233	46,386	79,792	14,623
2027	26,850	4%	20%	41	220,167	21,389	4%	2.50%	41	21,923	242,091	38,036	60,583	11,102
2028	27,924	4%	20%	25	139,618	22,244	4%	2.50%	25	13,903	153,521	24,121	35,573	6,519
2029	29,041	4%	20%	18	104,546	23,134	4%	2.50%	18	10,410	114,957	18,062	24,664	4,520
2030	30,202	4%	20%	12	72,485	24,059	4%	2.50%	12	7,218	79,703	12,523	15,834	2,902
2031	31,410	4%	20%	6	37,692	25,022	4%	2.50%	6	3,753	41,446	6,512	7,624	1,397
2032	32,667	4%	20%	1	6,533	26,023	4%	2.50%	1	651	7,184	1,129	1,224	224
Total					10,939,256					1,089,290	12,028,546	1,889,884	6,176,988	1,111,518

We consolidate Sanjiu into our consolidated financial statement based on FASB ASC 810-10-25 (FIN 46R). Since Sanjiu had ceased operation when we executed the lease agreement, we will consolidate the leased assets and the lease payment obligation, including the $362,450 (RMB 3,000,000) paid directly to the local government and the payments that were to be made directly to the local China Social Security Administration to satisfy all of the pension and unemployment insurance payments that were required in connection with the original Sanjiu employees in our consolidated financial statements.

CHINA DU KANG CO. LTD. - FORM 10-Q - August 14, 2012

CHINA DU KANG CO. LTD. Reports