U.S. SECURITIES AND EXCHANGE COMMISSION





WASHINGTON, D.C. 20549





FORM 10-Q





(Mark One)


xQUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934





For the quarterly period ended September 30, 2010





 ̈TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934





For the transition period from  _______________  to _______________





Commission File Number 000-26175





China Water Group, Inc.





(Exact name of small business issuer as specified in its charter)





Nevada

88-0409151(State or other jurisdiction of

(IRS Employerincorporation or organization)

Identification No.)





Suite 7A01, Baicheng Building


584 Yingbin Road


Dashi, Panyu District


Guangzhou, Guangdong, China


(Address of principal executive offices)


86-20-3479 9708


(Issuer’s telephone number)





NA


(Former name, former address and former fiscal year, if changed since last report)





Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES  ̈NO x





Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company filer.  See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):





Large Accelerated Filer  ̈
Accelerated Filer  ̈
Non-Accelerated Filer  ̈
Smaller Reporting Company x





Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES  ̈NO x





State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 139,383,450 shares of common stock, par value $.0001 per share, as of September 30, 2010.





Transitional Small Business Disclosure Format (Check one). YES  ̈NO x








CHINA WATER GROUP, INC.





CONSOLIDATED FINANCIAL STATEMENTS





September 30, 2010 AND 2009





(UNAUDITED)








CHINA WATER GROUP, INC.


Consolidated Financial Statements


September 30, 2010 and 2009


(Unaudited)





Table of Contents





PageConsolidated Financial StatementsConsolidated Balance Sheets
2Consolidated Statements of Operations
3Consolidated Statements of Comprehensive Income (Loss)
4Consolidated Statements of Cash Flows
5Notes to Consolidated Financial Statements
6










CHINA WATER GROUP, INC.





Consolidated Balance Sheets





September 30,


December 31,2010


2009(Unaudited)AssetsCurrent assets:Cash and cash equivalents

$
52,940


$
30,497Accounts receivable, net


101,105



179,373Inventory


286,472



282,999Receivable for disposal of Evergreen


1,197,600



1,173,600Other current assets


219,353



170,728Total current assets


1,857,470



1,837,197Property, plant and equipment, net


1,014,900



1,017,202Intangible assets, net


211,949



209,886Goodwill


13,447,993



13,178,494Total assets

$
16,532,312


$
16,242,779LiabilitiesCurrent liabilities:Warrant liability

$
51,814


$
143,875Accounts payable


210,340



188,105Accrued expenses


1,393,454



1,469,726Due to shareholders


279,000



2,817Due to related companies


2,898,787



2,780,956Due to affiliated companies


2,007,585



1,722,159Other current liabilities


416,530



602,235Total current liabilities


7,257,510



6,909,873Other payables for acquisition of a subsidiary


5,950,000



5,950,000Total liabilities


13,207,510



12,859,873EquityStockholders' equity:Preferred stock, $0.001 par value, 50,000,000 shares authorized, no shares issued and outstanding


-



-Common stock, $0.001 par value, 200,000,000 shares authorized; 139,383,450 shares issued and outstanding at September 30, 2010 and December 31, 2009


139,383



139,383Additional paid-in capital


6,131,532



6,131,532Accumulated deficit


(4,285,012
)


(4,045,147
)Accumulated other comprehensive income


1,690,155



1,468,759Total stockholders' equity


3,676,058



3,694,527Noncontrolling interest


(351,256
)


(311,621
)Total equity


3,324,802



3,382,906Total liabilities and equity

$
16,532,312


$
16,242,779





The accompanying notes are an integral part of these consolidated financial statements.


2





CHINA WATER GROUP, INC.





Consolidated Statements of Operations


(Unaudited)





ThreeMonthsEnded

September30,


NineMonthsEnded

September30,2010


2009


2010


2009SalesThird parties

$
95,073


$
675,903


$
241,010


$
752,488Related parties


27,232



-



27,232



-Total sales


122,305



675,903



268,242



752,488Cost of salesThird parties


51,893



190,232



144,311



224,687Related parties


14,841



-



14,841



-Total cost of sales


66,734



190,232



159,152



224,687Gross profit


55,571



485,671



109,090



527,801Operating expensesSelling and distribution expenses


49,584



50,517



109,246



81,712General and administrative expenses


90,191



141,450



347,471



418,865Total operating expenses


139,775



191,967



456,717



500,577Income (loss) from operations


(84,204
)


293,704



(347,627
)


27,224Other income (expense)Interest income (expense)


(69
)


364



(311
)


478Gain (loss) on financial instruments


4,058



(46,465
)


92,061



(69,610
)Other income (expense)


3,532



(53,779
)


(16,254
)


(57,683
)Total other income (expense)


7,521



(99,880
)


75,496



(126,815
)Income (loss) before income taxes


(76,683
)


193,824



(272,131
)


(99,591
)Provision for income taxes


2



53,502



419



54,206Net income (loss)


(76,685
)


140,322



(272,550
)


(153,797
)Less: net income (loss) attributable to noncontrolling interest


(7,429
)


18,679



(32,685
)


(3,822
)Net income (loss) attributable to CHWG

$
(69,256
)

$
121,643


$
(239,865
)

$
(149,975
)Basic income (loss) per share

$
(0.00
)

$
0.00


$
(0.00
)

$
(0.00
)Diluted income (loss) per share

$
(0.00
)

$
0.00


$
(0.00
)

$
(0.00
)Weighted average number of common shares outstandingBasic


139,383,450



139,383,450



139,383,450



139,383,450Diluted


139,383,450



139,383,450



139,383,450



139,383,450





The accompanying notes are an integral part of these consolidated financial statements.


3





CHINA WATER GROUP, INC.





Consolidated Statements of Comprehensive Income (Loss)


(Unaudited)





Three Months Ended


Nine Months EndedSeptember 30,


September 30,2010


2009


2010


2009Net income (loss)

$
(76,685
)

$
140,322


$
(272,550
)

$
(153,797
)Other comprehensive incomeForeign currency translation adjustment


171,450



15,588



214,446



63,287Total other comprehensive income


171,450



15,588



214,446



63,287Total Comprehensive income (loss)


94,765



155,910



(58,104
)


(90,510
)Less: Comprehensive income (loss)attributable to the noncontrolling interest


(13,223
)


19,234



(39,635
)


(8,533
)Comprehensive income (loss) attributable to CHWG

$
107,988


$
175,144


$
(18,469
)

$
(81,977
)





The accompanying notes are an integral part of these consolidated financial statements.


4





CHINA WATER GROUP, INC.





Consolidated Statements of Cash Flows


(Unaudited)





Nine Months Ended September 30,2010


2009Cash flows from operating activitiesNet loss

$
(272,550
)

$
(153,797
)Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Depreciation and amortization


60,361



53,784(Gain) loss on fair value of derivative instruments


(92,061
)


69,610Changes in operating assets and liabilities :Accounts receivable


80,512



(484,699
)Inventory


2,274



(20,746
)Receivable for disposal of Evergreen


-



(1,026,130
)Other current assets


(44,350
)


(75,555
)Accounts payable


18,069



34,402Accrued expenses


(77,861
)


363,080Other current liabilities


(194,580
)


130,404Total adjustments


(247,636
)


(955,850
)Net cash used in operating activities


(520,186
)


(1,109,647
)Cash flows from  investing activitiesDue from related companies


-



(584,480
)Acquisition of property, plant and equipment


(35,469
)


(255,338
)Acquisition of intangible assets


-



(27,954
)Disposal of subsidiary – Evergreen, net of cash


-



2,785,446Net cash provided by (used in) investing activities


(35,469
)


1,917,674Cash flows from financing activitiesDue to shareholders


271,330



(252,751
)Due to related companies


59,902



(284,886
)Due to affiliated companies


245,863



(80,793
)Net cash provided by (used in) financing activities


577,095



(618,430
)Effect of foreign currency translation on cash and cash equivalents


1,003



188Net increase in cash and cash equivalents


22,443



189,785Cash and cash equivalents, beginning of period


30,497



8,579Cash and cash equivalents, end of period

$
52,940


$
198,364





The accompanying notes are an integral part of these consolidated financial statements.


5





CHINA WATER GROUP, INC.





Notes to Consolidated Financial Statements


(Unaudited)





Note 1 – Organization and nature of business





In these notes, the terms “CHWG,” “we,” “us,” and “our” mean China Water Group, Inc. (formerly China Evergreen Environmental Corporation) and subsidiary companies.





We were organized as a Nevada corporation on September 10, 1996 under the name “Discovery Investments, Inc.” and were previously engaged in the business of seeking, investing and, acquiring an interest in various business opportunities.





On October 15, 2004, we were the subject of a reverse acquisition by Evergreen Asset Group Limited, an International Business Company organized under the laws of the British Virgin Islands (“Evergreen”), pursuant to which we acquired 100% of the outstanding shares of Evergreen capital stock in exchange for a controlling interest in our common stock. Pursuant to a securities purchase agreement dated September 9, 2004, as amended, we issued 83,500,000 shares of our common stock (representing 83.5% of our outstanding capital stock) in exchange for all of the issued and outstanding shares of Evergreen capital stock transferred to us by the Evergreen shareholders at the closing (the “Reverse Acquisition”). Following the close of the Reverse Acquisition, we changed our corporate name from “Discovery Investments, Inc.” to “China Evergreen Environmental Corporation.” On November 7, 2006, we changed our name to “China Water Group, Inc.” to reflect our focus on China’s water treatment and supply needs.





As a result of the Reverse Acquisition, Evergreen became our wholly owned subsidiary. Evergreen has three majority owned subsidiaries: Guang Dong Xin Xing Mei Biology Company Limited (“Xinxingmei”), and Hai Yang City Sheng Shi Environment Protection Company Limited (“Haiyang”). Through Xinxingmei and Haiyang, we provide wastewater turn-key engineering, equipment and chemical trading. Evergreen then holds 90% of Xinxingmei. Xinxingmei provides turn-key wastewater treatment engineering design and contracting. Xinxingmei also holds 90% and 35% respectively in the equity interest of the following two water treatment facilities operated through build, operate and transfer (“BOT”) arrangements with the PRC government: (i) Tian Jin Shi Sheng Water Treatment Company Limited (“Tian Jin”), which commissioned water treatment in November 2003 and has a daily treatment capacity of approximately 10,000 cubic meters and (ii) Xin Le Sheng Mei Water Purifying Company Limited (“Xin Le”), which also commissioned water treatment in November 2003 and has a daily treatment capacity of 40,000 cubic meters. Xinxingmei was retained to manage both Tian Jin and Xin Le.





The principal activities of the Group are the research and development of waste water, garbage treatment and aqueous purifying techniques, investment and construction of waste water treatment plant and sales of environment protection related products. The Company is now engaged in the production, sales and marketing of the bottled water.





On January 8, 2008, the Chinese government approved the sale of Evergreen’s 58% of the total equity interest in Guang Dong Xin Xing Mei Biology Company Limited (“Xinxingmei”) to Wenming Pu at a total consideration of RMB 7,308,600. After completing the transfer formalities, Evergreen possesses 32% of total equity of Xinxingmei, instead of the previous 90% interest.





On January 23, 2008, the Chinese government approved China Water Group Inc’s. acquisition of 90% equity interest in Guangzhou Xinchen Water Company Limited from Fortune Luck Global International Limited. Guangzhou Xinchen Water Company Limited owns 100% equity interest of Aba Xinchen Dagu Glacier Spring Co., Limited. The acquisition was completed for a consideration of $13.45 million, of which $7.5 million was paid in cash, and the remaining $5.95 million will be paid in the future.  The primary reason for the acquisition was to enter into the bottled water industry.  The results of operations for the period from January to December 2008 were included in the combined income statement.  The Company recorded a liability of $5.9 million, which represented the fair value of stock calculated based on US$ 0.2 per share, with reference to contemporaneous prices of the Company’s common stock on the Pink Quote, with total of 29.75 million shares.  This liability does not represent a contingent liability as defined under paragraph 25 of SFAS 141.  Approximately $13 million of the purchase price of $13.45 million was assigned to goodwill as the net asset of Aba Xinchen Dagu Glacier Spring Co., Limited. was minimum at the acquisition date.  The consolidated statement of operations for the twelve months ended December 31, 2008 included the twelve-month results of operations of Aba Xinchen Dagu Glacier Spring Co., Limited.


6





CHINA WATER GROUP, INC.





Notes to Consolidated Financial Statements


(Unaudited)





Note 1 – Organization and nature of business (continued)





In January, 2009, the Group sold 100% of the equity interest in Evergreen to Whole Treasure Investment Ltd. at a total consideration of RMB 19,000,000 (approximately $2,784,450). After completing the transfer formalities, the Group no longer possesses any share in Evergreen. As of September 30, 2010, the receivable for disposal of Evergreen is $1,197,600.





On February 26, 2009, Guangzhou Xinchen Water Company established a subsidiary, Chengdu Jiuqiannian Water Company, in the PRC as a wholly-owned limited liability company with registered capital of RMB 500,000 (approximately $73,250).





On August 24, 2009, Guangzhou Xinchen Water Company established a subsidiary, Beijing Jiuqiannian Trading Company Ltd., in the PRC as a wholly-owned limited liability company with registered capital of RMB 300,000 (approximately $43,971).





Note 2 – Summary of significant accounting policies





Basis of Presentation





The Company’sconsolidatedfinancialstatements include the accounts of its controlled subsidiaries. All intercompany balances and transactions are eliminated in consolidation.The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) applicable to interim financial information and the requirements of Form 10-Q and Article 8 of Regulation S-X of the Securities and Exchange Commission. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. Interim results are not necessarily indicative of results for a full year. In the opinion of management, all adjustments considered necessary for a fair presentation of the financial position and the results of operations and cash flows for the interim periods have been included.





In preparing the accompanying unaudited consolidated financial statements, the Company evaluated the period from September 30, 2010 through the date the financial statements were issued for material subsequent events requiring recognition or disclosure. (see Note 20)





Interim Financial Statements





These interim financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the years ended December 31, 2009 and 2008, as not all disclosures required by generally accepted accounting principles for annual financial statements are presented. The interim financial statements follow the same accounting policies and methods of computations as the audited financial statements for the years ended December 31, 2009 and 2008.





Financial instruments





The carrying amounts of all financial instruments approximate their fair value. The carrying amounts of cash, accounts receivable, related party receivables, unsecured loans, accounts payable and related party payables approximate their fair value due to the short-term nature of these items. The carrying amounts of borrowings approximate their fair value based on our expected borrowing rate for debt with similar remaining maturities and comparable risk.





Reclassification





Certain amounts of December 31, 2009 and September 30, 2009 were reclassified for presentation purposes.


7


CHINA WATER GROUP, INC.





Notes to Consolidated Financial Statements


(Unaudited)





Note 3 – Inventory





Inventory as of September 30, 2010 and December 31, 2009 consisted of the following:





September 30,


December 31,2010


2009Raw materials

$
112,907


$
139,077Finished goods


173,565



143,922Total

$
286,472


$
282,999





Note 4 – Other Current Assets





Other current assets consisted mainly of prepayments to vendors for goods and services. The balance of other current assets as of September 30, 2010 and December 31, 2009 was $219,353 and $170,728, respectively.





Note 5 – Property, Plant And Equipment, Net





Property, plant and equipment, net as of September 30, 2010 and December 31, 2009 consisted of the following:





September 30,


December 31,2010


2009Office equipment

$
36,280


$
31,448Furniture and fixtures


6,106



5,468Motor vehicles


254,423



249,323Building and structure


183,348



179,674Bottled water production equipment


717,076



729,945Subtotal


1,197,233



1,195,858Less: Accumulated depreciation


259,560



196,345937,673



999,513Construction in progress


77,227



17,689Total

$
1,014,900


$
1,017,202





Depreciation expenses for the three months ended September 30. 2010 and 2009 were $19,870and $32,194, and for the nine months ended September 30, 2010 and 2009 were $58,171 and $51,602, respectively.





Note 6– Intangible Assets





Intangible assets as of September 30, 2010 and December 31, 2009consisted ofthe following:





September 30,


December 31,2010


2009Rights to use land

$
226,561


$
222.021Less: accumulated amortization


14,612



12,135Total

$
211,949


$
209,886





Amortization expenses for thethree monthsendedSeptember 30, 2010 and 2009 were $734and $767, and for the nine months ended September 30, 2010 and 2009 were $2,190 and $2,259, respectively.


8


CHINA WATER GROUP, INC.
 
 Notes to Consolidated Financial Statements
 (Unaudited)
 
 Note 7 - Goodwill
 
 On January 23, 2008, the Group completed its acquisition of 90% equity interest in Guangzhou Xinchen Water Company Limited from Fortune Luck Global International Limited for a consideration of $13.45 million. Goodwill, which is equal to the excess of cost over the fair value of acquired assets, has been recorded in conjunction with the acquisition. Goodwill is accounted for in accordance with ASC 350 (formerly SFAS 142 “Goodwill and Other Intangible Assets”). Under ASC 350, goodwill is not amortized and is subject to impairment test, at least annually. The test consists of two steps. First, the identification of potential impairment is performed by comparing the fair value of the reporting unit to its carrying amount, including goodwill. If the fair value of the reporting unit is greater than its carrying amount, goodwill is not considered impaired. Second, if there is impairment identified in the first step, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with ASC 805-10 (formerly SFAS No. 141(R) “Business Combinations”). As of September 30, 2010, the Company concluded that there was no impairment of goodwill.
 
 Balance as of December 31, 2009

$
13,178,494Foreign currency exchange adjustment


269,499Adjusted balance as of September 30, 2010

$
13,447,993
 
 Note 8 - Warrant Liability
 
 The fair values of the warrant liability as of September 30, 2010 and December 31, 2009 were as following:
 
 September30,


December31,2010


2009Warrants issued in April 2005, at fair value

$
19,614


$
68,153Warrants issued in September 2005, at fair value


-



43,522Shares issued in September 2005, accounted for as liability


32,200



32,200Total

$
51,814


$
143,875
 
 The Group conducted a private placement in April 2005 (“April Private Placement”) of 20 investment units, at $25,000 per unit, for gross proceeds of $500,000. Each unit consisted of (a) a 12% convertible debenture in the original principal amount of $25,000, convertible into shares of our common stock at the rate of the lesser of (i) $0.20 per share or (ii) a 10% discount to the price per share of common stock (or conversion price per share of common stock) of the next private placement conducted by us prior to any conversion of the debenture, and (b) 125,000 detachable warrants to purchase one share each of our common stock at an exercise price of $0.20 per share, expiring ten years from their date of issuance (“April Warrants”). As a result of the September 2005 private placement, pursuant to Section 5(d) of the warrant agreement, the exercise price has been adjusted to $0.15 per share on September 14, 2005. The debentures were due and payable August 1, 2005. The debenture holders, however, extended the payment period to September 30, 2005. The debentures were converted into 3,703,701 shares of common stock on October 1, 2005.
  9
 
 CHINA WATER GROUP, INC.
 
 Notes to Consolidated Financial Statements
 (Unaudited)
 
 The Group used the Black-Scholes Option Pricing model in calculating the fair market value of the April Warrants and allocated $148,531, $74,266 and $185,664 of the $408,461 net proceeds to the Convertible Debenture, the Bifurcated Conversion Feature of the Debenture and the April Warrants, respectively. The differences between the fair value of each of the Convertible Debenture, the Bifurcated Conversion Feature of the Debenture and the April Warrants and the respective allocated amounts are recorded as non-cash financing charges and expensed at the date of issuance. The principal assumptions used in the
 
 Note 8 - Warrant Liability (Continued)
 
 The Group granted to the holders of the April Warrants certain piggy-back and demand registration rights. Pursuant to the agreements surrounding the April Private Placement, in the event that the Group determined to undertake a registration of securities, the Group would include, at the request of the holder of “Registrable Securities”, the Registrable Securities in the registration statement. If the Group did not file a registration statement by the 120th day from the closing of such financing, and the Group shall have received a written request signed by the holders holding the majority of the Registrable Securities, then the Group was obligated to file, at its expense, a registration statement covering the Registrable Securities. Once such registration statement has been filed and declared effective, the Group is obligated to keep such registration statement effective until the earlier of (i) the date that all of the Registrable Securities have been sold pursuant to such registration statement, (ii) all Registrable Securities have been otherwise transferred to persons who may trade such shares without restriction under the Securities Act, and the Group has delivered a new certificate or other evidence of ownership for such securities not bearing a restrictive legend, or (iii) all Registrable Securities may be sold at any time, without volume or manner of sale limitations pursuant to Rule 144(k) or any similar provision then in effect under the Securities Act. As of September 30, 2010, the Group has not received any written request signed by the holders holding the majority of the Registrable Securities.
 
 Under ASC 815-40-05, Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in a Company’s Own Stock, the fair value of the April Warrants should be reported as a liability. Pursuant to the related warrant agreement, because there is currently no effective registration statement covering the shares of common stock underlying these warrants, these warrants are currently subject to a cashless exercise whereby the warrant holders may surrender their warrants to the company in exchange for shares of common stock. The number of shares of common stock into which a warrant would be exchangeable in such a cashless exercise depends on both the exercise price of the warrants and the market price of the common stock, each at or near the time of exercise. Because both of these factors are variable, it is possible that we could have insufficient authorized shares to satisfy a cashless exercise. In this scenario, if we were unable to obtain shareholder approval to increase the number of authorized shares, we could be obligated to settle such a cashless exercise with cash rather than by issuing shares of common stock. Further, ASC 815-40-05 requires that we record the potential settlement obligation at each reporting date using the current estimated fair value of the warrants, with any changes being recorded through our statement of operations. We will continue to report the potential settlement obligation as a liability until such time as the warrants are exercised or expire or we are otherwise able to modify the warrant agreement to remove the provisions which require this treatment.
 
 The conversion feature of the convertible debenture issued in April did not qualify for the scope of exception from the provisions of SFAS 133 because the convertible debentures are convertible into a Variable number of share. As such, the conversion feature was bifurcated from the convertible debenture and accounted for as a derivative at fair value with changes in fair value recorded in earnings. Upon the conversion of the convertible debentures in October 2005, the convertible debentures were recorded in equity as additional capital.
 
 On September 14, 2005, the Group closed the private placement sale to accredited investors of units consisting of shares of our common stock and warrants to purchase shares of our common stock for aggregate gross proceeds of $4.83 million (“September Private Placement”). Pursuant to the subscription agreements entered into with the investors, we issued to the investors 161 units at a price of $30,000 per unit. Each unit consisted of 200,000 shares of our common stock, priced at $0.15 per share, and warrants to purchase 200,000 shares of our common stock over a five year period at an exercise price of $0.20 per share. Pursuant to the terms of the subscription agreements, we granted the investors limited registration rights for all common shares comprising the units, including the common shares issuable on exercise of the warrants. The Group also issued to Westminster Securities Corporation, as partial compensation for their placement agent services 7,728,000 placement agent warrants to purchase one share each of our common shares, a portion of which has been assigned by Westminster Securities Corporation to certain of its officers and employees (the warrants issued in the September Private Placement together with the placement agent warrants are hereinafter referred to as “September Warrants”).
  10
  CHINA WATER GROUP, INC.
 
 Notes to Consolidated Financial Statements
 (Unaudited)
 
 Note 8 - Warrant Liability (Continued)
 
 The Group used the Black-Scholes Option Pricing model in calculating the fair market value of the September Warrants and allocated $4,140,535 of the $4,172,735 net proceeds to the September Warrants. The difference between the fair value of the September Warrants and the allocated amount is recorded as non-cash financing charges and expensed of at the date of issuance. The principal assumptions used in the computation of the September Warrants are: expected term of 5 years; a risk-free rate of return of 4.24%; dividend yield of zero percent; and a volatility of 70%.
 
 Under the subscription agreement for the September Private Placement, we agreed to prepare and file with the SEC (and did so file), at our own expense, a registration statement covering the registrable securities related to that placement. We agreed that in the event that the registration statement is not declared effective by the SEC within the earlier of 120 days from the final closing, we would pay to the investors in the September Private Placement liquidated damages in the amount of 2.0% of the purchase price of the registrable securities for each month until the registration statement is declared effective. These liquidated damages began accruing on January 12, 2006. We agreed that if we do not remit payment of these liquidated damages, we will pay the investors in the September Private Placement interest at the rate of 12% per year until the liquidated damages are paid in full. The subscription agreement provides that if a registration statement is not effective at any time after one year following the issuance date of the September Warrants, these liquidated damages obligations will stop accruing. As of September 14, 2006 the liquidated damages obligations stopped accruing. As of June 30, 2010, we have made an accrual of $1,324,735 for registration right liability.
 
 Under ASC 815-40-05 and ASC 815-40-15, contracts that include any provision that could require net-cash settlements cannot be accounted for as equity. Accordingly, the proceeds of the September Private Placement allocated for par value of the common stock and the September Warrants have been recorded as a liability on the balance sheet. Upon the effectiveness of the registration statement, the amount will be recorded as equity.
 
 Note 9 – Accrued Expenses
 
 Accrued expenses as of September 30, 2010 and December 31, 2009 consisted of the following:
 
 September30


December31,2010


2009City maintenance construction tax and value added tax

$
24,786


$
39,466Contribution for employee welfare plan


43,933



39,650Registration right liability


1,324,735



1,324,735Income taxes payable


-



65,875Total

$
1,393,454


$
1,469,726
 
 Note 10 – Other Current Liabilities
 
 Other current liabilities as of September 30, 2010 and December 31, 2009 consisted of the following:
 
 September30,


December31,2010


2009Other payables

$
277,904


$
507,210Customer deposits


138,626



95,025Total

$
416,530


$
602,235
  11
 
 CHINA WATER GROUP, INC.
 
 Notes to Consolidated Financial Statements
 (Unaudited)
 
 Note 11 – Due to Related Companies
 
 As of September 30, 2010 and December 31, 2009, the balance due to related companies was $2,898,787 and $2,780,956, respectively. This balance represents financing obtained from Guang Dong Xin Sheng Environmental Protection Company Limited (“GDXS”) and Beijing Zhao Cheng Chuang Zhan Investment Company Limited (“BJZC”) in which Mr. Pu, the Chairman of the Board, has equity interests. All amounts are non-interest-bearing, unsecured and repayable on demand.
 
 Note 12 – Due to Affiliated Companies
 
 As of September 30, 2010 and December 31, 2009, the balance due to affiliated companies was $2,007,585, and $1,722,159, respectively. This balance represents financing obtained from Guang Dong Xin Xing Mei Biology Company Limited (“Xinxingmei”). All amounts are non-interest-bearing, unsecured and repayable on demand.
 
 Note 13 – Income Taxes
 
 The Company is a Nevada corporation and conducts all of its business through its Chinese subsidiary and its affiliated Chinese operating companies. All business is conducted in PRC. As the U.S. holding company has not recorded any income for the nine months ended September 30, 2010 and 2009, there was no provision or benefit for U.S. income tax purpose.
 
 The Company’s Chinese subsidiary and affiliated operating companies based in China are governed by the Income Tax Law of the PRC concerning the private-run enterprises, which are generally subject to tax at a new statutory rate of 25% and were, until January 2008, subject to tax at a statutory rate of 33% (30% state income tax plus 3% local income tax) on income reported in the statutory statements after appropriate tax adjustments.
 
 On March 16, 2007, the National People’s Congress of China approved the Corporate Income Tax Law of the PRC (the New CIT Law), which is effective from January 1, 2008. Under the new law, the corporate income tax rate applicable to all Companies, both domestic and foreign-invested companies, is 25%, replacing the previous applicable tax rate of 33%. For the nine months ended September 30, 2010, the income tax provision by the Company was $ 419.
 
 Note 14 – Income (Loss) Per Share
 
 The basic earnings (loss) per share are calculated using the net income (loss) and the weighted average number of shares outstanding during the year. The diluted earnings (loss) per share are calculated using the net income (loss) and the weighted average number of shares outstanding during the year together with incremental common shares issuable upon the exercise of all warrants issued.
 
 FortheThreeMonths

EndedSeptember30,


FortheNineMonths

EndedSeptember30,2010


2009


2010


2009Net income (loss) attributable to CHWG

$
(69,256
)

$
121,643


$
(239,865
)

$
(149,975
)Weighted average common shares (denominator for basic income per share)


139,383,450



139,383,450



139,383,450



139,383,450Effect of dilutive securities:


-



-



-



-Weighted average common shares (denominator for diluted income per share)


139,383,450



139,383,450



139,383,450



139,383,450Basic income (loss) per share

$
(0.00
)

$
0.00


$
(0.00
)

$
(0.00
)Diluted income (loss) per share

$
(0.00
)

$
0.00


$
(0.00
)

$
(0.00
)
 
 As the April Warrants and the September Warrants are anti-dilutive, they are excluded from the calculation of diluted earnings per share.
  12
  CHINA WATER GROUP, INC.
 
 Notes to Consolidated Financial Statements
 (Unaudited)
 
 Note 15 – Employee Welfare Plan
 
 The Company has established an employee welfare plan in accordance with Chinese law and regulations. The Company makes monthly contributions of 12% of all employees' salaries to the employee welfare plan.
 
 Note 16 – Risk Factors
 
 The Company's operations are carried out in the PRC. Accordingly, the Company's business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC as well as by the general state of the PRC’s economy. The Company's business may be influenced by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.
 
 Note 17 – Risk of Concentrations in Sales and Purchases
 
 For the nine months ended September 30, 2010 and 2009, two customers accounted for approximately 16% and 70% of the Company’s revenue, respectively. Total sales to these customers were $41,725 and $526,741 for the nine months ended September 30, 2010 and 2009, respectively.
 
 For the nine months ended September 30, 2010, one major vendor accounted for approximately 52% of the Company’s cost for purchases, while for the nine months ended September 30, 2009, one major vendors accounted for approximately 40% of the Company’s cost for purchases. Total purchases from these vendors were $16,004 and $60,893 for the nine months ended September 30, 2010 and 2009, respectively.
 
 Financial instruments which potentially subject the Company to credit risk consist principally of cash on deposit with financial institutions. Management believes that the financial institutions that hold the Company’s cash and cash equivalents are financially sound and minimal credit risk exists with respect to these investments.
 
 Note 18 - SUPPLEMENTAL Disclosure of CASH FLOW Information
 
 The following is the supplemental information relating to the consolidated statements of cash flows:
 
 September30,


September30,2010


2009Cash paid for interest

$
242


$
-Cash paid for income taxes

$
66,294


$
54,368
 
 Note 19 – Related Party Sales
 
 For the nine months ended September 30, 2010 and 2009, sales from related party that is from Guang Dong Xin Sheng Environmental Protection Company Limited accounted for approximately 22% and 0% of the Company’s revenue, respectively. Total sales to related party were $27,232 and $ 0 for the nine months ended September 30, 2010 and 2009, respectively.
 
 Note 20 – Subsequent Event
 
 On January 26, 2011, the Company issued 29,750,000 shares of its common stock, valued at $0.20 per share, to Fortune Luck Global International Limited. The issuance of the stock settled the remaining $5.95 million purchase price the Company incurred for the acquisition of 90% equity interest in Guangzhou Xinchen Water Company Limited. The Company incurred no penalty related to the delay in the time of the delivery of the stock.
  13
  CHINA WATER GROUP, INC.
 
 Notes to Consolidated Financial Statements
 (Unaudited)
 
 Note 20 – Subsequent EVENT (Continued)
 
 On the September 30, 2011 , Guangzhou Xinchen Water Co., a subsidiary of the Company and China Construction Bank Co., Ltd. Guangzou Liwan Sub-branch, concluded RMB 15 Million ($2.37 Million USD) loan agreement (the “Loan Agreement”). The Loan Agreement specifies the loan term as three years commencing from October 9, 2011, a variable loan interest rate of equal to the benchmark interest rate of People’s Bank of China as in effect from time to time (currently 6.65%) plus 15% resulting in a current rate of 7.65%, The proceeds of the Loan Agreement will be used for the Registrant’s working capital needs to expand its bottled water operations.
  14
 
 ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
 
 FORWARD-LOOKING INFORMATION
 
 Much of the discussion in this Item is “forward looking” as that term is used in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Actual operations and results may materially differ from present plans and projections due to changes in economic conditions, new business opportunities, changes in business conditions, and other developments. Other factors that could cause results to differ materially are described in our filings with the SEC.
 
 The following factors could cause actual results or events to differ materially from those anticipated, and include, but are not limited to general economic, financial and business conditions, changes in and compliance with governmental laws and regulations, including various state and federal environmental regulations, our ability to obtain additional financing from outside investors and/or bank and mezzanine lenders; and our ability to generate sufficient revenues to cover operating losses and position us to achieve positive cash flow.
 
 Readers are cautioned not to place undue reliance on the forward-looking statements contained herein, which speak only as of the date hereof. We believe the information contained in this Form 10-Q to be accurate as of the date hereof. Changes may occur after that date. We will not update that information except as required by law in the normal course of our public disclosure practices.
 
 Additionally, the following discussion regarding our financial condition and results of operations should be read in conjunction with the financial statements and related notes contained in Item 1 of Part I of this Form 10-Q.
 
 RESULTS OF OPERATIONS
 
 Quarter Ended September 30, 2010 vs. Quarter Ended September 30, 2009
 
 Total revenue. We reported total revenue of $122,305 for the three months ended September 30, 2010 represents and decrease of approximately 82% as compared to $675,903 for the three months ended September 30, 2009. In the quarter ended September 30, 2010 we were repositioning our brand through different distribution channels and distributed product on a free or promotional basis.  Management believes that these activities will be beneficial in the long term, but in the short term they impaired our results and may be viewed as a restart of our bottled water distribution.
 
 Cost of revenue. Our total cost of revenue decreased by $123,498from $190,232 for the three months ended September 30, 2009 to $66,734 for the three months ended September 30, 2010. This was primarily due to decreased levels of sales and promotional distribution of products.
 
 Gross profit. Gross profit, as a percentage of total revenue for the three months ended September 30, 2010 and 2009, was approximately 45% or $55,571 as compared to72% or $485,671.  Decreased gross margins were mainly due to increased unit costs, due to increased materials and transportation costs and costs to promotional distribution of products.
 
 Operating expenses. Our total operating expenses for the three months ended September 30, 2010 and 2009 were $139,775 and $191,967, respectively. The principal components of operating expenses were selling and distribution expenses, administrative salaries and benefits, depreciation and amortization, travel expense, rental expense and other general administration cost. A decrease in operating expenses for the three months ended September 30, 2010 of $52,192 as compared to the three months ended September 30, 2009 was primarily due to enhanced internal financial control and optimization of daily management and optimization of distribution channels as well as the lower level of sales.
 
 Penalty for late effectiveness of registration statementThis amount represents the liquidated damages payment obligation we accrued in connection with the September 2005 Private Placement by missing the deadline we agreed to for effectiveness of the registration statement we filed in connection with that financing.
  15
  Under the subscription agreement for the September Private Placement, we agreed to prepare and file with the SEC (and did so file), at our own expense, a registration statement covering the registrable securities related to that placement. We agreed that in the event that the registration statement is not declared effective by the SEC within the earlier of 120 days from the final closing, we would pay to the investors in the September Private Placement liquidated damages in the amount of 2.0% of the purchase price of the registrable securities for each month until the registration statement is declared effective. These liquidated damages began accruing on January 12, 2006. We agreed that if we do not remit payment of these liquidated damages, we will pay the investors in the September Private Placement interest at the rate of 12% per year until the liquidated damages are paid in full. The subscription agreement provides that if a registration statement is not effective at any time after one year following the issuance date of the September Warrants, these liquidated damages obligations have stopped accruing. As of September 14, 2006 the liquidated damages obligations stopped accruing for a period of time and then other related damages began to accrue. As of March 31, 2006, we had made an accrual of $828,027 for such liquidated damages.
 
 Under paragraphs 12–32 of EITF 00-19, contracts that include any provision that could require net-cash settlements cannot be accounted for as equity. Accordingly, the proceeds of the September Private Placement allocated for par value of the common stock and the September Warrants have been recorded as a liability on the balance sheet. Upon the effectiveness of the registration statement, the amount will be recorded as equity.  In 2007 we began accruing smaller amounts for other penalties which amounted to $22,688 for the first quarter of 2008.  We did not accrue any amounts in 2010.
 
 Unrealized gain on financial instruments. Unrealized gains or losses on financial instruments represent the change in the fair market value of the financial instruments at each reporting date. The unrealized gain on financial instruments for the three months ended September 30, 2010 was $4,058. There was an unrealized loss on financial instruments of $46,465 for the three months ended September 30,2009.
 
 Net  income. We had a net loss of $76,685for the three months ended September 30, 2010, and  net gain of $140,322 for the three months ended September 30, 2009.  The decreased due to decreased sales and we were repositioning our brand through different distribution channels and distributed product on free or promotional basis. 
 LIQUIDITY AND CAPITAL RESOURCES
 
 Our principal sources of liquidity are our cash and cash flow generated from financing. Net cash provided by financing activities during the three months ended September 30, 2010 was $ $577,095, which was mainly attributable to the proceeds due to affiliated(related) companies. Our cash and cash equivalents were $52,940. On the September 30, 2011 , Guangzhou Xinchen Water Co., a subsidiary of the Company and China Construction Bank Co., Ltd. Guangzou Liwan Sub-branch, concluded RMB 15 Million ($2.37 Million USD) loan agreement. The Loan Agreement specifies the loan term as three years commencing from October 9, 2011, The proceeds of the Loan Agreement will be used for the company working capital needs to expand its bottled water operations.
 
 APPLICATION OF CRITICAL ACCOUNTING POLICIES
 
 Our financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by management's application of accounting policies. Critical accounting policies include revenue recognition and impairment of assets.
 
 Revenue recognition. We recognize revenue using various revenue recognition policies based on the nature of the sale and the terms of the contract.
 
 Revenues from turn-key engineering projects are recognized on the percentage-of-completion method for individual contracts. We follow the guidance of the American Institute of Certified Public Accountants (“AICPA”)
  16
  Statement of Position (“SOP”) 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts, for our accounting policy relating to the use of the percentage-of-completion method, estimated costs and claim recognition for construction contracts. Revenues are recognized in the ratio that costs incurred bear to total estimated contract costs to the extent we believe related collection is probable. The use of the percentage-of-completion method of revenue recognition requires estimates of percentage of project completion. Changes in job performance, estimated profitability and final contract settlements may result in revisions to costs and income in the period in which the revisions are determined. Provisions for any estimated losses on uncompleted contracts are made in the period in which such losses are determinable. In instances when the work performed on fixed price agreements is of a relatively short duration, we use the completed contract method of accounting whereby revenue is recognized when the work is completed. From 5% to 10% of the total contract value will be treated as retention monies withheld to ensure performance of the contract during the warranty period of up to 12 months, as stipulated in both long term and short term fixed price contracts.
 
 Revenues arising from wastewater treatment are recognized based on wastewater treated as recorded daily by meters read at rates, in RMB/ton, as prescribed under the BOT agreements in accordance with SAB Topic 13, Revenue Recognition. We meet the following four criteria for revenue recognition outlined in SAB Topic 13:
 
 1. There is sufficient evidence to support that sales arrangements exist;
 
 2. The price to the buyer is fixed through signed contracts;
 
 3. Meter readings illustrate that delivery of treated wastewater has occurred; and
 
 4. Collectibility is reasonably assured through one or more of the following: due diligence prior to contract signing; historical payment practices; or required upfront payments.
 
 Revenues from the sale of bottled water products are recognized when goods are delivered. The contractual terms of the purchase agreements dictate the recognition of revenues by us. We recognize revenue in accordance with SAB No. 104. Accordingly, four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgments regarding the fixed nature of the selling prices of the products delivered and the collectibility of those amounts. Provisions for discounts and rebates to customers, estimated returns and allowances, and other adjustments are provided for in the same period the related sales are recorded. We defer any revenue for which the product has not been delivered or is subject to refund until such time that we and our customer jointly determine that the product has been delivered or no refund will be required.
 
 Impairment of assets. Our policy is to periodically review and evaluate whether there has been a permanent impairment in the value of long-lived assets. Factors considered in this evaluation include current operating results, trends and anticipated undiscounted estimated future cash flows that are expected to result from the use of the asset, or other measure of fair value, and whether such factors reflect that the value of the asset has been impaired.
 
 Allowances for accounts receivable. Our provisioning policy for bad and doubtful debt is based on the evaluation of collectibility and aging analysis of accounts receivable and on management's judgment. We do no require collateral or other security to support client receivables. We conduct periodic reviews of our clients' financial condition and customer payment practices to minimize collection risks on accounts receivable. This review is based on a considerable amount of judgment which is required in assessing the ultimate realization of these receivables, including the current creditworthiness and the past collection history of each customer. During the third quarter of 2006, we made no allowances for doubtful debts.
 
 Financial instruments. The carrying amounts of all financial instruments approximate fair value. The carrying amounts of cash, accounts receivable, related party receivables, unsecured loans, accounts payable and related party payables approximate fair value due to the short-term nature of these items. The carrying amounts of borrowings approximate the fair value based on our expected borrowing rate for debt with similar remaining maturities and comparable risk.
  17
  Earnings per share. Basic earnings per share are computed by dividing the net income attributable to common stock for the year by the weighted average number of common shares outstanding during the year. Diluted earnings  per share are computed by dividing the net income for the year by the weighted average number of common and common equivalent shares outstanding during the year. Common equivalent shares (which includes incremental common shares issuable upon the exercise of stock options, unvested restricted common stock and shares that may be issued on a contingent basis) are included in diluted earnings per share to the extent such shares are dilutive. In accordance with SFAS 128, Earnings Per Share, we use income from continuing operations, net of income taxes, as the “control number” in determining whether common equivalent shares are dilutive or anti-dilutive in periods where discontinued operations are reported.
 
 Recently issued accounting pronouncements
 
 In December 2007, the FASB issued SFAS No. 141 ®, “Business Combinations” (“SFAS 141®”). SFAS 141® defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control, and requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions specified in the Statement. SFAS 141® applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.
 
 In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. SFAS 160 requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest, and also requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. The requirements of SFAS 160 are effective for our fiscal year beginning January 1, 2009.
 
 In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.
 
 In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy). SFAS 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.
 
 Off-Balance Sheet Arrangements
 
 We do not have any off-balance sheet arrangements.
 
 ITEM 3.  QUANTITATIVE and QUALITATIVE DISCLOSURES about MARKET RISK.
 
 Not applicable.
  18


ITEM 4. CONTROLS AND PROCEDURES





Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure.





Material Weaknesses identified Prior to Fiscal 2010





Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures (as this term is defined under the rules of the SEC) as of August 10, 2006. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer and Executive Chairman concluded that, as of August 10, 2006, our disclosure controls and procedures were not effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the US Securities Exchange Act of 1934 as a result of material weaknesses in our internal control over financial reporting described below.





In the process of filing our registration statement, we identified certain accounting errors in our reported US GAAP annual results for fiscal 2004 and 2005 and certain quarterly results in 2005 and 2006. As a result, we have restated the amounts and disclosures in those annual financial statements.





The financial statements which should no longer be relied upon include:





(i)
the audited consolidated financial statements contained in our report on Form 10-KSB for the fiscal year ended December 31, 2004 (the “2004 10-KSB”), filed with the SEC on April 15, 2005, Amendment No. 1 to the 2004 10-KSB filed on July 15, 2005, and Amendment No. 2 to the 2004 10-KSB filed on January 13, 2006 ;





(ii)
the audited consolidated financial statements contained in our report on Form 10-KSB for the fiscal year ended December 31, 2005 (the “2005 10-KSB”), filed with the SEC on April 17, 2006;





(iii)
the unaudited consolidated financial statements contained in our quarterly report on Form 10-QSB for the quarterly period ended March 31, 2005 (the “March 31, 2005 10-QSB”), filed with the SEC on May 24, 2005;





(iv)
the unaudited consolidated financial statements contained in our quarterly report on Form 10-QSB for the quarterly period ended June 30, 2005 (the “June 30, 2005 10-QSB”), filed with the SEC on August 15, 2005;





(v)
the unaudited consolidated financial statements contained in our quarterly report on Form 10-QSB for the quarterly period ended September 30, 2005 (the “ September 30, 2005 10-QSB”), filed with the SEC on November 15, 2005 and Amendment No. 1 to the September 30, 2005 10-QSB filed on January 13, 2006; and





(vi)
the unaudited consolidated financial statements contained in our quarterly report on Form 10-QSB for the quarterly period ended March 31, 2006 (the “March 31, 2006 10-QSB”), filed with the SEC on May 15, 2006.





Gain on disposal of XY





As previously disclosed in our 2004 10-KSB, including amendments thereto, and comparative figures in our 2005 10-KSB, we recorded a gain on disposal of $2,029,720 in 2004 for the disposal of our 90% attributable interest in Xian Yang Bai Sheng Water Purifying Company Limited (“XY”) to True Global Limited (“TGL”), an independent party, at a consideration of $4,130,435 (RMB34.2 million). The disposal was made pursuant to a tri-party framework agreement between Evergreen Asset Group Limited (“EGAG”), TGL and Guang Dong Xin Sheng Environmental Protection Company Limited (“GDXS”) in which EGAG transferred 90% of its equity interest in XY to TGL while GDXS continued to own 10% of its equity interest in XY. The transaction was consummated on October 26, 2004 and the gain represents the difference between the disposal proceeds and our attributable share of net assets of XY at the date of disposal. In the same year, we also recognized an amount of $9,115,942 for the construction revenue of XY using the percentage-of-completion method, estimated costs and claim recognition for construction contracts. The amount accounted for 97% of our total revenue in 2004.


19





In the previously filed 2004 10-KSB, as amended to date, and comparative figures in our previously filed 2005 10-KSB, the accounting treatment for the construction revenue of XY does not comply with SOP 81-1 or EITF 00-21. As a result, we will file an amendment to the 2004 10-KSB and 2005 10-KSB with adjusted disclosure to record the transaction as part of the gain on the disposal of the XY subsidiary rather than as revenue from construction of wastewater treatment plant. As such our adjusted total revenue for the fiscal year ended December 31, 2004 was $250,571 and the adjusted gain on disposal of interest in a subsidiary - XY was $5,220,299. Due to the same reason, account receivable from TGL amounted to $9,416,039 as of December 31, 2004 will be reclassified to prepayment, deposits and other receivables in our upcoming amendment to the 2004 10-KSB, comparative figures in this amendment to the 2005 10-KSB and comparative figures in the upcoming or recently filed amendments to the June 30, 2005 10-QSB and September 30, 2005 10-QSB.





Group reorganization





In Note 2(ii) and 2(iii) to the consolidated financial statements contained in the previously filed 2004 10-KSB and 2005 10-KSB and Note 2 to the consolidated financial statements contained in the previously filed March 31, 2005 10-QSB, June 30, 2005 10-QSB, September 30, 2005 10-QSB and March 31, 2006 10-QSB, we disclosed group reorganization transactions. Pursuant to rules promulgated by the SEC, the merger or acquisition of a private operating company into a non-operating public shell corporation with nominal net assets is considered a capital transaction, rather than a business combination. As such, no disclosures are required under FAS 141 because the transactions described were not business combinations. For accounting purposes, the transaction has been treated as a reverse acquisition and a recapitalization, and pro-forma information is not presented. Accordingly, the upcoming amendments  to the 2004 10-KSB, this amendment to the 2005 10-KSB, and the recent or upcoming amendments to the March 31, 2005 10-QSB, June 30, 2005 10-QSB, September 30, 2005 10-QSB and March 31, 2006 10-QSB will not include references to the group reorganization transactions throughout the financial statements. We will also restate the common stock immediately after the recapitalization to $100,000 in the upcoming amended March 31, 2005 10-QSB and have done so in the recent amended June 30, 2005 10-QSB.





Reclassification of April warrants





In our previously filed 2005 10-KSB, June 30, 2005 10-QSB and March 31, 2006 10-QSB, we recorded as equity the warrants issued as part of the units sold in our April 2005 convertible debt issuance. Under EITF No. 00-19, the fair value of these warrants should be reported as a liability. Pursuant to the Warrant Agreement, because there is currently no effective registration statement covering the shares of common stock underlying these warrants, these warrants are currently subject to a cashless exercise whereby the warrant holders may surrender their warrants to the company in exchange for shares of common stock. The number of shares of common stock into which a warrant would be exchangeable in such a cashless exercise depends on both the exercise price of the warrants and the market price of the common stock, each at or near the time of exercise. Because both of these factors are variable, it is possible that the company could have insufficient authorized shares to satisfy a cashless exercise. In this scenario, if the company were unable to obtain shareholder approval to increase the number of authorized shares, the company could be obligated to settle such a cashless exercise with cash rather than by issuing shares of common stock. Further, EITF No. 00-19 requires that we record the potential settlement obligation at each reporting date using the current estimated fair value of the warrants, with any changes being recorded through our statement of operations. We will continue to report the potential settlement obligation as a liability until such time as the warrants are exercised or expire or we are otherwise able to modify the warrant agreement to remove the provisions which require this treatment. In addition to this restatement of our 2005 10-KSB, we will restate our June 30, 2005 10-QSB and our March 31, 2006 10-QSB to reclassify the April 2005 warrants as a liability.


20





April and September 2005 Private Placements—non-cash financing charges





In our June 30, 2005 10-QSB, we did not record any non-cash financing charges and in our September 30, 2005 10-QSB, as amended to date, we did not properly record the non-cash financing charges. Non-cash financing charges represent the amount by which the fair value of derivative liabilities issued exceeds the amount of proceeds received, as an expense at the date of issuance of the April convertible debenture and the September private placement. We will restate our June 30, 2005 10-QSB and our September 30, 2005 10-QSB to record the non-cash financing charges, which represent the amount by which the fair value of derivative liabilities issued exceeds the amount of proceeds received, as an expense at the date of issuance of the April convertible debenture and the September private placement. As a result of the recording of non-cash financing charges, certain expenses which were previously recorded under general and administrative expenses in our September 30, 2005 10-QSB will be reclassified under non-cash financing charges.





April 2005 Private Placements—unrealized gains or losses in financial instruments





In our June 30, 2005 10-QSB and our September 30, 2005 10-QSB, as amended to date, we did not record properly the unrealized gains or losses in financial instruments, which represent the change in fair market value of the financial instruments at each reporting date for the April warrants and the bifurcated conversion feature for the convertible debenture. The unrealized gains or losses in financial instruments should have been reported in those filings. We will restate the June 30, 2005 10-QSB and September 30, 2005 10-QSB, as amended to date, to record the unrealized gains or losses in financial instruments which represent the change in fair market value of the financial instruments at each reporting date for the April warrants and the bifurcated conversion feature for the convertible debenture.





Interest in associate





In our June 30, 2005 10-QSB and our September 30, 2005 10-QSB, as amended to date, the comparative figures for our interest in associate as of December 31, 2004 were recorded based on an effective percentage of equity attributable to the group of 31.5% instead of a direct interest of 35%. We will restate the comparative figures for our interest in associate as of December 31, 2004 in the June 30, 2005 10-QSB and September 30, 2005 10-QSB to include our interest in associate based on a direct interest of 35%.





Prior Restatements





On January 13, 2006, we amended our 2004 10-KSB. Prior to the January 13, 2006 amendment, in our 2004 10-KSB we recorded our interest in associate based on an effective percentage of equity attributable to the group of 31.5% instead of a direct interest of 35%.  In the January 13, 2006 restatement of our 2004 10-KSB, we reported our interest in associate based on a direct interest of 35%. In addition, we have restated the common stock immediately after the recapitalization to $100,000.





On January 13, 2006, we amended our September 30, 2005 10-QSB. Prior to the January 13, 2006 amendment, the September 30, 2005 10-QSB classified as equity the proceeds of our April Debenture and September 2005 private placement allocated to the warrants issued in these transactions. For reasons both the April warrants and September warrants should have been classified as a liability. The restated financial statements in the January 13, 2006 amendment of the September 30, 2005 10-QSB reflect this reclassification. In addition, prior to the January 13, 2006 amendment, the September 30, 2005 10-QSB did not originally report the unrealized gains or losses in financial instruments, which represent the change in fair market value of the financial instruments at each reporting date. The unrealized gains or losses in financial instruments should have been reported in the original filing. Accordingly, the January 13, 2006 restatement of the September 30, 2006 10-QSB reported the unrealized gains or losses in financial instruments, which represent the change in fair market value of the financial instruments at each reporting date. The restatement to the unrealized gains or losses in financial instruments, however, required to be further restated (refer discussion above). In addition, we have restated the common stock immediately after the recapitalization to $100,000.





Steps Undertaken with respect to Material Weaknesses Prior to 2009





In connection with the above matters, we have identified material weaknesses in our internal control over financial reporting, which weaknesses we have reported to our auditors. These material weaknesses comprise:





(a)
insufficient knowledge and experience among our internal accounting personnel regarding the application of US GAAP and SEC requirements;


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(b)
insufficient written policies and procedures for accounting and financial reporting with respect to the requirements and application of US GAAP and SEC disclosure requirements; and





(c)
insufficient emphasis by management on compliance with US GAAP requirements.





We have communicated with our auditors,Patrizio & Zhao,LLC. and concluded that these deficiencies constituted material weaknesses, as defined by Auditing Standard No. 2, “An Audit of Internal Control Over Financial Reporting Performed in Conjunction with an Audit of Financial Statements,” established by the Public Company Accounting Oversight Board, or PCAOB.





In order to address these material weaknesses our senior management is in the process of conducting a thorough review of our US GAAP financial reporting processes and will prepare and implement a US GAAP action plan. This plan will be designed to generally improve our US GAAP reporting processes and to strengthen our control processes and procedures in order to prevent a recurrence of the circumstances that resulted in the need to restate our quarterly financial statements. Our senior management intends to complete its review and implement a US GAAP action plan as soon as practicable. The US GAAP action plan will incorporate, among other matters, the following initiatives





1.
arrange for our senior management and certain accounting and finance-related personnel to attend training sessions on US GAAP and financial reporting responsibilities and SEC disclosure requirements;





2.
modify the mandate of our internal audit function to place greater emphasis on the adequacy of, and compliance with, procedures relating to internal controls over US GAAP financial reporting and engage an experience accountant familiar with USGAAP which is not affiliated with ,Patrizio & Zhao,LLC, to assist our accounting department and internal audit function in the preparation of our US GAAP consolidated financial statements;





3.
recruit an accounting staff member with US GAAP expertise and who is not affiliated with Patrizio & Zhao, LLC; and





4.
engage an internationally recognized accounting firm, which is not affiliated with ,Patrizio & Zhao, LLC, to provide us with technical advice on US GAAP matters and SEC disclosure requirements on an ongoing basis.





We have fully implemented items 1, 2, and 3, while item 4 remains in the planning stage.





Our board of directors discussed the matters disclosed in this filing with the registrant’s independent accountant. On September 25, 2006, we filed a current report on Form 8-K relating to these matters, including a response from our independent account relating to the statements contained therein.





Other than those disclosed above, there were no changes in our internal controls over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during the first quarter of our 2009 fiscal year.





Material Weaknesses as at September 30, 2010





(a) Evaluation of Disclosure Controls and Procedures


As of the end of the period covered by this report, China Water Group’s management, with the participation of Wenge Fang, our principal executive officer, and Ding Rencai, our principal financial officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). In designing and evaluating its disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Based upon that evaluation, Messrs. Fang and Rencai concluded that these disclosure controls and procedures were effective as of the end of the period covered in this report and that they provided reasonable assurance that the goals of the disclosure controls were met.


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(b) Management’s Report on Internal Control Over Financial Reporting


The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. In order to evaluate the effectiveness of internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act,  management has conducted an assessment, including testing, using the criteria in Internal Control - Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s system of internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.Based on its assessment, management has concluded that the Company’s internal control over financial reporting was effective as of September 30, 2010  Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.





(c) Changes in Internal Control over Financial Reporting


There was no change in internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that occurred during the second quarter of our year ended September 30, 2010 that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.





This report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.





PART II. OTHER INFORMATION





ITEM 1. LEGAL PROCEEDINGS





As of the date of this report, we are not involved in any legal proceedings





ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS





None.





ITEM 3. DEFAULTS UPON SENIOR SECURITIES





None.





ITEM 4.{ REMOVD AND RESERVD}








ITEM 5. OTHER INFORMATION





None.





ITEM 6. EXHIBITS


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Exhibit No.





Description


31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
Certification of Chief Executive Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
Certification of Chief Financial Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.





SIGNATURES





In accordance with the requirements of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.





CHINA WATER GROUP, INC.(Registrant)Dated: December 27 , 2011

By: /s/ Wenge FangWenge Fang,Chief Executive OfficerDated: December  27, 2011

By:  /s/ Ding RencaiDing Rencai,Chief Financial Officer


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