**U.S.
      SECURITIES AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**







****


**FORM
      10-Q**




(Mark
      one)




x
            Quarterly
                Report Under Section 13 or 15(d) of the Securities Exchange Act of
                1934




For
      the
      Quarterly Period Ended September 30, 2008


or




o
            Transition
                Report Under Section 13 or 15(d) of the Securities Exchange Act of
                1934




**Commission
      File Number 000-50491**


****


**China
      Fire & Security Group, Inc.**


(Name
      of
      small business issuer in its charter)




**Florida**
            
            **65-1193022****(State
                or other jurisdiction**
              **of
                incorporation or organization)**
            
            **(I.R.S.
                Employer**
              **Identification
                No.)****B-2508
                TYG Center, C2**
              **Dongsanhuanbeilu,**
              **Chaoyang
                District, Beijing 100027,**
              **People’s
                Republic of China**
            
            **100027****(Address
                of principal executive offices)**
            
            **(Zip
                Code)**




Issuer’s
      telephone number:  (86-10) 8441 7400.


****


Check
      whether the issuer (1) has 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 x No o




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




Large
                accelerated filero
            
            Accelerated
                fileroNon-accelerated
                filero(Do
                not check if smaller reporting company)
            
            Smaller
                reporting companyx




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




As
      of
      November 12, 2008, the Registrant had 27,586,593 shares of common stock
      outstanding.










**China
      Fire & Security Group, Inc.**




Table
      of
      Contents




PagePART
                I -
            
            FINANCIAL
                INFORMATIONItem
                1.
            
            Financial
                Statements (unaudited):Consolidated
                Balance Sheets as of September 30, 2008 and December 31,
                2007
            
            3Consolidated
                Statements of Income and Other Comprehensive IncomeFor
                the Three and Nine Months Ended September 30, 2008 and
                2007
            
            4Consolidated
                Statements of Stockholders' Equity
            
            5Consolidated
                Statements of Cash FlowsFor
                the Nine Months Ended September 30, 2008 and 2007
            
            6Notes
                to Consolidated Financial Statements
            
            7Item
                2.
            
            Management's
                Discussion and Analysis or Plan of Operation
            
            30Item
                3.
            
            Quantitative
                and Qualitative Disclosures About Market Risk
            
            37Item
                4.
            
            Controls
                and Procedures
            
            37PART II -
            
            OTHER
                INFORMATIONItem
                1.
            
            Legal
                Proceedings
            
            37Item
                1A.
            
            Risk
                Factors
            
            37Item
                2.
            
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            
            37Item
                3.
            
            Defaults
                Upon Senior Securities
            
            37Item
                4.
            
            Submission
                of Matters to a Vote of Security Holders.
            
            37Item
                5.
            
            Other
                Information
            
            37Item
                6.
            
            Exhibits
            
            37




2


**Item
      1. Financial Statements**





CHINA
                FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESCONSOLIDATED
                BALANCE SHEETSAS
                OF SEPTEMBER 30, 2008 AND DECEMBER 31, 2007ASSETSSeptember
                30,
            
            December
                31,2008
            
            2007CURRENT
                ASSETS:
            
            (Unaudited)Cash
            
            $
            21,805,340
            
            $
            17,110,449Restricted
                cash
            
            
            5,177,631
            
            
            3,829,927Accounts
                receivable, net of allowance for doubtful accounts of $3,188,660
                and$2,483,359
                as of September 30, 2008 and December 31, 2007,
                respectively
            
            
            19,159,300
            
            
            16,525,161Notes
                receivable
            
            
            5,139,588
            
            
            3,315,811Other
                receivables
            
            
            1,291,967
            
            
            748,195Other
                receivable - related party
            
            
            329,884
            
            
            -Inventories
            
            
            7,752,813
            
            
            4,048,283Costs
                and estimated earnings in excess of billings
            
            
            28,786,789
            
            
            13,068,036Employee
                advances
            
            
            1,147,653
            
            
            1,307,433Employee
                advances - officers and directors
            
            
            36,910
            
            
            18,682Prepayments
                and deferred expenses
            
            
            3,562,333
            
            
            2,218,391Total
                current assets
            
            
            94,190,208
            
            
            62,190,368PLANT
                AND EQUIPMENT, net
            
            
            8,372,761
            
            
            6,568,250OTHER
                ASSETS:Restricted
                cash - non current
            
            
            990,616
            
            
            -Accounts
                receivable - retention
            
            
            831,043
            
            
            193,029Deferred
                expenses - non current
            
            
            -
            
            
            21,234Advances
                on building and equipment purchases
            
            
            156,709
            
            
            366,317Investment
                in joint ventures
            
            
            1,166,782
            
            
            1,156,294Intangible
                assets, net of accumulated amortization
            
            
            1,133,601
            
            
            1,150,935Total
                other assets
            
            
            4,278,751
            
            
            2,887,809Total
                assets
            
            $
            106,841,720
            
            $
            71,646,427LIABILITIES
                AND SHAREHOLDERS' EQUITYCURRENT
                LIABILITIES:Accounts
                payable
            
            $
            7,515,936
            
            $
            6,327,182Customer
                deposits
            
            
            16,168,355
            
            
            4,757,179Billings
                in excess of costs and estimated earnings
            
            
            3,363,588
            
            
            4,882,217Other
                payables
            
            
            1,338,031
            
            
            168,868Accrued
                liabilities
            
            
            5,346,951
            
            
            4,214,530Taxes
                payable
            
            
            1,454,849
            
            
            1,088,335Total
                current liabilities
            
            
            35,187,710
            
            
            21,438,311COMMITMENTS
                AND CONTINGENCIES
            
            
            -
            
            
            -SHAREHOLDERS'
                EQUITY:Common
                stock, $0.001 par value, 65,000,000 shares authorized,27,586,593
                and 27,556,893shares
                issued and outstanding as ofSeptember
                30, 2008 and December 31, 2007, respectively
            
            
            27,586
            
            
            27,556Additional
                paid-in-capital
            
            
            19,353,835
            
            
            19,317,287Statutory
                reserves
            
            
            5,067,061
            
            
            5,067,061Retained
                earnings
            
            
            40,102,939
            
            
            22,228,095Accumulated
                other comprehensive income
            
            
            7,102,589
            
            
            3,568,117Total
                shareholders' equity
            
            
            71,654,010
            
            
            50,208,116Total
                liabilities and shareholders' equity
            
            $
            106,841,720
            
            $
            71,646,427


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


3





CHINA
                FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESCONSOLIDATED
                STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOMEFOR
                THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008 AND
                2007(UNAUDITED)Three
                Months Ended September 30,
            
            Nine
                Months Ended September 30,2008
            
            2007
            
            2008
            
            2007REVENUESSystem
                contracting projects
            
            $
            15,173,858
            
            $
            6,105,899
            
            $
            41,060,246
            
            $
            23,270,285Products
            
            
            978,806
            
            
            5,188,117
            
            
            5,393,942
            
            
            8,827,922Maintenance
                services
            
            
            590,603
            
            
            302,954
            
            
            1,639,429
            
            
            545,410Total
                revenues
            
            
            16,743,267
            
            
            11,596,970
            
            
            48,093,617
            
            
            32,643,617COST
                OF REVENUESSystem
                contracting projects
            
            
            6,459,973
            
            
            2,539,812
            
            
            18,001,928
            
            
            10,564,382Products
            
            
            117,258
            
            
            2,065,515
            
            
            1,176,638
            
            
            3,705,298Maintenance
                services
            
            
            301,605
            
            
            124,211
            
            
            821,932
            
            
            181,085Total
                cost of revenues
            
            
            6,878,836
            
            
            4,729,538
            
            
            20,000,498
            
            
            14,450,765GROSS
                PROFIT
            
            
            9,864,431
            
            
            6,867,432
            
            
            28,093,119
            
            
            18,192,852OPERATING
                EXPENSESelling
                and marketing
            
            
            1,582,557
            
            
            1,205,360
            
            
            4,592,598
            
            
            3,058,663General
                and administrative
            
            
            1,268,864
            
            
            1,297,037
            
            
            4,021,984
            
            
            3,390,596Depreciation
                and amortization
            
            
            123,829
            
            
            128,394
            
            
            445,779
            
            
            387,933Research
                and development
            
            
            762,382
            
            
            139,205
            
            
            1,656,983
            
            
            457,126Total
                operating expense
            
            
            3,737,632
            
            
            2,769,996
            
            
            10,717,344
            
            
            7,294,318INCOME
                FROM OPERATIONS
            
            
            6,126,799
            
            
            4,097,436
            
            
            17,375,775
            
            
            10,898,534OTHER
                INCOME (EXPENSE)Other
                income
            
            
            280,094
            
            
            249,537
            
            
            501,737
            
            
            577,535Other
                expense
            
            
            (3,675
            )
            
            (1,400
            )
            
            (89,063
            )
            
            (7,817
            )Interest
                income
            
            
            48,010
            
            
            46,462
            
            
            139,754
            
            
            90,632Change
                in fair value of derivative instruments
            
            
            -
            
            
            -
            
            
            -
            
            
            1,205,791Total
                other income
            
            
            324,429
            
            
            294,599
            
            
            552,428
            
            
            1,866,141INCOME
                BEFORE PROVISION FOR INCOME TAXES
            
            
            6,451,228
            
            
            4,392,035
            
            
            17,928,203
            
            
            12,764,675PROVISION
                (CREDIT) FOR INCOME TAXES
            
            
            (6,736
            )
            
            -
            
            
            53,359
            
            
            -NET
                INCOME
            
            
            6,457,964
            
            
            4,392,035
            
            
            17,874,844
            
            
            12,764,675OTHER
                COMPREHENSIVE INCOME:Foreign
                currency translation adjustment
            
            
            173,873
            
            
            540,152
            
            
            3,534,472
            
            
            1,350,486COMPREHENSIVE
                INCOME
            
            $
            6,631,837
            
            $
            4,932,187
            
            $
            21,409,316
            
            $
            14,115,161BASIC
                EARNINGS PER SHAREWeighted
                average number of shares
            
            
            27,572,112
            
            
            27,026,221
            
            
            27,562,087
            
            
            26,649,859Earnings
                per share
            
            $
            0.23
            
            $
            0.16
            
            $
            0.65
            
            $
            0.48DILUTED
                EARNINGS PER SHAREWeighted
                average number of shares
            
            
            28,259,171
            
            
            27,825,442
            
            
            28,205,583
            
            
            27,436,695Earnings
                per share
            
            $
            0.23
            
            $
            0.16
            
            $
            0.63
            
            $
            0.47





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


4





CHINA
                FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESCONSOLIDATED
                STATEMENTS OF SHAREHOLDERS' EQUITYAccumulatedRetained
                Earnings
            
            otherCommon
                Stock
            
            Additional
            
            Statutory
            
            
            
            comprehensiveShares
            
            Par
                value
            
            paid-in-capital
            
            reserves
            
            Unrestricted
            
            income
            
            TotalBALANCE,
                December 31, 2006
            
            
            26,461,678
            
            $
            26,462
            
            $
            13,393,171
            
            $
            4,030,627
            
            $
            6,462,893
            
            $
            1,065,522
            
            $
            24,978,675Net
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            12,764,675
            
            
            
            
            
            12,764,675Warrants
                reclassified from liabilities
            
            
            
            
            
            
            
            
            1,475,020
            
            
            
            
            
            
            
            
            
            
            
            1,475,020Issuance
                of common stock
            
            
            876,985
            
            
            877
            
            
            3,638,768
            
            
            
            
            
            
            
            
            
            
            
            3,639,645Warrants
                exercised
            
            
            90,147
            
            
            90
            
            
            (90
            )
            
            
            
            
            
            
            
            
            
            
            -Warrants
                issued for services
            
            
            
            
            
            
            
            
            94,274
            
            
            
            
            
            
            
            
            
            
            
            94,274Options
                issued to employees
            
            
            
            
            
            
            
            
            159,288
            
            
            
            
            
            
            
            
            
            
            
            159,288Adjustment
                to statutory reserves
            
            
            
            
            
            
            
            
            
            
            
            (605,000
            )
            
            605,000
            
            
            
            
            
            -Foreign
                currency translation adjustment
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,350,486
            
            
            1,350,486****
            
            
            ****
            
            
            ****
            
            
            ****
            
            
            ****
            
            
            ****
            
            
            ****BALANCE,
                September 30, 2007 (Unaudited)
            
            
            27,428,810
            
            $
            27,429
            
            $
            18,760,431
            
            $
            3,425,627
            
            $
            19,832,568
            
            $
            2,416,008
            
            $
            44,462,063Net
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            4,036,961
            
            
            
            
            
            4,036,961Issuance
                of common stock
            
            
            107,695
            
            
            106
            
            
            525,446
            
            
            
            
            
            
            
            
            
            
            
            525,552Warrants
                exercised
            
            
            20,388
            
            
            21
            
            
            (21
            )
            
            
            
            
            
            
            
            
            
            
            -Options
                issued to employees
            
            
            
            
            
            
            
            
            31,431
            
            
            
            
            
            
            
            
            
            
            
            31,431Adjustment
                to statutory reserves
            
            
            
            
            
            
            
            
            
            
            
            1,641,434
            
            
            (1,641,434
            )
            
            
            
            
            -Foreign
                currency translation adjustment
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,152,109
            
            
            1,152,109****
            
            
            ****
            
            
            ****
            
            
            ****
            
            
            ****
            
            
            ****
            
            
            ****BALANCE,
                December 31, 2007
            
            
            27,556,893
            
            $
            27,556
            
            $
            19,317,287
            
            $
            5,067,061
            
            $
            22,228,095
            
            $
            3,568,117
            
            $
            50,208,116Net
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            17,874,844
            
            
            
            
            
            17,874,844Options
                issued to employees
            
            
            
            
            
            
            
            
            36,578
            
            
            
            
            
            
            
            
            
            
            
            36,578Warrants
                exercised
            
            
            29,700
            
            
            30
            
            
            (30
            )
            
            
            
            
            
            
            
            
            
            
            -Foreign
                currency translation adjustment
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            3,534,472
            
            
            3,534,472****
            
            
            ****
            
            
            ****
            
            
            ****
            
            
            ****
            
            
            ****BALANCE,
                September 30, 2008 (Unaudited)
            
            
            27,586,593
            
            $
            27,586
            
            $
            19,353,835
            
            $
            5,067,061
            
            $
            40,102,939
            
            $
            7,102,589
            
            $
            71,654,010


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


5





CHINA
                FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESCONSOLIDATED
                STATEMENTS OF CASH FLOWSFOR
                THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007(Unaudited)Nine
                months endedSeptember
                302008
            
            2007CASH
                FLOWS FROM OPERATING ACTIVITIES:Net
                income
            
            $
            17,874,844
            
            $
            12,764,675Adjustments
                to reconcile net income to cashprovided
                by operating activities:Depreciation
            
            
            652,290
            
            
            409,261Amortization
            
            
            56,224
            
            
            35,539Provision
                for doubtful accounts
            
            
            527,870
            
            
            465,482Gain
                on disposal of equipment
            
            
            (32,828
            )
            
            (9,136
            )Stock
                compensation to employees
            
            
            36,579
            
            
            159,288Warrants
                issued for services
            
            
            -
            
            
            94,274Change
                in fair value of derivative instruments
            
            
            -
            
            
            (1,205,791
            )Change
                in operating assets and liabilitiesAccounts
                receivable
            
            
            (2,635,095
            )
            
            (3,389,580
            )Notes
                receivable
            
            
            (1,569,203
            )
            
            (337,052
            )Other
                receivables
            
            
            (483,680
            )
            
            (458,743
            )Other
                receivables - related party
            
            
            (323,278
            )
            
            -Inventories
            
            
            (3,364,122
            )
            
            26,023Costs
                and estimated earnings in excess of billings
            
            
            (14,544,590
            )
            
            (2,145,503
            )Employee
                advances
            
            
            262,093
            
            
            (814,369
            )Advances
                to officers and directors
            
            
            (36,171
            )
            
            (10,130
            )Prepayments
                and deferred expenses
            
            
            (1,149,078
            )
            
            (1,090,443
            )Accounts
                payable
            
            
            754,464
            
            
            617,376Customer
                deposits
            
            
            10,869,806
            
            
            2,070,561Billings
                in excess of costs and estimated earnings
            
            
            (1,809,272
            )
            
            (4,684,877
            )Other
                payables
            
            
            1,134,642
            
            
            156,501Accrued
                liabilities
            
            
            838,157
            
            
            586,981Taxes
                payable
            
            
            287,605
            
            
            (3,407
            )Net
                cash provided by operating activities
            
            
            7,347,257
            
            
            3,236,930CASH
                FLOWS FROM INVESTING ACTIVITIES:Purchase
                of plant and equipment
            
            
            (1,637,531
            )
            
            (971,743
            )Advances
                on building and equipment purchase
            
            
            (156,709
            )
            
            (2,345,809
            )Proceeds
                from sale of equipment
            
            
            67,839
            
            
            19,646Purchase
                of intangible assets
            
            
            -
            
            
            (608,782
            )Payments
                for investment in Hubei Sureland Changjiang Fire Safety Technology
                Co.,
                Ltd.
            
            
            -
            
            
            (148,930
            )Payments
                for investment in King Galaxy Investments Limited
            
            
            -
            
            
            (1,000,000
            )Proceeds
                from sale of investment in Tianjin Fire Safety Equipment Co.,
                Ltd.
            
            
            -
            
            
            510,829Proceeds
                from sale of Beijing Zhong Xiao Fire Safety Technology Co.,
                Ltd
            
            
            -
            
            
            1,060,535Net
                cash used in investing activities
            
            
            (1,726,401
            )
            
            (3,484,254
            )CASH
                FLOWS FROM FINANCING ACTIVITIES:Change
                in restricted cash
            
            
            (2,039,634
            )
            
            841,349Payments
                to Beijing Zhong Xiao Fire Safety Technology Co., Ltd.
            
            
            -
            
            
            (2,447,101
            )Proceeds
                from Beijing Zhong Xiao Fire Safety Technology Co., Ltd
            
            
            -
            
            
            1,353,955Proceeds
                from issuance of common stock
            
            
            -
            
            
            3,639,645Net
                cash (used in) provided by financing activities
            
            
            (2,039,634
            )
            
            3,387,848EFFECT
                OF EXCHANGE RATE CHANGES ON CASH
            
            
            1,113,669
            
            
            412,282INCREASE
                IN CASH
            
            
            4,694,891
            
            
            3,552,806CASH,
                beginning of period
            
            
            17,110,449
            
            
            9,426,091CASH,
                end of period
            
            $
            21,805,340
            
            $
            12,978,897SUPPLEMENTAL
                DISCLOSURE OF CASH FLOW INFORMATIONIncome
                taxes paid
            
            $
            36,473
            
            $
            -Interest
                paid
            
            $
            -
            
            $
            -NON-CASH
                TRANSACTIONS INVESTING AND FINANCING ACTIVITIES:Reclassification
                of warrant liability to paid-in capitalupon
                modification of warrants agreement
            
            $
            -
            
            $
            1,475,020Reclassification
                of advances on building and equipment purchaseto
                plant and equipment upon receipt of purchase
            
            $
            390,898
            
            $
            -





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


6




CHINA
      FIRE & SECURITY GROUP, INC. AND
      SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)





**Note
      1 - Background**





**China
      Fire & Security Group Inc.** (the
      “Company”), is a Florida corporation. The Company, through its subsidiaries, is
      engaged in the design, development, manufacturing and sales of fire protection
      products and services for industrial customers in China.





**Note
      2 - Summary of significant accounting policies**





The
      reporting entity





The
      consolidated financial statements of China Fire & Security Group Inc. and
      subsidiaries reflect the activities of the parent and the following
      subsidiaries:





Subsidiaries
            
            Incorporated
                in
            
            Ownership
                PercentageChina
                Fire Protection Group Inc (“CFPG”)
            
            British
                Virgin Islands
            
            100%Sureland
                Industrial Fire Safety Limited (“Sureland Industrial”)
            
            People’s
                Republic of China
            
            100%Sureland
                Industrial Fire Equipment Co. Ltd (“Sureland Equipment”)
            
            People’s
                Republic of China
            
            100%Tianxiao
                Fire Safety Equipment Co., Ltd. (“Tianxiao Equipment”)
            
            People’s
                Republic of China
            
            100%Beijing
                Hua An Times Fire Safety Technology Co., Ltd. (“Beijing Hua
                An”)
            
            People’s
                Republic of China
            
            100%




Basis
      of presentation





The
      accompanying consolidated financial statements have been prepared in accordance
      with accounting principles generally accepted in the United States of America.
      All material intercompany transactions and balances have been eliminated in
      consolidation.





Management
      has included
      all normal recurring adjustments considered necessary to give a fair
      presentation of operating results for the periods presented. Interim results
      are
      not necessarily indicative of results for a full year. The information included
      in this Form 10-Q should be read in conjunction with information included
      in the 2007 annual report filed on Form 10-KSB.




Use
      of
      estimates





The
      preparation of financial statements in conformity with generally accepted
      accounting principles of the United States of America requires management to
      make estimates and assumptions that affect the amounts reported in the combined
      financial statements and accompanying notes. Management believes that the
      estimates utilized in preparing its financial statements are reasonable and
      prudent. Actual results could differ from these estimates.


7


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)





Certain
      of the Company’s accounting policies require higher degrees of judgment than
      others in their application. These include the recognition of revenue and
      earnings from system contracting projects under the percentage of completion
      method, determining the fair value of stock based compensation and the allowance
      of doubtful accounts. Management evaluates all of its estimates and judgments
      on
      an on-going basis.





Revenue
      recognition





Revenue
      is recognized when it is probable that the economic benefits will flow to the
      Company as follows:





1.
            Revenue
                from system contracting projects are recognized using the
                percentage-of-completion method of accounting and, therefore, take
                into
                account the costs, estimated earnings and revenue to date on contracts
                not
                yet completed. Revenue recognized is that percentage of the total
                contract
                price that cost expended to date bears to anticipated final total
                cost,
                based on current estimates of costs to complete. Contract costs include
                all direct material and labor costs and those indirect costs related
                to
                contract performance, such as indirect labor, supplies, tools, repairs,
                and depreciation costs. Selling, general, and administrative costs
                are
                charged to expense as incurred. At the time a loss on a contract
                becomes
                known, the entire amount of the estimated ultimate loss is recognized
                in
                the consolidated financial statements. Claims for additional contract
                costs are recognized upon a signed change order from the customer
                or in
                accordance with paragraphs 62 and 65 of the AICPA’S Statement of Position
                ("SOP") 81-1, "Accounting for Performance of Construction - Type
                and
                Certain Production - Type Contracts" ("SOP
                81-1").





2.
            Revenue
                from product sales is recognized when the goods are delivered and
                title
                has passed. Product sales revenue is presented net of a value-added
                tax
                (VAT). All of the Company’s products that are sold in the People’s
                Republic of China (“PRC”) are subject to a Chinese value-added tax at a
                rate of 17% of the gross sales price. This VAT may be offset by VAT
                paid
                by the Company on raw materials and other materials included in the
                cost
                of producing their finished
                product.





3.
            Revenue
                from the rendering of Maintenance Services is recognized over the
                service
                period on a straight line basis.





In
      accordance with SFAS 48, “Revenue Recognition when Right of Return Exists,”
revenue is recorded net of an estimate of markdowns, price concessions and
      warranty costs. Such reserve is based on management’s evaluation of historical
      experience, current industry trends and estimated costs.


8


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)





Shipping
      and handling





Costs
      related to shipping and handlings are included in cost of revenue pursuant
      to EITF 00-10 “Accounting for Shipping and Handling Fees and
      Costs.”





Foreign
      currency translation




The
      reporting currency of the Company is the US dollar. The Company uses their
      local
      currency, Renminbi (RMB), as their functional currency. Results of operations
      and cash flow are translated at average exchange rates during the period, and
      assets and liabilities are translated at the unified exchange
      rate as quoted by the People’s Bank of China at the
      end of the period. Translation adjustments resulting from this process are
      included in accumulated other comprehensive income in the statement of
      shareholders’ equity.




Translation
      adjustments amounted to $7,102,589
      and $3,568,117 as of September
      30, 2008 and
      December 31, 2007, respectively. Asset and liability accounts at September
      30,
      2008 were translated at 6.84 RMB to $1.00 as compared to 7.29 RMB at December
      31, 2007. Equity accounts were stated at their historical rate. The average
      translation rates applied to income statements accounts for the nine months
      ended September 30, 2008 and 2007 were 6.97 RMB and 7.65 RMB, respectively.
      Cash
      flows are also translated at average translation rates for the period,
      therefore, amounts reported on the statement of cash flows will not necessarily
      agree with changes in the corresponding balances on the balance sheet.





Transaction
      gains and losses that arise from exchange rate fluctuations on transactions
      denominated in a currency other than the functional currency are included in
      the
      results of operations as incurred. Historically, the Company has not entered
      any
      currency trading or hedging transactions, although there is no assurance that
      the Company will not enter into such transactions in the future.





Plant
      and equipment





Plant
      and
      equipment are stated at cost less accumulated depreciation. Depreciation is
      computed using the straight-line method over the estimated useful lives of
      the
      assets with 5% residual value. For the three months ended September 30, 2008
      and
      2007, depreciation expense amounted to $ 325,742 and $140,393
      respectively.  Depreciation
      expense amounted to $652,290 and $409,261 for the nine months ended September
      30, 2008 and 2007, respectively.




9


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)





Estimated
      useful lives of the assets are as follows:


Useful
                LifeBuildings
                and improvements
            
            
            40
                yearsTransportation
                equipment
            
            
            5
                yearsMachinery
            
            
            10
                yearsOffice
                equipment
            
            
            5
                yearsFurniture
            
            
            5
                years




Construction
      in progress represents the costs incurred in connection with the construction
      of
      buildings or additions to the Company’s plant facilities. No depreciation is
      provided for construction in progress until such time as the assets are
      completed and placed into service.





The
      cost
      and related accumulated depreciation of assets sold or otherwise retired are
      eliminated from the accounts and any gain or loss is included in the statements
      of income. Maintenance, repairs and minor renewals are charged directly to
      expense as incurred. Major additions and betterment to buildings and equipment
      are capitalized.





Long-term
      assets of the Company are reviewed periodically or more often if circumstances
      dictate, to determine whether their carrying value has become impaired. The
      Company considers assets to be impaired if the carrying value exceeds the future
      projected cash flows from related operations. The Company evaluates the periods
      of depreciation and amortization to determine whether subsequent events and
      circumstances warrant revised estimates of useful lives. As of September 30,
      2008, the Company expects these assets to be fully recoverable.





Plant
      and
      equipment consist of the following:





September
                30, 2008
              (Unaudited)
            
            December
                31, 2007Buildings
                and improvements
            
            $
            5,418,087
            
            $
            5,077,373Transportation
                equipment
            
            
            2,553,048
            
            
            1,985,701Machinery
            
            
            1,193,576
            
            
            970,500Office
                equipment
            
            
            1,223,402
            
            
            1,047,350Furniture
            
            
            38,386
            
            
            35,972Construction
                in progress
            
            
            971,356
            
            
            -Total
            
            
            11,397,855
            
            
            9,116,896Less
                accumulated depreciation
            
            
            (3,025,094
            )
            
            (2,548,646
            )Plant
                and equipment, net
            
            $
            8,372,761
            
            $
            6,568,250




10


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)





Concentration
      of risk





Cash
      includes cash on hand and demand deposits in accounts maintained with
      state **** owned
      banks within the People’s Republic of China and Hong Kong. The Company maintains
      balances at financial institutions which, from time to time, may exceed Hong
      Kong Deposit Protection Board insured limits for the banks located in Hong
      Kong.
      Balances at financial institutions or state owned banks within the PRC are
      not
      covered by insurance. As of September 30, 2008 and December 31, 2007, the
      Company had deposits (including restricted cash balances) totaling to
      $27,973,587 and $20,940,016, that are not covered by insurance, respectively.
      The Company has not experienced any losses in such accounts and believes it
      is
      not exposed to any risks on its cash in bank accounts.





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, and by the general state
      of the PRC's economy. The Company's operations in the PRC are subject to
      specific considerations and significant risks not typically associated with
      companies in the North America and Western Europe. These include risks
      associated with, among others, the political, economic and legal environments
      and foreign currency exchange. The Company's results may be adversely affected
      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.





The
      Company has one major customer who represents approximately 34% and 21% of
      the
      Company’s sales for both the three months and nine
      months ended September 30, 2008 .
      Accounts receivable from this customer was $0 as of September 30, 2008. The
      Company had one major customer who represents approximately 23% of the Company’s
      sales for the nine months ended September 30, 2007. Accounts receivable from
      this customer was $0 as of September 30, 2007.





Cash
      and cash equivalents





The
      Company considers all highly liquid investments with original maturities of
      three months or less to be cash equivalents. Cash equivalents are carried at
      cost, which approximates at
      its
      market value.




Restricted
      cash





Restricted
      cash represents cash required to be deposited in
      a
      separate bank account subject to withdrawal restrictions by its system
      contracting projects and product sales customers to guarantee its contracts
      will
      be performed. The deposit cannot be drawn or transferred by the Company until
      the restriction period has expired. The amounts are $6,168,247 and $3,829,927
      as
      of September 30, 2008 and December 31, 2007, respectively.


11


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)








September
                30, 2008
              (Unaudited)
            
            December
                31, 2007Restricted
                cashProducts
                sales
            
            $
            1,279,427
            
            $
            102,355System
                contracting projects
            
            
            4,888,820
            
            
            3,727,572Total
                restricted cash
            
            
            6,168,247
            
            $
            3,829,927Restricted
                cash - non current
            
            
            (990,616
            )
            
            -Restricted
                cash - current
            
            $
            5,177,631
            
            
            3,829,927





Inventories





Inventories
      are stated at the lower of cost or market, using weighted average method.
      Inventories consisted of the following at:





September
                30, 2008
              (Unaudited)
            
            December
                31, 2007Raw
                materials
            
            $
            1,153,522
            
            $
            310,255Finished
                goods
            
            
            4,816,764
            
            
            2,617,638Work
                in progress
            
            
            1,782,527
            
            
            1,120,390Total
            
            $
            7,752,813
            
            $
            4,048,283





Raw
      materials consist primarily of materials used in production. Finished goods
      consist primarily of equipment used in product sales and system contracting
      projects. The costs of finished goods include direct costs of raw materials
      as
      well as direct labor used in production. Indirect production costs such as
      utilities and indirect labor related to production such as assembling, shipping
      and handling costs are also included in the cost of inventory. The Company
      reviews its inventories periodically to determine if any reserves are necessary
      for potential obsolescence. As of September 30, 2008 and December 31, 2007
      the
      Company determined no reserves are necessary.





Accounts
      receivable





Accounts
      receivable represents amounts due from customers for products sales, maintenance
      services and system contracting projects. Overdue balances are reviewed
      regularly by senior management. Reserves are recorded when collection of amounts
      due are in doubt.





Accounts
      receivable consists of the following:




September
                30, 2008
              (Unaudited)
            
            December
                31, 2007Accounts
                receivable:System
                contracting projects
            
            $
            12,640,635
            
            $
            10,296,762Maintenance
                services
            
            
            2,287,425
            
            
            670,357Products
                sales
            
            
            8,250,943
            
            
            8,234,430Total
                accounts receivable
            
            
            23,179,003
            
            
            19,201,549Allowance
                for bad debts
            
            
            (3,188,660
            )
            
            (2,483,359
            )Accounts
                receivable, net
            
            
            19,990,343
            
            
            16,718,190Accounts
                receivable - non-current retentions
            
            
            (831,043
            )
            
            (193,029
            )Accounts
                receivable - current
            
            $
            19,159,300
            
            $
            16,525,161





12


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)








The
      activity in the allowance for doubtful accounts for trade accounts
      receivable for the
      nine months ended September
      30, 2008 and the
      year ended December 31, 2007 is as follows:





September
                30, 2008
              (Unaudited)
            
            December
                31, 2007Beginning
                allowance for doubtful accounts
            
            $
            2,483,359
            
            $
            1,252,947Additional
                charged to bad debt expense
            
            
            527,870
            
            
            1,111,051Write-off
                charged against the allowance
            
            
            -
            
            
            (12,700
            )Foreign
                currency translation adjustment
            
            
            177,431
            
            
            132,061Ending
                allowance for doubtful accounts
            
            $
            3,188,660
            
            $
            $2,483,359





Retentions
      held by customers of system contracting projects included in the Company’s
      accounts receivable as following:




September
                30, 2008
              (Unaudited)
            
            December
                31, 2007RetentionsCurrent
            
            $
            2,158,523
            
            $
            2,829,250Non-current
            
            
            831,043
            
            
            193,029Total
                retentions
            
            $
            2,989,566
            
            $
            3,022,279





These
      balances represent portions of billings made by the Company but held for payment
      by the customer pending satisfactory completion of the project. Retention
      payments are generally collected within one year of the completion of the
      project.





Costs
      and estimated earnings in excess of billings





The
      current asset, “Costs and estimated earnings in excess of billings” on
      contracts, represents revenues recognized in excess of amounts
      billed.


13


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)


September
                  30, 2008
                (Unaudited)
              
              December
                  31, 2007Contract
                  costs incurred plus recognizedprofits
                  less recognized losses to date
              
              $
              71,961,987
              
              $
              50,877,880Less:
                  progress billings
              
              
              43,175,198
              
              
              37,809,844Costs
                  and estimated earnings in excess of billings
              
              $
              28,786,789
              
              $
              13,068,036





Billings
      in excess of costs and estimated earnings





The
      current liability, “Billings in excess of costs and estimated earnings” on
      contracts, represents billings in excess of revenues recognized.





September
                30, 2008
              (Unaudited)
            
            December
                31, 2007Progress
                billings
            
            $
            22,331,319
            
            $
            15,713,786Less:
                contracts costs incurred plus recognizedprofits
                less recognized losses to date
            
            
            18,967,731
            
            
            10,831,569Billings
                in excess of costs and estimatedearnings
            
            $
            3,363,588
            
            $
            4,882,217





Research
      and development





Research
      and development expenses include salaries, consultant fees, supplies and
      materials, as well as costs related to other overhead such as depreciation,
      facilities, utilities and other departmental expenses. The costs we incur with
      respect to internally developed technology and engineering services are included
      in research and development expenses as incurred as they do not directly relate
      to any particular licensee, license agreement or licenses fee.





Warranties





Generally, the
      Company’s products are not covered by specific warranty terms. However, it is
      the Company’s policy to replace parts if they become defective within one year
      after deployment at no additional charge. Historically, failure of product
      parts
      due to materials or workmanship is rare. Therefore, at September 30, 2008 and
      December 31, 2007, the Company made no provision for warranty claims for our
      products. Management continuously evaluates the potential warranty obligation.
      Management will record the expenses related to the warranty obligation when
      the
      estimated amount become material at the time revenue is recorded.


14


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)





Fair
      value of financial instruments





On
      January 1, 2008, the Company adopted SFAS 157, Fair Value Measurements, which
      defines fair value, establishes a three-level valuation hierarchy for
      disclosures of fair value measurement and enhances disclosures requirements
      for
      fair value measures. The carrying amounts reported in the balance sheets for
      current assets and current liabilities qualify as financial instruments and
      are
      a reasonable estimate of fair value because of the short period of time between
      the origination of such instruments and their expected realization and their
      current market rate of interest. The three levels are defined as
      follow:





·
            Level
                1 inputs to the valuation methodology are quoted prices (unadjusted)
                for
                identical assets or liabilities in active
                markets.


·
            Level
                2 inputs to the valuation methodology include quoted prices for similar
                assets and liabilities in active markets, and inputs that are observable
                for the assets or liability, either directly or indirectly, for
                substantially the full term of the financial
                instruments.


·
            Level
                3 inputs to the valuation methodology are unobservable and significant
                to
                the fair value.





The
      Company invested $166,782 to Hubei Shou An Changjiang Fire Protection Co.,
      Ltd
      for 19% ownership and invested $1,000,000 to King Galaxy Investments Limited
      for
      5% ownership. Total investment as of September 30, 2008 amounted to $1,166,782.
      Since there is no quoted or observable market price for the fair value of
      similar long term in joint venture, the Company then used the level 3 inputs
      for
      its valuation methodology. The determination of the fair value was based on
      the
      cost of the capital contribution to the joint ventures.





The
      Company did not identify any other assets and liabilities that are required
      to
      be presented on the balance sheet at fair value in accordance with SFAS No.
      157.





Intangible
      assets





Land
      use
      rights - All land in the People’s Republic of China is owned by the government.
      However, the government grants the user “land use rights”. The Company acquired
      land use rights in 2001 and the land use rights expire in 2051. The costs of
      these rights are being amortized over
      fifty years using
      the straight-line method





Technology
      rights - In May 2007, the Company acquired two technology rights to manufacture
      fire protection products for and the costs of these rights are being amortized over
      ten years using
      the straight-line method


15


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)





September
                30, 2008
              (Unaudited)
            
            December
                31, 2007Land
                use rights
            
            $
            768,689
            
            $
            720,445Technology
                rights
            
            
            608,745
            
            
            608,745Accumulated
                amortization
            
            
            (243,833
            )
            
            (178,255
            )Balance
            
            $
            1,133,601
            
            $
            1,150,935





Amortization
      expense amounted to $18,816 and $18,658 for the three months ended September
      30,
      2008 and 2007, respectively. Amortization expense amounted to $56,224 and
      $35,539 for the nine months ended September 30, 2008 and 2007,
      respectively.





Intangible
      assets of the Company are reviewed annually to determine whether their carrying
      value has become impaired. The Company considers assets to be impaired if the
      carrying value exceeds the future projected cash flows from related operations.
      The Company also evaluates the periods of amortization to determine whether
      subsequent events and circumstances warrant revised estimates of useful lives.
      As of September 30, 2008, the Company expects these assets to be fully
      recoverable.





Income
      taxes





The
      Company adopted Statement of Financial Accounting Standards No. 109, “Accounting
      for Income Taxes” (SFAS 109). SFAS 109 requires the recognition of deferred
      income tax liabilities and assets for the expected future tax consequences
      of
      temporary differences between income tax basis and financial reporting basis
      of
      assets and liabilities. Provision for income taxes consist of taxes currently
      due plus deferred taxes. There are no deferred tax amounts at June 30, 2008
      and
      December 31, 2007.





The
      Company adopted FASB Interpretation 48, “Accounting for Uncertainty in Income
      Taxes” (“FIN 48”), as of January 1, 2007. A tax position is recognized as a
      benefit only if it is “more likely than not” that the tax position would be
      sustained in a tax examination, with a tax examination being presumed to occur.
      The amount recognized is the largest amount of tax benefit that is greater
      than
      50% likely of being realized on examination. For tax positions not meeting
      the
“more likely than not” test, no tax benefit is recorded. FIN 48 also provides
      guidance on derecognition, classification, interest and penalties, accounting
      in
      interim periods, disclosures, and transition. The adoption had no affect on
      the
      Company’s financial statements.





The
      Company’s operations are subject to income and transaction taxes in the United
      States and in the PRC jurisdictions. Significant estimates and judgments are
      required in determining the Company’s worldwide provision for income taxes. Some
      of these estimates are based on interpretations of existing tax laws or
      regulations. The ultimate amount of tax liability may be uncertain as a
      result.





The
      Company does not anticipate any events which could cause change to these
      uncertainties.





16


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)





The
      charge for taxation is based on the results for the year as adjusted for items,
      which are non-assessable or disallowed. It is calculated using tax rates that
      have been enacted or substantively enacted by the balance sheet
      date.





Deferred
      tax is accounted for using the balance sheet liability method in respect of
      temporary differences arising from differences between the carrying amount
      of
      assets and liabilities in the financial statements and the corresponding tax
      basis used in the computation of assessable tax profit.





In
      principal, deferred tax liabilities are recognized for all taxable temporary
      differences, and deferred tax assets are recognized to the extent that it is
      probably that taxable profit will be available against which deductible
      temporary differences can be utilized. Deferred tax is calculated using tax
      rates that are expected to apply to the period when the asset is realized or
      the
      liability is settled. Deferred tax is charged or credited in the income
      statement, except when it is related to items credited or charged directly
      to
      equity, in which case the deferred tax is also dealt with in equity. Deferred
      tax assets and liabilities are offset when they relate to income taxes levied
      by
      the same taxation authority and the Company intends to settle its current tax
      assets and liabilities on a net basis.





Beginning
      January 1, 2008, the new Enterprise Income Tax (“EIT”) law replaced the existing
      laws for Domestic Enterprises (“DES”) and Foreign Invested Enterprises (“FIEs”).





Value
      Added Tax





Enterprises
      or individuals who sell products, engage in repair and maintenance or import
      and
      export goods in the PRC are subject to a value added tax in accordance with
      Chinese laws. The value added tax standard rate is 17% of the gross sales price.
      A credit is available whereby VAT paid on the purchases of semi-finished
      products or raw materials used in the contract and production of the Company’s
      finished products can be used to offset the VAT due on sales of the finished
      product.





VAT
      on
      sales and VAT on purchases amounted to $1,573,500 and $1,195,867 for the three
      months ended September 30, 2008, and $1,687,472 and $971,409 for the three
      months ended September 30, 2007 respectively. VAT on sales and VAT on purchases
      amounted to $4,291,620 and $3,266,583 for the nine months ended September 30,
      2008, and $4,313,715 and $3,397,843 for the nine months ended September 30,
      2007
      respectively. Sales and purchases are recorded net of VAT collected and paid
      as
      the Company acts as an agent for the government. VAT taxes are not impacted
      by
      the income tax holiday.





Stock based
      compensation





The
      Company adopted Statement of Financial Accounting Standards No. 123R “Accounting
      for Stock-Based Compensation” (“SFAS 123R”) at the beginning of 2006, which
      defines a fair-value-based method of accounting for stock based employee
      compensation and transactions in which an entity issues its equity instruments
      to acquire goods and services from non-employees. Stock compensation for stock
      granted to non-employees has been determined in accordance with SFAS 123R and
      the Emerging Issues Task Force consensus Issue No. 96-18, "Accounting for Equity
      Instruments that are issued to Other than Employees for Acquiring, or in
      Conjunction with Selling Goods or Services" ("EITF 96-18"), as the fair value
      of
      the consideration received or the fair value of equity instruments issued,
      whichever is more reliably measured.


17


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)








Recently
      issued accounting pronouncements





In
      February 2007, the FASB SFAS 159, The Fair Value Option for Financial Assets
      and
      Financial Liabilities—including an amendment of FASB Statement No. 115. FAS 159
      permits companies to choose to measure many financial instruments and certain
      other items at fair value that  are
      not currently required to be measured at fair value. The objective of FAS 159
      is
      to provide opportunities to mitigate volatility in reported earnings caused
      by  measuring
      related assets and liabilities differently without having to apply hedge
      accounting provisions. FAS 159 also establishes presentation and
      disclosure  requirements
      designed to facilitate comparisons between companies that choose different
      measurement attributes for similar types of assets and liabilities. SFAS No.
      159
      is effective as of the beginning of an entity’s first fiscal year that begins
      after November 15, 2007. The Company adopted SFAS No. 159 on January 1, 2008.
      The Company chose not to elect the option to measure the fair value of eligible
      financial assets and liabilities.





In
      June 2007, the
      FASB
      issued FASB Staff Position No. EITF 07-3, “Accounting for Nonrefundable Advance
      Payments for Goods or Services Received for use in Future Research and
      Development Activities” (“FSP EITF 07-3”), which addresses whether nonrefundable
      advance payments for goods or services that used or rendered for research and
      development activities should be expensed when the advance payment is made
      or
      when the research and development activity has been performed. FSP EITF 07-3
      will be effective for an entity’s financial statements issued for fiscal years
      beginning after than December 15, 2007. The adoption of FSP EITF 07-3 did not
      impact our consolidated financial statements.





In
      December 2007, the FASB issued SFAS 160, “Noncontrolling Interests in
      Consolidated Financial Statements - an amendment of Accounting Research Bulletin
      No. 51”, which establishes accounting and reporting standards for ownership
      interests in subsidiaries held by parties other than the parent, the amount
      of
      consolidated net income attributable to the parent and to the noncontrolling
      interest, changes in a parent’s ownership interest and the valuation of retained
      non-controlling equity investments when a subsidiary is deconsolidated. The
      Statement also establishes reporting requirements that provide sufficient
      disclosures that clearly identify and distinguish between the interests of
      the
      parent and the interests of the non-controlling owners. SFAS 160 is effective
      for fiscal years beginning after December 15, 2008. The Company has not
      determined the effect that the application of SFAS 160 will have on its
      consolidated financial statements.





In
      December 2007, SFAS 141(R), Business Combinations, was issued. SFAS 141R
      replaces SFAS No. 141, Business Combinations. SFAS 141R retains the fundamental
      requirements in SFAS 141 that the acquisition method of accounting (which SFAS
      141 called the purchase method) be used for all business combinations and for
      an
      acquirer to be identified for each business combination. SFAS 141R 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. This replaces SFAS
      141’s cost-allocation process, which required the cost of an acquisition to be
      allocated to the individual assets acquired and liabilities assumed based on
      their estimated fair values. SFAS 141R also requires the acquirer in a business
      combination achieved in stages (sometimes referred to as a step acquisition)
      to
      recognize the identifiable assets and liabilities, as well as the noncontrolling
      interest in the acquiree, at the full amounts of their fair values (or other
      amounts determined in accordance with SFAS 141R). SFAS 141R 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. An entity may not apply it before that date. The Company
      is
      currently evaluating the impact that adopting SFAS 141R will have on its
      financial statements.


18


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)








In
      March
      2008, the FASB issued SFAS No. 161, “Disclosures about Derivative
      Instruments and Hedging Activities - An Amendment of SFAS No. 133” (“SFAS
      161”). Effective on January 1, 2009, SFAS 161 seeks to improve financial
      reporting for derivative instruments and hedging activities by requiring
      enhanced disclosures regarding the impact on financial position, financial
      performance, and cash flows. To achieve this increased transparency, SFAS 161
      requires (1) the disclosure of the fair value of derivative instruments and
      gains and losses in a tabular format; (2) the disclosure of derivative
      features that are credit risk-related; and (3) cross-referencing within the
      footnotes. The Company is in the process of evaluating the new disclosure
      requirements under SFAS 161.





In
      May
      2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted
      Accounting Principles" ("SFAS 162"). FAS 162 is intended to improve financial
      reporting by identifying a consistent framework, or hierarchy, for selecting
      accounting principles to be used in preparing financial statements that are
      presented in conformity with U.S. GAAP for nongovernmental entities. 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." The Company is in
      the
      process of evaluating the impact of adoption of this statement on the results
      of
      operations, financial position or cash flows.





In
      June
      2008, the FASB issued EITF 07-5 “Determining whether an Instrument (or Embedded
      Feature) is indexed to an Entity’s Own Stock”. This Issue is effective for
      financial statements issued for fiscal years beginning after December 15, 2008,
      and interim periods within those fiscal years. Early application is not
      permitted. Paragraph 11(a) of SFAS 133 “Accounting for Derivatives and Hedging
      Activities” specifies that a contract that would otherwise meet the definition
      of a derivative but is both (a) indexed to the Company’s own stock and
      (b) classified in stockholders’ equity in the statement of financial
      position would not be considered a derivative financial instrument. EITF 07-5
      provides a new two-step model to be applied in determining whether a financial
      instrument or an embedded feature is indexed to an issuer’s own stock and thus
      able to qualify for the SFAS 133 paragraph 11(a) scope exception. This
      standard will triggered liability accounting on all options and warrants
      exercisable at strike prices denominated in any currency other than the
      functional currency of the operating entity in China (Renminbi). The
      Company is currently evaluating the impact of the adoption of EITF 07-5 on
      the
      Company’s consolidated financial statements.


19


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)








In
      June
      2008, FASB issued EITF 08-4, “Transition Guidance for Conforming Changes to
      Issue No. 98-5”. The objective of EITF 08-4 is to provide transition
      guidance for conforming changes made to EITF 98-5, “Accounting for Convertible
      Securities with Beneficial Conversion Features or Contingently Adjustable
      Conversion Ratios”, that result from EITF 00-27 “Application of Issue No. 98-5
      to Certain Convertible Instruments”, and SFAS 150, “Accounting for Certain
      Financial Instruments with Characteristics of both Liabilities and Equity”. This
      Issue is effective for financial statements issued for fiscal years ending
      after
      December 15, 2008. Early application is not permitted. Management is
      currently evaluating the impact of adoption of EITF 08-4 on the accounting
      for
      the convertible notes and related warrants transactions.





On
      October 10, 2008, the FASB issued FSP 157-3, “Determining the Fair Value of a
      Financial Asset When the Market for That Asset Is Not Active,” which clarifies
      the application of SFAS 157 in a market that is not active and provides an
      example to illustrate key considerations in determining the fair value of a
      financial asset when the market for that financial asset is not active. FSP
      157-3 became effective on October 10, 2008, and its adoption did not have a
      material impact on our financial position or results for the quarter ended
      September 30, 2008.





Reclassifications





Certain
      prior period amounts have been reclassified to conform to the current period
      presentation. These reclassifications have no effect on net income or cash
      flows.





**Note
      3 - Earnings per share**





The
      Company reports earnings per share in accordance with the provisions of SFAS
      128, “Earnings per Share.” SFAS 128 requires presentation of basic and diluted
      earnings per share in conjunction with the disclosure of the methodology used
      in
      computing such earnings per share. Basic earnings per share is computed by
      dividing income available to common stockholders by the weighted average common
      shares outstanding during the period. Diluted earnings per share takes into
      account the potential dilution that could occur if securities or other contracts
      to issue common stock were exercised and converted into common
      stock.


20


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)





The
      following is a reconciliation of the basic and diluted earnings per share
      computation:





For
                the three months ended September 30,
            
            For
                the nine months ended September 30,2008
            
            2007
            
            2008
            
            2007(Unaudited)
            
            (Unaudited)
            
            (Unaudited)
            
            (Unaudited)Net
                income for earnings per share
            
            $
            6,457,964
            
            $
            4,392,035
            
            $
            17,874,844
            
            $
            12,764,675Weighted
                average shares used in basic computation
            
            
            27,572,112
            
            
            27,026,221
            
            
            27,562,087
            
            
            26,649,859Diluted
                effect of stock options and warrants
            
            
            687,059
            
            
            799,221
            
            
            643,496
            
            
            786,836Weighted
                average shares used in diluted computation
            
            
            28,259,171
            
            
            27,825,442
            
            
            28,205,583
            
            
            27,436,695Earnings
                per share:Basic
            
            $
            0.23
            
            $
            0.16
            
            $
            0.65
            
            $
            0.48Diluted
            
            $
            0.23
            
            $
            0.16
            
            $
            0.63
            
            $
            0.47





For
      the
      three and nine months ended September 30, 2008 and 2007, all options and
      warrants have been included in the calculation of diluted earnings per share.





**Note
      4 - Notes receivable**





Notes
      receivable represents trade accounts receivable due from various customers
      where
      the customers’ bank has guaranteed the payment of the receivable. This amount is
      non-interest bearing and is normally paid within three to six months. The
      Company has the ability to submit their request for payment to the customer’s
      bank earlier than the scheduled payment date. However, the Company will incur
      an
      interest charge and a processing fee when they submit the payment request early.
      The Company‘s notes receivable totaled $5,139,588 and $3,315,811 as of September
      30, 2008 and December 31, 2007, respectively.





**Note
      5 - Other receivable from related party**





The
      Company has other receivable from Hubei Shou An Changjiang Fire Protection
      Co.,
      Ltd. (“Hubi Shou An”), which the Company has 19% interest in. Receivable due
      from Hubei Shou An was $329,884 and $0 as of September 30, 2008 and December
      31,
      2007, respectively. This balance was for the operating cash flow in Hubei Shou
      An and expected to be repaid by December 31, 2008 in cash.





**Note
      6 - Prepayments and deferred expenses**





Prepayments
      and deferred expenses are monies deposited with or advanced to subcontractors
      to
      perform services on System Contracting Projects. Some subcontractors require
      a
      certain amount of money to be deposited as a guarantee payment in order for
      them
      start performing the services. Prepayments and deferred expenses also include
      monies deposited or advanced to vendors on future inventory purchases to ensure
      timely delivery. The total outstanding amount was $3,562,333 and $2,218,391
      as
      of September 30, 2008 and December 31, 2007, respectively.


21


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)








**Note
      7 - Investment in joint ventures**





During
      the second quarter of 2007, the Company invested $166,782 (RMB 1,140,000) for
      a
      19% interest in Hubei Shou An Changjiang Fire Protection Co., Ltd., located
      in
      China Hubei, PRC. Investment is recorded under cost method.





During
      the third quarter of 2007, the Company invested $1,000,000 for a 5% interest
      in
      King Galaxy Investments Limited. King Galaxy through its wholly owned
      subsidiary, China Alliance Security Holdings Company Limited owns 100% of Wan
      Sent (China) Technology Co., Ltd. (“Wan Sent”), an emerging Chinese fire
      emergency remote-monitoring system provider based in Beijing, PRC. The
      investment has been recorded under the cost accounting method.





**Note
      8 - Customer deposits**





Customer
      deposits represent amounts advanced by customers on products orders and
      maintenance services deposits and system contracting projects deposits. The
      product or service normally is shipped or performed within six months after
      receipt of the advance payment and the related sale is recognized in accordance
      with the Company’s revenue recognition policy. Customer deposits also represent
      amounts advanced by customers on system contracting projects deposits. The
      advance payment will apply to the invoices when the Company billed our customer
      based on the progression of the projects. As of September 30, 2008 and December
      31, 2007, customer deposits amounted to $16,168,355 and $4,757,179,
      respectively.





**Note
      9 - Accrued liabilities**





Accrued
      liabilities represent subcontractors’ expenses incurred as of balance sheet date
      for system contracting projects. As of September 30, 2008 and December 31,
      2007,
      accrued liabilities amounted to $5,346,951 and $4,214,530,
      respectively.





**Note
      10 - Income taxes**





Prior
      to
      January 1, 2008, under the Income Tax Laws of PRC, the Company’s subsidiaries
      are generally subject to an income tax at an effective rate of 25% on income
      reported in the statutory financial statements after appropriate tax
      adjustments, unless the enterprise is located in a specially designated region
      where it allows enterprises a three-year income tax exemption and a 50% income
      tax reduction for the following three years or the enterprise is a manufacturing
      related joint venture with a foreign enterprise or a wholly owned subsidiary
      of
      a foreign enterprise, where it allows enterprises a two-year income tax
      exemption and a 50% income tax reduction for the following three
      years.





22


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)





Under
      the
      Income Tax Laws of Beijing State Administration Taxation of PRC, any enterprise
      with manufacturing operations in the City of Beijing who is a wholly owned
      subsidiary of a foreign enterprise is subject to income tax rate of
      24%.





The
      Company’s subsidiaries are paying the following tax rate for the three months
      and nine months ended September 30, 2007.





Subsidiaries
            
            Percentage
                of exemption
            
            Effective
                income tax rateSureland
                Industrial
            
            100%
            
            0%Sureland
                Equipment
            
            100%
            
            0%Beijing
                Hua
            
            100%
            
            0%Tianxiao
                Equipment
            
            0%
            
            33%





Beginning
      from January 1, 2008, the new Enterprise Income Tax (“EIT”) law will replace the
      existing income tax laws for Domestic Enterprises (“DES”) and Foreign Invested
      Enterprises (“FIEs”).





The
      key
      changes are:





a.
            The
                new standard EIT rate of 25% will replace the 33% rate currently
                applicable to both DES and FIEs, except for High Tech companies who
                pays a
                reduced rate of 15%;


b.
            Companies
                established before March 16, 2007 will continue to enjoy tax holiday
                treatment approved by local government for a grace period of the
                next 5
                years or until the tax holiday term is completed, whichever is sooner.





The
      Company’s subsidiaries are paying the following tax rate for the three months
      and nine months ended September 30, 2008.





Subsidiaries
            
            Percentage
                of exemption
            
            Effective
                income tax rateSureland
                Industrial
            
            100%
            
            0%Sureland
                Equipment
            
            50%
            
            12.5%Beijing
                Hua
            
            100%
            
            0%Tianxiao
                Equipment
            
            0%
            
            25%





The
      credit for income taxes for the three months ended September 30, 2008 and 2007
      amounted to $6,737 and $0, respectively. The provision for income taxes amounted
      to $53,359 and $0 for the nine months ended September 30, 2008 and 2007,
      respectively.





The
      following table reconciles the U.S. statutory rates to the Company’s effective
      tax rate for the three months and nine months ended September 30:





23


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)








2008
            
            2007
            
            2008
            
            2007(Three
                months ended)
            
            (Three
                months ended)
            
            (Nine
                months ended)
            
            (Nine
                months ended)(Unaudited)
            
            (Unaudited)
            
            (Unaudited)
            
            (Unaudited)U.S.
                Statutory rates
            
            
            34.0
            %
            
            34.0
            %
            
            34.0
            %
            
            34.0
            %Foreign
                income not recognized in USA
            
            
            (34.0
            )
            
            (34.0
            )
            
            (34.0
            )
            
            (34.0
            )China
                income taxes
            
            
            25.0
            
            
            33.0
            
            
            25.0
            
            
            (33.0
            )China
                income tax exemption
            
            
            (25.0
            )
            
            (33.0
            )
            
            (24.7
            )
            
            (33.0
            )Total
                provision (credit) for income taxes
            
            
            (0.0
            )%
            
            0.0
            %
            
            0.3
            %
            
            0.0
            %





The
      estimated tax savings for the three months ended September 30, 2008 and 2007
      amounted to $1,414,294 and $1,638,589, respectively. The net effect on basic
      earnings per share if the income tax had been applied would decrease basic
      earnings per share for the three months ended September
      30, 2008 and 2007 by $0.05
      and $0.06, respectively. The estimated tax savings for the nine months ended
      September 30, 2008 and 2007 amounted to $4,611,290 and $4,124,617, respectively.
      The net effect on basic earnings per share if the income tax had been applied
      would decrease basic earnings per share for the nine months ended September
      30,
      2008 and 2007 by $0.17 and $0.15, respectively.





China
      Fire & Security Group,
      Inc. was incorporated in the United States and has incurred net operating losses
      of $0 for income tax purposes for the nine months ended September 30, 2008.
      The
      net operating loss carry forwards for United States income taxes amounted to
      $1,004,414 may be available to reduce future years’ taxable income. These carry
      forwards will expire, if not utilized, beginning in 2025 and continue through
      2027. Management believes that the realization of the benefits from these losses
      appears uncertain due to the Company’s limited operating history and continuing
      losses for United States income tax purposes. Accordingly, the Company has
      provided a 100% valuation allowance on the deferred tax asset benefit to reduce
      the asset to zero. The accumulated valuation allowance as of September 30,
      2008
      amounted to $341,501 will review this valuation allowance periodically and
      make
      adjustments as warranted.





Taxes
      payable





Taxes
      payable consisted of the following:





September
                30, 2008
              (Unaudited)
            
            December
                31, 2007VAT
                taxes payable
            
            $
            -
            
            $
            71,367Income
                taxes payable
            
            
            22,877
            
            
            5,915Sales
                taxes
            
            
            1,401,580
            
            
            979,999Other
                taxes payable
            
            
            30,392
            
            
            31,054Total
            
            $
            1,454,849
            
            $
            1,088,335





24


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)





**Note
      11 - Retirement plan**





The
      Compan y
      and its
      subsidiaries are required to participate in a central pension scheme operated
      by
      the local municipal government. The Company is required to contribute 20% of
      its
      payroll costs to the central pension scheme in 2008 and 2007. The contributions
      are charged to the income statement of the Company as they become payable in
      accordance with the rules of the scheme. The aggregate contributions of the Company to retirement benefit schemes
      amounted to $54,879 and $58,460 for
      the
      three months ended September 30, 2008 and 2007 ,
      respectively. The aggregate contributions of the Company to retirement benefit
      schemes amounted to $179,806 and $134,147 for
      the
      nine months ended September 30, 2008 and 2007 ,
      respectively.





**Note
      12 - Statutory reserves**





The
      laws and regulations of the People’s Republic of China require that before an
      enterprise distributes profits to its partners, it must first satisfy all tax
      liabilities, provide for losses in previous years, and make allocations, in
      proportions determined at the discretion of the board of directors, after the
      statutory reserve. The statutory reserves include surplus reserve
      fund and the enterprise fund. These
      statutory reserves represent restricted retained earnings.





Surplus
      reserve fund





The
      Company is required to transfer 10% of its net income, as determined in
      accordance with the PRC accounting rules and regulations, to a statutory surplus
      reserve fund until such reserve balance reaches 50% of the Company’s registered
      capital.





The
      transfer to this reserve must be made before distribution of any dividend to
      shareholders. For the nine months ended September 30, 2008 and 2007, the Company
      did not make any contribution to this fund. The surplus reserve fund is
      non-distributable other than during liquidation and can be used to fund previous
      years’ losses, if any, and may be utilized for business expansion or converted
      into share capital by issuing new shares to existing shareholders in proportion
      to their shareholding or by increasing the par value of the shares currently
      held by them, provided that the remaining reserve balance after such issue
      is
      not less than 25% of the registered capital.





On
      May
      17, 2007, the Beijing Shunyi District Business Administration approved the
      Company to increase registered capital from RMB 50,000,000 to RMB 100,000,000.
      $605,000 or RMB 5,000,000 was approved by the Beijing Shunyi District Business
      Administration to be transferred out from this surplus reserve fund as an
      increase of registered capital.





Enterprise
      fund





The
      enterprise fund may be used to acquire plant and equipment or to increase the
      working capital to expend on production and operation of the business. No
      minimum contribution is required and the Company did not make any contribution
      to this fund for the nine months ended September 30, 2008 and
      2007.


25


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)








**Note
      13 - Shareholders’ equity**




On
      January 30, 2008, the Company’s 2008 Omnibus Long-term Incentive Plan was
      adopted and approved by shareholders. Pursuant to the 2008 Omnibus Long-term
      Incentive Plan, the Company reserved 2,000,000 shares of our common stock for
      issuance.




On
      March
      12, 2008, the Company ’ s Board of
      Directors authorized the repurchase of up to $10 million of the Company's
      outstanding common stock.





Warrants





On
      April
      26, 2007, the Company amended its Series A Warrants and Series B Warrants issued
      to certain investors on October 27 and December 5, 2006 pursuant to the
      Securities Purchase Agreement in connection with a private placement (the
“Amendment”). The Amendment eliminates the right of the warrant holders to be
      paid in cash in the event of a merger or other types of reorganization. The
      warrants no longer need to be accounted for as derivative instrument
      liabilities.  The fair value of the warrants were transferred to equity on
      the signing date and no further accounting (i.e., no mark-to-market) is required
      going forward. As of December 31, 2006 the fair value of the derivative
      instrument totaled $2,680,811. At April 26, 2007, the Company determined the
      fair value of the warrants was $1,475,020 using the Cox-Ross-Rubinstein binomial
      model with the following assumptions: volatility 25%; risk free interest rate
      4.59%; dividend yield of 0% and expected term of 4.5 years. On April 26, 2007,
      the fair value of the warrants was transferred to additional paid-in capital.





In
      2007,
      a total of 492,340 series A warrants exercised at $3.58 and 492,340 series
      B
      warrants exercised at $4.88 for a total of 984,680 shares of common stock.
      The
      Company received a total of $4,165,197 from various warrant holders.





In
      2007,
      a total of 179,626 warrants were converted into 110,535 shares of common stock
      by the warrants holders using the cashless exercise options.





On
      February 1, 2007, CFPG issued 50,000 warrants to Hayden Communication, the
      Company’s investor relations consultant, as part of its compensation. These
      warrants meet the conditions for equity classification pursuant to FAS 133
      and
      EITF 00-19. Therefore, the warrants were classified as equity and accounted
      as
      compensation expenses. The warrants vest one year from the grant date. The
      Company used the Black Scholes model to value the options at the time they
      were
      issued, based on the exercise price of $4.25 and expiration dates of the
      instruments and using a risk-free rate of 4.84% and the volatility at 50% that
      was estimated by analyzing the trading history of the Company’s stock. At that
      market price, the 50,000 warrants had a fair value of approximately $94,274.
      The
      service that the investor relation consultant provides started from the second
      quarter of 2007; the related compensation expense is recognized on a
      straight-line basis over the total service period and has been fully expensed
      in
      2007.


26


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)








On
      June
      23, 2008, a total of 5,000 warrants were converted into 3,634 shares of common
      stock by the warrants holders using the cashless exercise options.





On
      August
      21, 2008, a total of 40,000 warrants were converted into 26,066 shares of common
      stock by the warrants holders using the cashless exercise options..





The
      Company’s warrant activity is as follows:





AverageWeighted
            
            RemainingWarrants
            
            Warrants
            
            Average
                Exercise
            
            ContractualOutstanding
            
            Exercisable
            
            Price
            
            LifeOutstanding,
                December 31, 2006
            
            
            1,169,306
            
            
            1,169,306
            
            $
            4.23
            
            
            4.58Granted
            
            
            50,000
            
            
            
            
            $
            4.25ForfeitedExercised
            
            
            (1,164,306
            )
            
            (1,164,306
            )
            $
            4.23Outstanding,
                December 31, 2007
            
            
            55,000
            
            
            5,000
            
            $
            4.19
            
            
            4.08Granted
            
            
            
            
            
            50,000
            
            $
            4.25ForfeitedExercised
            
            
            (45,000
            )
            
            (45,000
            )
            $
            4.24Outstanding,
                September 30, 2008 (Unaudited)
            
            
            10,000
            
            
            10,000
            
            $
            4.25
            
            
            3.33





**Note
      14 - Options issued to employees**





On
      April
      20, 2007, CFPG issued 9,500 options to the Company’s four independent directors
      as part of their compensation. The options will vest immediately after one
      year
      from the issuance date. The fair value of these warrants was determined to
      be
      $19,428 using the Black Sholes model with the following assumptions: volatility
      45%; risk free interest rate 4.57%; dividend yield of 0% and expected term
      of 5
      years. Options were vested immediately at exercise price of $4.51 per share
      which was the close price of the Company’s stock on April 19, 2007. Because the
      services that the independent directors are to provide started from the second
      quarter of 2007 and will last for one year, the related compensation expense
      is
      recognized on a straight-line basis over the total service period.





On
      July
      1, 2007, CFPG issued 20,000 options to Mr. Yuan, Xiaoyuan, who joined the
      Company as Chief Accounting Officer on the same day. The options will vest
      evenly each quarter over the following four years, starting from the third
      quarter of 2007. The Company used the Black Sholes model to value the options
      at
      the time they were issued, based on the exercise price of $6.70, which was
      the
      close price of the Company’s stock on June 30, 2007 and expiration dates of the
      instruments and using a risk-free rate of 4.84% and the volatility of 40% that
      was estimated by analyzing the trading history of the Company’s stock. At that
      market price, the 20,000 employee options had a fair value of $57,178. Because
      the options will vest each quarter over the following four years, the related
      compensation expense is recognized on a straight-line basis over the total
      vesting period.


27


CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES





NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


September
      30, 2008


(Unaudited)








The
      total
      compensation expense recognized for the three months ended September 30, 2008
      and 2007 was $3,574 and $89,568, respectively, and for the nine months ended
      September 30, 2008 and 2007 was $36,578 and $253,562, respectively.





The
      Company has stock options as follows:





WeightedOptions
            
            Average
                Exercise
            
            AggregateOutstanding
            
            Price
            
            Intrinsic
                ValueOutstanding,
                December 31, 2006
            
            
            750,000
            
            $
            1.25
            
            $
            2,250,000Granted
            
            
            29,500
            
            $
            5.99ForfeitedExercised
            
            
            779,500
            
            $
            1.43
            
            $
            8,925,615Outstanding,
                December 31, 2007GrantedForfeitedExercisedOutstanding,
                September 30, 2008 (Unaudited)
            
            
            779,500
            
            $
            1.43
            
            $
            7,078,340





Following
      is a summary of the status of options outstanding at September 30,
      2008:





Outstanding
                Options
            
            Exercisable
                OptionsNumber
                of Options
            
            Exercise
                Price
            
            Average
                Remaining Contractual Life
            
            Number
                of Options
            
            Exercise
                Price
            
            Average
                Remaining Contractual Life750,000
            
            
            1.25
            
            
            2.75
            
            
            750,000
            
            
            1.25
            
            
            2.759,500
            
            
            4.51
            
            
            3.58
            
            
            9,500
            
            
            4.51
            
            
            3.5820,000
            
            
            6.70
            
            
            3.75
            
            
            6,250
            
            
            6.70
            
            
            3.75




**Note
      15** ** **-** ** **Restructuring
      of subsidiaries**




On
      April
      2, 2007, the Company evaluated the operations of its subsidiary, Beijing Zhong
      Xiao Fire Safety Technology Co., Ltd. (“Beijing Zhong Xiao”) and noted
      efficiencies could be obtained by consolidating the operations of Beijing Zhong
      Xiao into Sureland Equipment.





Beijing
      Zhong Xiao was a subsidiary of Sureland Industrial established in the PRC as
      a
      limited liability company on March 18, 2003. On April 3, 2007, Sureland
      Industrial signed an agreement to transfer 100% ownership in Beijing Zhong
      Xiao
      to Gong Gang Qiang, a Chinese individual, for consideration price equal to
      the
      net assets of Beijing Zhong Xiao as of March 31, 2007.






28


CHINA
        FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        CONSOLIDATED FINANCIAL STATEMENTS
 September
        30, 2008
 (Unaudited)


After
      the
      restructuring of Beijing Zhong Xiao, the Company still has a significant
      continuing involvement in the historical operations of the manufacturing of
      fire
      safety and protection products through Sureland Equipment, which results in
      the
      Company failing the test in paragraph 42 of FAS 144 “Accounting for the
      Impairment or Disposal of Long-Lived Assets”. The failure of this test therefore
      does not require the classification of the disposal of Beijing Zhong Xiao as
      a
      discontinued operation.




29




**Item
      2. Management's Discussion and Analysis or Plan of
      Operation**




The
      following discussion and analysis provides information which the management
      of
      China Fire & Security Group, Inc., (the "Company" or "CFSG") believes to be
      relevant to an assessment and understanding of the Company's results of
      operations and financial condition. This discussion should be read together
      with
      the Company's financial statements and the notes to financial statements, which
      are included in this report.





**Overview**





We
      are engaged in the design, development, manufacturing and sale of fire
      protection products and services for large industrial consumers in China. We
      have developed a proprietary product line that addresses all aspects of
      industrial fire safety from fire detection to fire system control and
      extinguishing. The Company is the first in China to leverage high technology
      for
      fire protection and safety to clients such as iron and steel companies, power
      plants, petrochemical plants, as well as, special purpose construction in
      China.





**Reorganization**





We
      were organized as a Florida corporation on June 17, 2003.




On
      September 1, 2006, we entered into a share exchange agreement, pursuant to
      which
      we acquired all of the outstanding capital shares of China Fire Protection
      Group
      Inc. in exchange for a controlling interest in our common shares. The
      transaction was completed on Oct 27, 2006.





China
      Fire Protection Group was organized on June 2, 2006 for the purpose of acquiring
      all of the capital shares of Sureland Industrial Fire Safety Limited (Sureland
      Industrial), a Chinese corporation, and, Sureland Industrial Fire Equipment
      Co.,
      Ltd. (Sureland Equipment), a Chinese corporation, which collectively engage
      in
      the design, development, manufacturing and sale of fire protection products
      and
      services for large industrial consumers in China. As a result of the
      transactions described above, both Sureland Industrial Fire Safety Limited
      and
      Sureland Industrial Fire Equipment Co., Ltd became wholly-owned subsidiaries
      of
      China Fire Protection Group Limited, and China Fire Protection Group Limited
      is
      a wholly-owned subsidiary of Unipro.





On
      February 9, 2007, Unipro changed its name to China Fire & Security Group,
      Inc. (CFSG) and started trading on OTC Bulletin Board under its new ticker
      symbol CFSG. On July 16, 2007, China Fire & Security Group, Inc. began
      trading on Nasdaq Capital Market and retained the ticker symbol
      CFSG.




CFSG
      owns, through its wholly owned subsidiary China Fire Protection Group, Inc.,
      Sureland Industrial and Sureland Equipment (jointly “Sureland”). Sureland is
      engaged primarily in the design, development, manufacture and sale in China
      of a
      variety of fire safety products for the industrial fire safety market and of
      design and installation of industrial fire safety systems in which it uses
      its
      own fire safety products. To a minor extent, it provides maintenance services
      for customers of its industrial fire safety systems. Its business is primarily
      in China, but it has recently begun contract manufacturing products for the
      export market and it has begun to provide a fire safety system for a Chinese
      company operating abroad.




Sureland
      markets its industrial fire safety products and systems primarily to major
      companies in the iron and steel, power and petrochemical industries in China.
      It
      has also completed projects for highway and railway tunnels, wine distilleries,
      tobacco warehouses and a nuclear reactor. It is developing its business in
      the
      transportation, wine and tobacco, vessels, nuclear energy, and public space
      markets. Its products can be readily adapted for use on vessels and in
      exhibition halls and theatres. It plans to expand its marketing efforts to
      secure business in these industries.




Sureland
      has internal research and development facilities engaged primarily in furthering
      fire safety technologies. It believes that its technologies allow it to offer
      cost-effective and high-quality fire safety products and systems. It has
      developed products for industrial fire detecting and extinguishing. It believes
      that it is the only manufacturer in China which has successfully developed
      a
      comprehensive line of linear heat detectors.




By
      September 30, 2008, Sureland operates more than 30 sales and liaison offices
      in
      China.




Sureland
      has been ranked as the leading Chinese industrial fire safety company two times
      by the China Association for Fire Prevention based on six major factors
      including total revenue, growth rate, net profit, return on assets, investment
      in research and development and intellectual property. Its key products include
      linear heat detectors and water mist extinguishers, whose sales volumes are
      the
      largest in China. Its products have been used by its customers in more than
      20
      provinces throughout China.





**Critical
      Accounting Policies and Estimates**




30


While
      our significant accounting policies are more fully described in Note 2 to our
      consolidated financial statements appearing at the end of this quarterly report,
      we believe that the following accounting policies are the most critical to
      aid
      you in fully understanding and evaluating our reported financial
      results.




Revenue
      recognition




Revenue
      is recognized when it is probable that the economic benefits will flow to the
      Company as follows:




1.
            Revenue
                from system contracting projects are recognized using the
                percentage-of-completion method of accounting and, therefore, take
                into
                account the costs, estimated earnings and revenue to date on contracts
                not
                yet completed. Revenue recognized is that percentage of the total
                contract
                price that cost expended to date bears to anticipated final total
                cost,
                based on current estimates of costs to complete. Contract costs include
                all direct material and labor costs and those indirect costs related
                to
                contract performance, such as indirect labor, supplies, tools, repairs,
                and depreciation costs. Selling, general, and administrative costs
                are
                charged to expense as incurred. At the time a loss on a contract
                becomes
                known, the entire amount of the estimated ultimate loss is recognized
                in
                the consolidated financial statements. Claims for additional contract
                costs are recognized upon a signed change order from the customer
                or in
                accordance with paragraphs 62 and 65 of AICPA Statement of Position
                81-1,
                "Accounting for Performance of Construction - Type and Certain Production
                - Type Contracts" ("SOP 81-1")




2.
            Revenue
                from product sales is recognized when the goods are delivered and
                title
                has passed. Product sales revenue represents the invoiced value of
                goods,
                net of a value-added tax (VAT). All of the Company’s products that are
                sold in the PRC are subject to a Chinese value-added tax at a rate
                of 17
                percent of the gross sales price. This VAT may be offset by VAT paid
                by
                the Company on raw materials and other materials included in the
                cost of
                producing their finished product.




3.
            Revenue
                from the rendering of Maintenance Services is recognized when such
                services are provided.


4.
              Provision
                    is made for foreseeable losses as soon as they are anticipated
                    by
                    management.
 5.
                Where
                      contract costs incurred to date plus recognized profits less
                      recognized
                      losses exceed progress billings, the surplus is treated as
                      an amount due
                      from contract consumers. Where progress billings exceed contract
                      costs
                      incurred to date plus recognized profits less recognized losses,
                      the
                      surplus is treated as an amount due to contract
                      customers.


Almost
      all the Company’s products (fire detecting products, fire alarm control device,
      and water mist/sprinkler systems) are sold via system contracting projects
      or as
      part of the integrated products sales. The composition of these three types
      of
      products varies significantly from project to project, both in quantity and
      in
      dollar amounts. Although the Company could provide a breakdown of sales
      contribution for our own products for each project, it is almost impossible
      to
      provide revenues for each of our products when the revenue from each project
      is
      recognized based on percentage of completion. More importantly, the revenues
      from the Company’s own products do not accurately reflect our overall financial
      performance. The Company is a system contracting projects provider rather than
      product vendors who sell their own products directly or through channels.
      Therefore, it is not practical to separately disclose the revenues from external
      customers for each of our products.





Foreign
      currency translation




The
      reporting currency of the Company is the US dollar. The Company uses their
      local
      currency, Renminbi (RMB), as their functional currency. Results of operations
      and cash flow are translated at average exchange rates during the period, and
      assets and liabilities are translated at the unified exchange rate as quoted
      by
      the People’s Bank of China at the end of the period. Translation adjustments
      resulting from this process are included in accumulated other comprehensive
      income in the statement of shareholders’ equity. Transaction gains and losses
      that arise from exchange rate fluctuations on transactions denominated in a
      currency other than the functional currency are included in the results of
      operations as incurred. Historically, the Company has not entered any currency
      trading or hedging, although there is no assurance that the Company will not
      enter into such activities in the future.




Plant
      and equipment




Plant
      and equipment are stated at cost less accumulated depreciation. Depreciation
      is
      computed using the straight-line method over the estimated useful lives of
      the
      assets with 5 percent residual value.




Use
      of estimates




The
      preparation of financial statements in conformity with generally accepted
      accounting principles of the United States of America requires management to
      make estimates and assumptions that affect the amounts reported in the combined
      financial statements and accompanying notes. Management believes that the
      estimates utilized in preparing its financial statements are reasonable and
      prudent. Actual results could differ from these estimates.





31


Certain
      of the Company’s accounting policies require higher degrees of judgment than
      others in their application. These include the recognition of revenue and
      earnings from system contracting projects under the percentage of completion
      method and the allowance of doubtful accounts. Management evaluates all of
      its
      estimates and judgments on an on-going basis.




Inventories




Inventories
      are stated at the lower of cost or market, using the weighted average method.
      Inventories consist of raw materials, work in progress, finished goods and
      consumables. Raw materials consist primarily of materials used in production.
      Finished goods consist primarily of equipment used in project contracts. The
      cost of finished goods included direct costs of raw materials as well as direct
      labor used in production. Indirect production costs such as utilities and
      indirect labor related to production such as assembling, shipping and handling
      costs are also included in the cost of inventory. The Company reviews its
      inventory annually for possible obsolete goods or to determine if any reserves
      are necessary for potential obsolescence.





Accounts
      receivable




Accounts
      receivable represents the products sales, maintenance services and system
      contracting projects with its customers that were on credit. The credit term
      is
      generally for a period of three months for major customers. Each customer has
      a
      maximum credit limit. The Company seeks to maintain strict control over its
      outstanding receivables. Overdue balances are reviewed regularly by senior
      management.





**Results
      of Operations**





The
      following is a schedule showing results of our business.





**Three
      Months Financial Results**





***Comparison
      of the three months ended on September 30, 2008 and
      2007:***





**Three
                months ended**
              **September
                30,****2008**
            
            **2007**(Unaudited)
            
            (Unaudited)Revenues
            
            $
            16,743,267
            
            $
            11,596,970Cost
                of revenues
            
            
            6,878,836
            
            
            4,729,538Gross
                profits
            
            
            9,864,431
            
            
            6,867,432Operating
                expenses
            
            
            3,737,632
            
            
            2,769,996Income
                from operations
            
            
            6,126,799
            
            
            4,097,436Total
                other income(expense)
            
            
            324,429
            
            
            294,599Change
                in fair value of derivative instruments
            
            
            -Income
                before income taxes and minority interest
            
            
            6,451,228
            
            
            4,392,035Income
                taxes
            
            
            (6,736)
            
            
            -Minority
                interest
            
            
            -
            
            
            -Net
                profit (loss)
            
            
            6,457,964
            
            
            4,392,035Foreign
                exchange adjustment
            
            
            173,873
            
            
            540,152Comprehensive
                income
            
            
            6,631,837
            
            
            4,932,187weighted
                average number of shares-basic
            
            
            27,572,112
            
            
            27,026,221weighted
                average number of shares-diluted
            
            
            28,259,171
            
            
            27,825,442earning
                per share-basic
            
            
            0.23
            
            
            0.16earning
                per share-diluted
            
            
            0.23
            
            
            0.16




Total
      revenues were approximately $16.7 million for the three months ended September
      30, 2008 as compared to approximately $11.6 million for the three months ended
      September 30, 2007, an increase of approximately $5.1 million or 44.4 percent.
      This increase was primarily due to increase in our revenues from system
      contracting projects and maintenance services during the period. The Company
      recognized revenues from 163 total solution, product sales and maintenance contracts for the three months
      ended September 30, 2008 as compared to 104 contracts for the three months
      ended
      September 30, 2007.





The
      revenues from total solution contracts increased by 148.5 percent to $15.2
      million which were derived from 97 contracts for the three months ended
      September 30, 2008, compared to $6.1 million which were derived from 52
      contracts for the same period of last year. The revenues from product sales
      were
      $1.0 million which were derived from 28 contracts for the three months ended
      September 30, 2008, compared to $5.2 million derived from 36 contracts for
      the
      same period of last year. The revenues from maintenance service increased by
      94.9 percent to $0.6 million which were derived from 38 contracts for the three
      months ended September 30, 2008, compared to $0.3 million which were derived
      from 16 contracts for the same period of last year. In particular, the three
      largest customers were Capital Iron and Steel Group, Datang Tashan Power Plant
      and Chengde Iron and Steel Group, which collectively contributed approximately
      $8.1 million of revenues, representing 48.1 percent of total revenues for this
      period..


32





Gross
      profit for the three months ended September 30, 2008 was approximately $9.9
      million compared to $6.9 million for the three months ended September 30, 2007,
      an increase of approximately $3.0 million. Gross margin during this period
      was
      58.9 percent, compared to the gross margin of 59.2 percent for the same period
      of 2007. The slightly decrease in the gross margin was mainly attributable
      to
      the increase in the cost of our raw materials, offset by the execution of total
      solution contracts which contributed higher gross margins and a higher
      percentage of revenue contribution from the sales of the Company’s
      self-manufactured proprietary products which enjoy higher margins.




Operating
      expenses were approximately $3.7 million for the three months ended September
      30, 2008 compared to approximately $2.8 million for the three months ended
      September 30, 2007. This represents an increase of approximately $1.0 million
      or
      34.9 percent. Compared to the same period of last year, we increased the number
      of employees and the expenditure in sales incentive compensation. The increase
      in operating expenses is also attributable to increased R&D expenses in new
      product development and improvement in our existing product offerings including
      linear heat detectors and water mist systems.




Operating
      income was approximately $6.1 million for the three months ended September
      30,
      2008 as compared to approximately $4.1 million for the three months ended
      September 30, 2007, representing an increase of 49.5 percent. The improvement
      in
      operating income was mainly attributable to the increased revenues during the
      period. Operating margin for the three months ended September 30, 2008 was
      36.6
      percent, compared to the operating margin of 35.3 percent for the same period
      of
      2007. The improvement in our operating margin was mainly attributable to our
      tighter control over general administrative expenses during the period.





Total
      other income was $280,094 for the three months ended September 30, 2008,
      compared to $249,537 for the three months ended September 30, 2007. The increase
      in our total other income was mainly attributable to the increased tax refund
      to
      Beijing Hua An during the period.





Credit
      for income tax was $6,736 for the three months ended September 30, 2008,
      compared to no provisions for income tax for the three months ended September
      30, 2007. The credit for income tax was mainly attributable to the income tax
      recovery from Tianxiao Equipment during the period.





Our
      net income was approximately $6.5 million for the three months ended September
      30, 2008 as compared to approximately $4.4 million net income for the three
      months ended September 30, 2007, representing an increase of $2.1 million or
      47
      percent.





Currency
      translation adjustments resulting from RMB appreciation process amounted to $173,873 million and $540,152 million for the three months
      ended September 30, 2008 and 2007, respectively.





The
      comprehensive income, which adds the currency adjustment to our net income,
      was
      approximately $6.6 million for the three months ended September 30, 2008 as
      compared to approximately $4.9 million comprehensive income for the three months
      ended September 30, 2007, representing an increase of $1.7 million or 34.5
      percent.








**Nine
      Months Financial Results**





***Comparison
      of the nine months ended on September 30, 2008 and
      2007:***





**Nine
                months ended**
              **September
                30,****2008**
            
            **2007**(Unaudited)
            
            (Unaudited)Revenues
            
            $
            48,093,617
            
            $
            32,643,617Cost
                of revenues
            
            
            20,000,498
            
            
            14,450,765Gross
                profits
            
            
            28,093,119
            
            
            18,192,852Operating
                expenses
            
            
            10,717,344
            
            
            7,294,318Income
                from operations
            
            
            17,375,775
            
            
            10,898,534Total
                other income(expense)
            
            
            552,428
            
            
            1,866,141Change
                in fair value of derivative instruments
            
            
            -
            
            
            1,205,791Income
                before income taxes and minority interest
            
            
            17,928,203
            
            
            12,764,675Income
                taxes
            
            
            53,359
            
            
            -Minority
                interest
            
            
            -
            
            
            -Net
                profit (loss)
            
            
            17,874,844
            
            
            12,764,675Foreign
                exchange adjustment
            
            
            3,534,472
            
            
            1,350,486Comprehensive
                income
            
            
            21,409,316
            
            
            14,115,161weighted
                average number of shares-basic
            
            
            27,562,087
            
            
            26,649,859weighted
                average number of shares-diluted
            
            
            28,205,583
            
            
            27,436,695earning
                per share-basic
            
            
            0.65
            
            
            0.48earning
                per share-diluted
            
            
            0.63
            
            
            0.47




33


Total
      revenues were approximately $48.1 million for the nine months ended September
      30, 2008 as compared to approximately $32.6 million for the nine months ended
      September 30, 2007, an increase of approximately $15.5 million or 47.3 percent.
      This increase was primarily due to increases in our revenues from system
      contracting projects and maintenance services during the period. The Company
      recognized revenues from 278 total solution, product sales and maintenance
      contracts for the nine months ended September 30, 2008 as compared to 196
      contracts for the nine months ended September 30, 2007.





The
      revenues from total solution contracts increased by 76.4 percent to $41.1
      million which were derived from 162 contracts for the nine months ended
      September 30, 2008, compared to $23.3 million which were derived from 99
      contracts for the same period of last year. The revenues from product sales
      were
      $5.4 million which were derived from 75 contracts for the nine months ended
      September 30, 2008, compared to $8.9 million which were derived from 72
      contracts for the same period of last year. The revenues from maintenance
      service increased by 200.6 percent to $1.6 million which were derived from
      41
      contracts for the nine months ended September 30, 2008, compared to $0.5 million
      which were derived from 25 contracts for the same period of last year. In
      particular, the three largest customers were Capital Iron and Steel Group,
      Datang Tashan Power Plant and Anshan Iron and Steel Group, which collectively
      contributed approximately $15.9 million of the revenues, representing 33.1
      percent of our total revenues for this period.





Gross
      profit for the nine months ended September 30, 2008 was approximately $28.1
      million, as compared to $18.2 million for the nine months ended September 30,
      2007, an increase of approximately $9.9 million. Gross margin during this period
      was 58.4 percent, which is higher than the gross margin of 55.7 percent for
      the
      same period of 2007. The increase in the gross margin was mainly attributable
      to
      the execution of total solution contracts which contributed higher gross margins
      and a higher percentage of revenue contribution from the sales of the Company’s
      self-manufactured proprietary products which enjoy higher margins.




Operating
      expenses were approximately $10.7 million for the nine months ended September
      30, 2008, as compared to approximately $7.3 million for the nine months ended
      September 30, 2007. This represents an increase of approximately $3.4 million
      or
      46.9 percent. Compared to the same period of last year, we increased the number
      of employees, its expenditures in sales incentive compensation and raised the
      compensation for management to be in line with other US public companies. The
      increase in operating expenses is also attributable to increased R&D
      expenses in new product development and improvement in our existing product
      offerings including linear heat detectors and water mist systems.




Operating
      income was approximately $17.4 million for the nine months ended September
      30,
      2008 as compared to approximately $10.9 million for the nine months ended
      September 30, 2007, representing an increase of 59.4 percent. The improvement
      in
      operating income was mainly attributable to the increased revenues and improved
      gross margin during the period.





Total
      other income was $552,428 for the nine months ended September 30, 2008, compared
      to $1.9 million for the nine months ended September 30, 2007, which included
      a
      one-time non-cash gain of $1.2 million due to the change in fair value of
      derivative instruments.





Provision
      for income tax was $53,359 for the nine months ended September 30, 2008,
      compared to no provisions for income tax for the nine months ended September
      30,
      2007.





Net
      income was approximately $17.9 million for the nine months ended September
      30,
      2008 as compared to approximately $12.8 million net income for the nine months
      ended September 30, 2007, representing an increase of $5.1 million or 40.0
      percent. Excluding a one-time non-cash gain of $1.2 million for the change
      in
      fair value of derivative in the nine months ended September 30, 2007, the
      non-GAAP net income for the nine months ended September 30 of 2007 was $11.6
      million. Our net income for the nine months ended September 30, 2008 increased
      54.3 percent in comparison to the non-GAAP net income for the nine months ended
      September 30, 2007. The reason for the increase in the net income was mainly
      due
      to the increase in our revenues and the improvement in gross
      margin.





Currency
      translation adjustments resulting from RMB appreciation process amounted to
      $3.5
      million and $1.4 million for the nine months ended September 30, 2008 and 2007,
      respectively.





The
      comprehensive income, which adds the currency adjustment to the net income,
      was
      approximately $21.4 million for the nine months ended September 30, 2008 as
      compared to approximately $14.1 million comprehensive income for the nine months
      ended September 30, 2007, representing an increase of $7.3 million or 51.7
      percent.





**Liquidity
      and Capital Resources**




As
      of September 30, 2008, we had working capital of $59.0 million including cash
      and cash equivalents of $21.8 million. The following table sets forth a summary
      of our cash flows for the periods indicated:





34


**Statement
      of Cash Flow**





Nine
                months Ended
              September
                30,2008
            
            2007(Unaudited)
            
            (Unaudited)Net
                cash provided by (used in) operating activities
            
            $
            7,347,257
            
            $
            3,236,930Net
                cash (used in) investing activities
            
            
            (1,726,401)
            
            
            (3,484,254)Net
                cash provided by financing activities
            
            
            (2,039,634)
            
            
            3,387,848Effect
                of foreign currency translation on cash and cash
                equivalents
            
            
            1,113,669
            
            
            412,282Net
                cash flow
            
            $
            21,805,340
            
            $
            12,978,897




***Operating
      Activities***




Net
      cash provided by operating activities was approximately $7.3 million for the
      nine months ended September 30, 2008 as compared to $3.2 million net cash
      provided in operating activities for the same period in 2007. Net cash provided
      by operating activities in the nine months ended September 30, 2008 was mainly
      due to the results of net income of $17.9 millions during the period, a $10.9
      million increase in customer deposits and $1.1 million increase in other
      payables, offset by a $2.6 million increase in account receivables, a $1.6
      million increase in notes receivable, a $3.4 million increase in inventories,
      a
      $14.5 million increase in costs and estimated earnings in excess of billings,
      a
      $1.1 million decrease in prepayments and deferred expenses and a $1.8 million
      decrease in billings in excess of costs and estimated earnings.





The
      increase of $14.5 million in costs and estimated earnings in excess of billings
      was mainly due to the increased aggregate value of projects where we have
      recognized revenues more than we have billed the customers for these projects,
      while the decrease of $1.8 million in billings in excess of costs and estimated
      earnings was mainly due to the decreased aggregate value of projects where
      we
      have billed our customers less than we have recognized revenues for these
      projects.





***Investing
      Activities***




Net
      cash used in investing activities in the nine months ended September 30, 2008
      was $1.7 million as compared to net cash used in investing activities of $3.5
      million in the same period of 2007. The cash used in investing activities in
      the
      nine months ended September 30, 2008 was mainly attributable to capital
      expenditure in the purchase of new equipments and the improvement of office
      and
      manufacturing facilities.




***Financing
      Activities***




Net
      cash used by financing activities in the nine months ended September 30, 2008
      totaled $2.0 million as compared to $3.4 million provided in financing
      activities in the same period of 2007. The cash used by financing activities
      in
      the nine months ended September 30, 2008 was mainly attributable to the increase
      in restricted cash during the period.




As
      a result of the total cash activities, net cash increased $4.7 million from
      December 31, 2007 to September 30, 2008.  We believe that our currently
      available working capital of $59.0 million including cash and cash equivalents
      of $21.8 million should be adequate to sustain our operations at our current
      level and our anticipated expansion.




**Off-Balance
      Sheet Arrangements**





We
      do not have any off-balance sheet financing arrangements.





**Recently
      issued accounting pronouncements**





In
      February 2007, the FASB SFAS 159, The Fair Value Option for Financial Assets
      and
      Financial Liabilities—including an amendment of FASB Statement No. 115. FAS 159
      permits companies to choose to measure many financial instruments and certain
      other items at fair value that  are
      not currently required to be measured at fair value. The objective of FAS 159
      is
      to provide opportunities to mitigate volatility in reported earnings caused
      by  measuring
      related assets and liabilities differently without having to apply hedge
      accounting provisions. FAS 159 also establishes presentation and
      disclosure  requirements
      designed to facilitate comparisons between companies that choose different
      measurement attributes for similar types of assets and liabilities. SFAS No.
      159
      is effective as of the beginning of an entity’s first fiscal year that begins
      after November 15, 2007. The Company adopted SFAS No. 159 on January 1, 2008.
      The Company chose not to elect the option to measure the fair value of eligible
      financial assets and liabilities.





35


In
      June 2007, the
      FASB
      issued FASB Staff Position No. EITF 07-3, “Accounting for Nonrefundable Advance
      Payments for Goods or Services Received for use in Future Research and
      Development Activities” (“FSP EITF 07-3”), which addresses whether nonrefundable
      advance payments for goods or services that used or rendered for research and
      development activities should be expensed when the advance payment is made
      or
      when the research and development activity has been performed. FSP EITF 07-3
      will be effective for an entity’s financial statements issued for fiscal years
      beginning after than December 15, 2007. The adoption of FSP EITF 07-3 did not
      impact our consolidated financial statements.





In
      December 2007, the FASB issued SFAS 160, “Noncontrolling Interests in
      Consolidated Financial Statements - an amendment of Accounting Research Bulletin
      No. 51”, which establishes accounting and reporting standards for ownership
      interests in subsidiaries held by parties other than the parent, the amount
      of
      consolidated net income attributable to the parent and to the noncontrolling
      interest, changes in a parent’s ownership interest and the valuation of retained
      non-controlling equity investments when a subsidiary is deconsolidated. The
      Statement also establishes reporting requirements that provide sufficient
      disclosures that clearly identify and distinguish between the interests of
      the
      parent and the interests of the non-controlling owners. SFAS 160 is effective
      for fiscal years beginning after December 15, 2008. The Company has not
      determined the effect that the application of SFAS 160 will have on its
      consolidated financial statements.





In
      December 2007, SFAS 141(R), Business Combinations, was issued. SFAS 141R
      replaces SFAS No. 141, Business Combinations. SFAS 141R retains the fundamental
      requirements in SFAS 141 that the acquisition method of accounting (which SFAS
      141 called the purchase method) be used for all business combinations and for
      an
      acquirer to be identified for each business combination. SFAS 141R 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. This replaces SFAS
      141’s cost-allocation process, which required the cost of an acquisition to be
      allocated to the individual assets acquired and liabilities assumed based on
      their estimated fair values. SFAS 141R also requires the acquirer in a business
      combination achieved in stages (sometimes referred to as a step acquisition)
      to
      recognize the identifiable assets and liabilities, as well as the noncontrolling
      interest in the acquiree, at the full amounts of their fair values (or other
      amounts determined in accordance with SFAS 141R). SFAS 141R 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. An entity may not apply it before that date. The Company
      is
      currently evaluating the impact that adopting SFAS 141R will have on its
      financial statements.





In
      March
      2008, the FASB issued SFAS No. 161, “Disclosures about Derivative
      Instruments and Hedging Activities - An Amendment of SFAS No. 133” (“SFAS
      161”). Effective on January 1, 2009, SFAS 161 seeks to improve financial
      reporting for derivative instruments and hedging activities by requiring
      enhanced disclosures regarding the impact on financial position, financial
      performance, and cash flows. To achieve this increased transparency, SFAS 161
      requires (1) the disclosure of the fair value of derivative instruments and
      gains and losses in a tabular format; (2) the disclosure of derivative
      features that are credit risk-related; and (3) cross-referencing within the
      footnotes. The Company is in the process of evaluating the new disclosure
      requirements under SFAS 161.





In
      May
      2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted
      Accounting Principles" ("SFAS 162"). FAS 162 is intended to improve financial
      reporting by identifying a consistent framework, or hierarchy, for selecting
      accounting principles to be used in preparing financial statements that are
      presented in conformity with U.S. GAAP for nongovernmental entities. 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." The Company is in
      the
      process of evaluating the impact of adoption of this statement on the results
      of
      operations, financial position or cash flows.





In
      June
      2008, the FASB issued EITF 07-5 “Determining whether an Instrument (or Embedded
      Feature) is indexed to an Entity’s Own Stock”. This Issue is effective for
      financial statements issued for fiscal years beginning after December 15, 2008,
      and interim periods within those fiscal years. Early application is not
      permitted. Paragraph 11(a) of SFAS 133 “Accounting for Derivatives and Hedging
      Activities” specifies that a contract that would otherwise meet the definition
      of a derivative but is both (a) indexed to the Company’s own stock and
      (b) classified in stockholders’ equity in the statement of financial
      position would not be considered a derivative financial instrument. EITF 07-5
      provides a new two-step model to be applied in determining whether a financial
      instrument or an embedded feature is indexed to an issuer’s own stock and thus
      able to qualify for the SFAS 133 paragraph 11(a) scope exception. This standard
      will triggered liability accounting on all options and warrants exercisable
      at
      strike prices denominated in any currency other than the functional currency
      of
      the operating entity in China (Renminbi). The Company is currently evaluating
      the impact of the adoption of EITF 07-5 on the Company’s consolidated financial
      statements.





In
      June
      2008, FASB issued EITF 08-4, “Transition Guidance for Conforming Changes to
      Issue No. 98-5”. The objective of EITF 08-4 is to provide transition
      guidance for conforming changes made to EITF 98-5, “Accounting for Convertible
      Securities with Beneficial Conversion Features or Contingently Adjustable
      Conversion Ratios”, that result from EITF 00-27 “Application of Issue No. 98-5
      to Certain Convertible Instruments”, and SFAS 150, “Accounting for Certain
      Financial Instruments with Characteristics of both Liabilities and Equity”. This
      Issue is effective for financial statements issued for fiscal years ending
      after
      December 15, 2008. Early application is not permitted. Management is
      currently evaluating the impact of adoption of EITF 08-4 on the accounting
      for
      the convertible notes and related warrants transactions.





On
      October 10, 2008, the FASB issued FSP 157-3, “Determining the Fair Value of a
      Financial Asset When the Market for That Asset Is Not Active,” which clarifies
      the application of SFAS 157 in a market that is not active and provides an
      example to illustrate key considerations in determining the fair value of a
      financial asset when the market for that financial asset is not active. FSP
      157-3 became effective on October 10, 2008, and its adoption did not have a
      material impact on our financial position or results for the quarter ended
      September 30, 2008.


36




**Item
      3. Quantitative and Qualitative Disclosures about Market
      Risk**





Not
      required.





**Item
      4. Controls and Procedures.**





a) *Evaluation
      of Disclosure Controls.* Brian Lin, our Chief Executive Officer and Robert Yuan, our Chief Accounting
      Officer evaluated the effectiveness of our disclosure controls and procedures
      as
      of the end of our second fiscal quarter 2008 pursuant to Rule 13a-15(b) of
      the
      Securities and Exchange Act. 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
      is
      recorded, processed, summarized and reported within the time periods specified
      in the SEC’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, as appropriate to allow
      timely decisions regarding required disclosure. Based on their evaluations,
      Mr.
      Lin and Mr. Yuan concluded that our disclosure controls and procedures were
      effective as of September 30, 2008.





It
      should be noted that any system of controls, however well designed and operated,
      can provide only reasonable, and not absolute, assurance that the objectives
      of
      the system are met. In addition, the design of any control system is based
      in
      part upon certain assumptions about the likelihood of future events. Because
      of
      these and other inherent limitations of control systems, there can be no
      assurance that any design will succeed in achieving its stated goals under
      all
      potential future conditions.





** (b) *Changes
      in internal control over financial reporting.* Other than training our staff in US GAAP accounting skills and implementing
      stronger internal audit function during the last quarter, there have been no
      changes in our internal control over financial reporting that occurred during
      the last fiscal quarter that has materially affected, or is reasonably likely
      to
      materially affect, our internal control over financial reporting. Our management
      team will continue to evaluate our internal control over financial reporting
      in
      2008 as we implement our Sarbanes Oxley testing.







PART
      II - OTHER INFORMATION





Item
      1. Legal Proceedings





None





Item
      2. Unregistered Sales of Equity Securities and Use of Proceeds





During
      the quarter ended September 30, 2008, we
      issued
      26,066 shares of common stock for cashless exercise of 40,000
      shares


of
      warrants.





Item
      3. Defaults Upon Senior Securities





None





Item
      4. Submission of Matters to a Vote of Security Holders.





None





Item
      5. Other Information.





None





Item
      6.  Exhibits




The
      following exhibits are hereby filed as part of this Quarterly Report on Form
      10-Q.




Exhibit
              Number:
            
            Description31.1
            
            Certification
                of Chief Executive Officer under Section 302 of the Sarbanes-Oxley
                Act of
                2002.31.2
            
            Certification
                of Principal Accounting Officer under Section 302 of the Sarbanes-Oxley
                Act of 2002.32.1
            
            Certifications
                Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C.
                Section 135033.2
            
            Certification
                Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C.
                Section 1350





37





**SIGNATURES**





Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, the Registrant certifies that it has duly caused this Quarterly Report
      on
      Form 10-Q to be signed on its behalf by the undersigned, thereunto duly
      authorized, in Beijing.




**CHINA
                FIRE & SECURITY GROUP, INC.**Dated:
                November 14, 2008
            By:
            /s/ Brian
                LinBrian
                LinChief
                Executive Officer




Dated:
                November 14, 2008
            By:
            /s/ Robert
                YuanRobert
                YuanChief
                Accounting Officer/Principal Accounting
                Officer





38