2. ACCOUNTING POLICIES

Significant Accounting Policies

Use of Estimates

The preparation of consolidated financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and notes thereto. Actual results could differ from these estimates. Estimates and assumptions principally relate to estimates of the fair value of its warrant liability and excess lease facility liability, the initial fair value and forfeiture rates of stock options issued to employees and consultants and clinical trial and manufacturing accruals.

Cash Equivalents

The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents, which it considers as available for sale and carries at market value, with unrealized gains and losses, if any, reported as accumulated other comprehensive income or loss, which is a separate component of shareholders’ equity.

Short-Term Investments

Short-term investments consist of financial instruments purchased with an original maturity of greater than three months and less than one year. The Company considers its short-term investments as available-for-sale and carries them at market value, with unrealized gains and losses except other than temporary losses, if any, reported as accumulated other comprehensive income or loss, which is a separate component of shareholders’ equity. Realized gains and losses on the sale of these securities are recognized in net income or loss. The cost of investments sold is based on the specific identification method.

Fair value of financial instruments

The fair value of the Company’s cash equivalents and marketable securities is based on quoted market prices and trade data for comparable securities. The Company determines the fair value of its warrant liability based on the Black-Scholes pricing model and using considerable judgment, including estimating stock price volatility and expected warrant life. Other financial instruments including amounts receivable, accounts payable and accrued liabilities, are carried at cost, which the Company believes approximates fair value because of the short-term maturities of these instruments.

Intellectual Property

The costs of acquiring intellectual property rights to be used in the research and development process, including licensing fees and milestone payments, are charged to research and development expense as incurred in situations where the Company has not identified an alternative future use for the acquired rights, and are capitalized in situations where it has identified an alternative future use. No costs associated with acquiring intellectual property rights have been capitalized to date. Costs of maintaining intellectual property rights are expensed as incurred.

Revenue Recognition

Revenue recognized to date is attributable solely to the upfront payment the Company received in the fourth quarter of 2009 pursuant to its Collaboration Agreement with Teva, as well as cash reimbursements from Teva for certain costs incurred by the Company under the Clinical Development Plan the Company and Teva developed under which three phase 3 clinical trials are initiated. Under the Collaboration Agreement, the Company and Teva share certain custirsen-related development costs. The Company has spent the required $30 million in direct and indirect development costs, such as full-time equivalent (FTE) reimbursement for time incurred by its personnel for the benefit of the custirsen development plan. On a quarterly basis Teva will reimburse all development expenses incurred in accordance with the Clinical Development Plan. The Company’s policy is to account for these reimbursements as Collaboration Revenue. For a summary description of the Collaboration Agreement, see Note 4 to Notes to Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.

The Collaboration Agreement contains multiple elements and deliverables, and requires evaluation pursuant to ASC 605-25, Multiple-Element Arrangements, or ASC 605-25. The Company evaluated the facts and circumstances of the Collaboration Agreement to determine whether it had obligations constituting deliverables under ASC 605-25. The Company concluded that it had multiple deliverables under the Collaboration Agreement, including deliverables relating to the grant of a technology license, and performance of manufacturing, regulatory and clinical development services in the U.S. and Canada, and estimated that the period in which it would perform those deliverables began in the fourth quarter of 2009 and will be completed in the fourth quarter of 2012. Because the Company has been able to establish vendor specific objective evidence, or VSOE, of the fair value of the maintenance, regulatory, and clinical services, the Company concluded that these deliverables should be accounted as separate units of accounting under ASC 605-25. In establishing VSOE for the manufacturing, regulatory, and clinical development services, management relied on rates charged by other service providers providing similar development services.

The Company has now recognized the entire $30 million allocated to the manufacturing, regulatory and clinical development services element as revenue on a proportional performance basis, as it incurred direct and indirect development costs under the Collaboration Agreement. As the direct and indirect costs associated with the Clinical Development plan were incurred and the associated revenue was recognized, the Current Deferred Collaboration Revenue balance was reduced to zero as at December 31, 2012.

Because the Company was not able to reliably estimate the fair value of the technology license, it used the residual value approach to determine the amount of revenue to recognize. Based on this approach, the Company recognized $22 million in 2009 relating to this element.

Under the Collaboration Agreement, the Company is entitled to receive up to $370 million upon the achievement of developmental and commercial milestones. The Company evaluated the nature of the events triggering these contingent payments and concluded that these events constituted substantive milestones. This conclusion was based primarily on the facts that each triggering event represents a specific outcome that can be achieved only through successful performance by the Company of one or more of its deliverables, and that achievement of each triggering event was subject to inherent risk and uncertainty and would result in additional payments becoming due to the it. The Company concluded that each of these milestones was substantive, based primarily on the facts that the payments they trigger are non-refundable, that achievement of the milestone entails risk and was not reasonably assured at inception of the Collaboration Agreement, that substantial effort is required to complete each milestone, that the amount of each milestone payment is reasonable in relation to the value created in achieving the milestone, that a substantial amount of time is expected to pass between the upfront payment and the potential milestone payments, and that the milestone payments, once received, relate solely to past performance. Based on the foregoing, the Company will recognize any revenue from these milestone payments under the substantive milestone method in the period in which the underlying triggering event occurs.

Under the Collaboration Agreement, the Company is also entitled to receive percentage royalties on sales of custirsen ranging from the mid-teens to the mid-twenties. The Company will recognize any revenue from these events based on the revenue recognition criteria set forth in ASC 605, Revenue Recognition. Based on those criteria, the Company considers these potential payments to be contingent revenue, and will recognize them as revenue in the period in which the applicable contingency is resolved.

Barter Transactions

During 2012, the Company entered into a barter transaction, exchanging laboratory capital assets with a zero net book value for barter credits on future preclinical research services on OGX-427. Such credits are estimated to be redeemed over the one year period that the preclinical research services are expected to be rendered by the vendor.

The credits were recorded at the fair value of the laboratory capital assets exchanged, in accordance with ASC 845, “Nonmonetary Transactions” resulting in other income of $0.2 million which was recorded in the Company’s Consolidated Statement of Loss in the year ended December 31, 2012.

Property and Equipment

Property and equipment assets are recorded at cost less accumulated depreciation. Depreciation expense on assets acquired under capital lease is recorded within depreciation expense. Depreciation is provided on a straight-line basis over the following periods:

Income Taxes

Income taxes are accounted for under the liability method. Deferred tax assets and liabilities are recognized for the differences between the carrying values of assets and liabilities and their respective income tax bases and for operating losses and tax credit carry forwards. A valuation allowance is provided for the portion of deferred tax assets that is more likely than not to be unrealized. Deferred tax assets and liabilities are measured using the enacted tax rates and laws.

Scientific Research and Development Tax Credits

The benefits of tax credits for scientific research and development expenditures are recognized in the year the qualifying expenditure is made provided there is reasonable assurance of recoverability. The tax credits recorded are based on the Company’s estimates of amounts expected to be recovered and are subject to audit by taxation authorities. The non-refundable tax credit reduces the tax provision; however, no reduction to the tax provision has been recorded to date as the Company records a full valuation allowance. All qualifying expenditures are eligible for non-refundable tax credits only.

Therapeutic Discovery Research Grants

The Internal Revenue Service’s therapeutic discovery tax credit program, created under the Patient Protection and Affordable Care Act of 2010, provides tax credits or grants representing up to 50 percent of eligible qualified investments in therapeutic discovery projects during tax years 2009 and 2010. The Company applied for and received funds under this program to support custirsen and OGX-427 development projects. The benefits of research grants under the Internal Revenue Service’s therapeutic discovery tax credit program were recognized in the year the qualifying expenditure was approved. The research grants reduced R&D expenditures in 2010.

Research and Development Costs

Research and development costs are expensed as incurred, net of related refundable investment tax credits, with the exception of non-refundable advanced payments for goods or services to be used in future research and development, which are capitalized in accordance with ASC 730, “Research and Development” and included within Prepaid Expenses.

Clinical trial expenses are a component of research and development costs. These expenses include fees paid to contract research organizations and investigators and other service providers, which conduct certain product development activities on the Company’s behalf. The Company uses an accrual basis of accounting, based upon estimates of the amount of service completed. In the event payments differ from the amount of service completed, prepaid expense or accrued liabilities amounts are adjusted on the balance sheet. These expenses are based on estimates of the work performed under service agreements, milestones achieved, patient enrollment and experience with similar contracts. The Company monitors each of these factors to the extent possible and adjusts estimates accordingly.

Stock-Based Compensation

Effective January 1, 2006, the Company adopted the fair value recognition provisions of the ASC 718, “Stock Compensation”, using the modified prospective method with respect to options granted to employees and directors. Under this transition method, compensation cost is recognized in the financial statements beginning with the effective date for all share-based payments granted after January 1, 2006 and for all awards granted prior to but not yet vested as of January 1, 2006. The expense is amortized on a straight-line basis over the graded vesting period.

Restricted Stock Awards

The Company grants restricted stock awards that generally vest and are expensed over a four-year period. In 2012, the Company also granted restricted stock awards that vest in conjunction with certain performance conditions to certain executive officers and key employees. At each reporting date, the Company evaluates whether achievement of the performance conditions is probable. Compensation expense is recorded over the appropriate service period based upon the Company’s assessment of accomplishing each performance provision or the occurrence of other events that may have caused the awards to accelerate and vest.

Segment Information

The Company follows the requirements of ASC 280, “Segment Reporting.” The Company has one operating segment, dedicated to the development and commercialization of new cancer therapies, with operations located in Canada and the United States.

Comprehensive Income (Loss)

Comprehensive income (loss) is comprised of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) consists of unrealized gains and losses on the Company’s available-for-sale marketable securities. The Company has reported the components of comprehensive loss in the statement of shareholders’ equity.

Loss per Common Share

Basic loss per common share is computed using the weighted average number of common shares outstanding during the period. Diluted loss per common share is computed in accordance with the treasury stock method. The effect of potentially issuable common shares from outstanding stock options is anti-dilutive for all periods presented.

Warrants

The Company accounts for warrants pursuant to the authoritative guidance on accounting for derivative financial instruments indexed to, and potentially settled in, a company’s own stock, on the understanding that in compliance with applicable securities laws, the warrants require the issuance of registered securities upon exercise and therefore do not sufficiently preclude an implied right to net cash settlement. The Company classifies warrants on the consolidated balance sheet as a liability which is revalued at each balance sheet date subsequent to the initial issuance. Determining the appropriate fair-value model and calculating the fair value of registered warrants requires considerable judgment, including estimating stock price volatility and expected warrant life. The computation of expected volatility was based on the historical volatility of shares of the Company’s common stock for a period that coincides with the expected life of the warrants. A small change in the estimates used may have a relatively large change in the estimated valuation. The Company uses the Black-Scholes pricing model to value the warrants. Changes in the fair market value of the warrants are reflected in the consolidated statement of loss as gain (loss) on revaluation of warrants.

Reclassifications

Certain prior period balances have been reclassified to conform to the current period presentation. The expenses associated with adjustments to sublease income assumptions relating to the Company’s Bothell facility (please see Note 7 to Notes to Consolidated Financial Statements) were reclassified during the third quarter of 2010 from research and development expenses to restructuring expenses. This reclassification on the statements of loss was made in all prior periods presented for comparability purposes. This reclassification had no effect on net loss attributable to common shareholders, shareholders’ equity, total assets and total liabilities, or the major categories of the cash flow statement.

Foreign Currency Translation

The Company’s functional and reporting currency is the U.S. dollar. Revenues and expenses denominated in other than U.S. dollars are translated at average monthly rates.

The functional currency of the Company’s foreign subsidiary is the U.S. dollar. For this foreign operation, assets and liabilities denominated in other than U.S. dollars are translated at the period-end rates for monetary assets and liabilities and historical rates for non-monetary assets and liabilities. Revenues and expenses denominated in other than U.S. dollars are translated at average monthly rates. Gains and losses from this translation are recognized in the current consolidated statement of operations.

Recently Adopted Accounting Policies

In December 2011, the FASB issued ASU No. 2011-12, “Comprehensive Income.” This ASU defers the effective date for amendments to the presentation of reclassification of items out of accumulated other comprehensive income in ASU No. 2011-05. The amendments are being made to allow the FASB time to redeliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. While the FASB is considering the operational concerns about the presentation requirements for reclassification adjustments and the needs of financial statement users for additional information about reclassification adjustments, entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before Update 2011-05.

All other requirements in ASU 2011-05 are not affected by this ASU, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities are required to apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company adopted this standard beginning in the quarter ended March 31, 2012. The adoption of this standard did not have a significant impact on the Company’s financial position or results of operations.

In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement.” This ASU clarifies the concepts related to highest and best use and valuation premise, blockage factors and other premiums and discounts, the fair value measurement of financial instruments held in a portfolio and of those instruments classified as a component of shareowners’ equity. The guidance includes enhanced disclosure requirements about recurring Level 3 fair value measurements, the use of nonfinancial assets, and the level in the fair value hierarchy of assets and liabilities not recorded at fair value. The provisions of this ASU are effective prospectively for interim and annual periods beginning on or after December 15, 2011. The Company adopted this standard on a prospective basis beginning with the quarter ended March 31, 2012. The adoption of this standard did not have a significant impact on the Company’s financial position or results of operations.