NOTE 8 DERIVATIVE LIABILITY AND FAIR VALUE MEASUREMENTS
Effective August 9, 2010, the Company adopted ASC Topic No. 815-40 which defines determining whether an instrument (or embedded feature) is solely indexed to an entitys own stock. On February 28, 2011, the Company sold units to investors which consisted of four (4) shares of the Companys common stock, one (1) Series A warrant and one (1) Series B warrant.
Within the unit subscription agreement, subscribers of the units are given anti-dilution protection for a period of twenty-four (24) months. In the event the Company subsequently issues common stock, stock warrants, stock options or convertible debt with a stock price, exercise price or conversion price lower than 130% of $5.00, the subscriber will be compensated with additional shares of the Companys common stock so that the average per share purchase price of the purchased securities owned by the subscriber on the date of the lower price issuance plus such additional shares issued to the subscriber is equal to the lower price per share. As a result, the Company has determined that the anti-dilution feature is not considered to be solely indexed to the Companys own stock and is therefore not afforded equity treatment. In accordance with ASC 815, the Company has bifurcated the anti-dilution feature of the units and recorded a derivative liability.
The fair value of the derivative liability was calculated using a Lattice Model that values the compound embedded derivatives based on future projections of the various potential outcomes. The assumptions that were analyzed and incorporated into the model included the conversion feature with the full ratchet and weighted average anti-dilution reset, expectations of future stock price performance and expectations of future issuances. Probabilities were assigned to various scenarios in which the reset provisions would go into effect and weighted accordingly.
The total fair value of the anti-dilutive feature issued on February 28, 2011, amounting to $129,422, has been recognized as a derivative liability on the date of issuance with all future changes in the fair value of this anti-dilutive feature being recognized in earnings in the Companys statement of operations under the caption Other income (expense) Gain (loss) on derivative liability until such time as the anti-dilution provision expires. The total cash proceeds of $1,000,000 were first applied to the derivative with the remaining $653,804 being allocated to the 200,000 common shares, $111,434 being allocated to the Series A warrants and $105,340 being allocated to the Series B Warrants. The common stock and warrants were valued as described in Note 9.
On August 15, 2011, the Company sold further units to investors in the same format as the issue of February 28, 2011. Accordingly the derivative liability was adjusted and the total fair value of the anti-dilutive feature issued on August 15, 2011, amounting to $137,520, has been recognized as a derivative liability on the date of issuance. The total cash proceeds of $1,000,000 were first applied to the derivative with the remaining $633,396 being allocated to the 200,000 common shares, $117,420 being allocated to the Series A warrants and $111,664 being allocated to the Series B Warrants. The common stock and warrants were valued as described in Note 9.
ASC 815 requires Company management to assess the fair market value of certain derivatives at each reporting period and recognize any change in the fair market value as an other income or expense item. At September 30, 2011, the Company revalued the warrants and determined that, during the year ended September 30, 2011, the Companys derivative liability increased by $8,096 to $275,038. The Company recognized a corresponding loss on derivative liability in conjunction with this revaluation.