Audited Financial Statements AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Business  Basis of Presentation  Use of Estimates  Correction of Accounting Errors  Reclassifications  Accounting Standards Adopted in 2011 Auburn National Bancorporation, Inc. (the “Company”) is a bank holding company whose primary business is  conducted by its wholly-owned subsidiary, AuburnBank (the “Bank”). AuburnBank is a commercial bank located in Auburn,  Alabama. The Bank provides a full range of banking services in its primary market area, Lee County, which includes the  Auburn-Opelika Metropolitan Statistical Area.  The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary,  AuburnBank. Significant intercompany transactions are eliminated in consolidation.  The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires  management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of  contingent assets and liabilities as of the balance sheet date and the reported amounts of income and expense during the  reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to  significant change in the near term include the determination of the allowance for loan losses, fair value measurements,  valuation of other real estate owned, and valuation of deferred tax assets. Income tax benefit for the year ended December 31, 2009 included a $281 thousand tax benefit related to the correction  of an error in prior periods that resulted from the incorrect calculation of tax basis for certain available-for-sale securities,  primarily related to periods prior to January 1, 2007. Management believes the impact of this correction is not material to  current or prior period financial statements and the Company’s Audit Committee of the Board of Directors, based on  information reviewed by management with the Audit Committee, concurs with management’s conclusion.  Certain amounts reported in prior periods have been reclassified to conform to the current-period presentation. These  reclassifications had no effect on the Company’s previously reported net earnings or total stockholders’ equity.  In the first quarter of 2011, the Company adopted new guidance related to the following Codification topic: • Accounting Standards Update (“ASU”) 2010-06,  Improving Disclosures about Fair Value Measurements. In the third quarter of 2011, the Company adopted new guidance related to the following Codification topic: • ASU 2011-02,  A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring . Information about these pronouncements is described in more detail below.  ASU 2010-06,  Improving Disclosures about Fair Value Measurements,  amends the disclosure requirements for fair  value measurements. Companies are required to disclose significant transfers in and out of Levels 1 and 2 of the fair value  hierarchy. The ASU also clarifies that fair value measurement disclosures should be presented for each asset and liability  class, which is generally a subset of a line item in the statement of financial position. In the roll-forward of Level 3 activity,  companies must present information on purchases, sales, issuances, and settlements on a gross basis rather than on a net  basis. Companies should also provide information about the valuation techniques and inputs used to measure fair value for  both recurring and nonrecurring instruments classified as either Level 2 or Level 3. In the first quarter of 2011, the Company adopted the requirement for gross presentation in the Level 3 roll-forward with prospective application. The remaining  provisions were effective for the Company in the first quarter of 2010. Adoption of the ASU did not have a significant impact page 39