China YCT International Group, Inc. - FORM 10-K - XML - IDEA: XBRL DOCUMENT - July 11, 2012

NOTE 12 – DERIVATIVE LIABILITY

On February 28, 2011, the Company entered into a purchase agreement with L.Y. Research Corp., a New Jersey corporation (“LY Research”); and the purchase agreement was amended and restated on August 15, 2011 (the “Purchase Agreement”). Pursuant to the terms of the Purchase Agreement, the Company acquired a patent (the “LY Patent”) from L.Y. (HK) Biotech Limited, a wholly owned company by L.Y. Research corp., in exchange for 44,254,952 shares of common stock at the acquisition date. In addition, 11,063,968 shares of common stock will be issued to the seller upon the occurrence of the quotation of the Company’s common stock on the OTCQB or OTCBB; and 20,546,711 shares will be issued to the seller upon the receipt by the Company of a minimum of $20,000,000 in gross proceeds from a debt or equity financing, or a series of debt and/or equity financings (the “Financing”); or upon the quotation of its common stock on NASDAQ or a major stock exchange located outside of the United States (collectively, “Events”). On September 9, 2011, the Company’s stock became quoted at OTCQB; therefore, 11,063,968 shares of common stock became issuable on September 9, 2011.

On October 21, 2011, the Purchase Agreement was further amended to state that if either of the Events should not occur within one year from October 21, 2011; the shares issued pursuant to the Purchase Agreement shall be returned to the Company and the LY Patent shall be returned to LY Research and the Purchase Agreement, as amended, shall be cancelled and of no further force or effect. Because the Company is required to acquire the issued shares by returning the US patent if the predetermined financing event is not met, the term meets the definition under the ASC 480-10-25-8, “Obligations to Repurchase Issuer’s Equity Shares by Transferring Assets”. Per ASC 480-10-25-8, the obligation to repurchase an issuer’s own shares by transferring asset should be recognized as a liability at inception.

In addition, because the acquisition is not a certain future event as of October 21, 2011 and March 31, 2012, the Company considers the contingent obligation to repurchase its own shares as a written put option. Per ASC 480-10-30-7, all financial instruments, recognized under the guidance in Section 480-10-25,other than certain physically settled forward purchase contracts, shall be measured initially at fair value.

The fair value of the obligation on October 21, 2011 should be the market price of the shares that the company is obligated to repurchase if the financing is failing and weighted by the probability of the Company failing to meet the financing target of $20,000,000 or achieving the listing on NASDAQ or a major foreign stock exchange. On October 21, 2011, the company had issued and was obligated to issue 55,318,920 common shares to Dr. Liu. Therefore, the number of potential shares needed to repurchase was 55,318,920 on October 21, 2011 and March 31, 2012.

Determination of the market price of the shares:

Per ASC 820-10-20 “Readily Determinable Fair Value”, “ The fair value of an equity security is readily determinable if sales prices or bid-and-asked quotations are currently available on a securities exchange registered with the U.S. Securities and Exchange Commission (SEC) or in the over-the-counter market, provided that those prices or quotations for the over-the-counter market are publicly reported by the National Association of Securities Dealers Automated Quotations systems or by Pink Sheets LLC. Restricted stock meets that definition if the restriction terminates within one year. ” Because the sales price of the company’s common stock shares was currently available in the over-the-counter market, the fair value of the company’s stock is readily determinable and is the sales price of the stock on October 21, 2011. Because the company’s common stock was not traded on October 21, 2011, the closest quotations were the prices on October 23, 2011, which was $0.40/share; therefore, the fair values per share for were $0.40 for October 21, 2011. As of March 31, 2012, the most recent quoted CYIG stock price was $0.10 (at February 21, 2012).

Determination of the probability of the Company failing to meet the predetermined event:

The Company determined that on October 21, 2011, the chance that the final contingency would not be met, thereby triggering our obligation to repurchase those shares, was around 15% based on the reasons described in its amended 10Q for the quarter ended December 31, 2011. Therefore, the Company recognized $3,319,135 as a derivative liability as of December 31, 2011.

However, during the month of March 2012, the Company was informed by its placement agent that it was highly unlikely that they could achieve the $20M financing by October 21, 2012. Therefore, the Company reassessed the probability of failing to achieve the financing target by October 21, 2012 to be 100% as of March 31, 2012.

The fair value of the derivative obligation at March 31, 2012 was calculated as follows:

$5,531,892 = 55,318,920 x $0.10/share x 100%

The fair value of the derivative obligation was increased by $2,212,757 for the period from October 21, 2011 to March 31, 2012 as a result of the CYIG stock price change and the increased probability of failing to achieve the financing target by October 21, 2012.