Annual report pursuant to Section 13 and 15(d)

NOTE 7: DERIVATIVE LIABILITIES

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NOTE 7: DERIVATIVE LIABILITIES
 12 Months Ended
Dec. 31, 2014
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Instruments and Hedging Activities Disclosure [Text Block]
NOTE 7: DERIVATIVE LIABILITIES

In October 2013, a note issued by the Company became convertible and qualified as a derivative liability under ASC 815 (see Note 6). The fair value of this conversion option was estimated to be $55,198 using the Black-Scholes option pricing model and it was recorded as a discount to the associated debt. Between October and December 2013, principal of this note totaling $40,000 was converted to common stock resulting in the resolution of derivative liabilities of $40,641. As of December 31, 2013, the fair value of this conversion option was determined to be $36,975 resulting in a loss on the change in the fair value of this derivative liability of $22,418 during the year ended December 31, 2013.

As a result of this convertible note outstanding, an aggregate of 142,857 previously issued nonemployee common stock options became tainted under ASC 815 and were reclassed from equity to derivative liability. The fair value of these options on the date they became tainted was estimated using the Black-Scholes option pricing model and was determined to be $78,789. On December 31, 2013, the fair value of these tainted options was determined to be $57,389 resulting in a gain on the change in fair value of derivative liabilities of $21,400 for the year ended December 31, 2013.

During November 2013, the Company issued 310,863 common stock warrants in connection with a note payable. The common stock warrants are required to be accounted for as derivative liabilities under ASC 815. The fair value of these warrants on the date of issuance was estimated using the Black-Scholes option pricing model and was determined to be $292,148. This fair value was recorded as a discount to the associated debt. On December 31, 2013, the fair value of these warrants was determined to be $260,917 resulting in a gain on the change in fair value of derivative liabilities of $31,231 for the year ended December 31, 2013.

As of December 31, 2013, the aggregate fair value of the outstanding derivative liabilities was $355,281.

During the year ended December 31, 2014, additional convertible notes with an aggregate principal amount of $2,894,069 became convertible. The fair value of the conversion options associated with these notes was determined to be $2,464,135 of which $1,245,816 was recorded as a discount to the notes and $1,218,319 was expensed as a loss on derivative liabilities. Also during year ended December 31, 2014, an additional 38,571 previously issued common stock warrants became tainted under ASC 815. The fair value of these warrants was determined to be $6,026 and was reclassed from equity to derivative liabilities.  In addition, during the year ended December 31, 2014, the Company granted 4,180,000 warrants with convertible debt. These warrants are tainted under ASC 815. The fair value of these warrants associated with the notes was determined to be $855,440 of which $400,000 was recorded as a discount to the notes and $455,440 was expensed as a loss on derivative liabilities. Also during the year ended December 31, 2014, convertible notes with an aggregate principal amount of $1,460,547 and accrued interest of $37,498 were converted into common shares. The fair value of the derivative liabilities associated with these converted notes was determined to be $1,685,616 on the dates of conversion. This amount was reclassified from derivative liabilities to stockholder’s deficit as resolution of derivative liabilities. As of December 31, 2014, the aggregate fair value of the outstanding derivative liabilities was $1,550,703. For the year ended December 31, 2014, the net loss on derivative liabilities was $1,444,188.

The Company estimated the fair value of the derivative liabilities using the Black-Scholes option pricing model and the following key assumptions during 2014 and 2013

   
2014
   
2013
 
Expected dividends
    - %     - %
Expected term (years)
    0.01 – 1.00       0.17 – 5.01  
Volatility
    171% - 223 %     105% - 155 %
Risk-free rate
    0.01% - 0.25 %     0.09% - 1.34 %

The Company determines the fair market values of its financial instruments based on the fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The following three levels of inputs may be used to measure fair value:

Level 1
Quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.
Level 2
Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The Company uses Level 3 inputs to estimate the fair value of its derivative liabilities.

The following table sets forth by level with the fair value hierarchy the Company’s assets and liabilities measured at fair value as of December 31, 2014 and 2013:

   
Level 1
   
Level 2
   
Level 3
   
Total
 
December 31, 2014:
                       
  Derivative liabilities
  $ -     $ -     $ 1,765,695     $ 1,765,695  
 
                               
December 31, 2013:
                               
  Derivative liabilities
  $ -     $ -     $ 355,281     $ 355,281  

The below table presents the change in the fair value of the derivative liabilities during the years ended December 31, 2014 and 2013:

Fair value as of December 31, 2012
  $ -  
  Fair value on the date of issuance
    426,135  
  Resolution of derivatives
    (40,641 )
  Gain on change in fair value of derivatives
    (30,213 )
Fair value as of December 31, 2013
    355,281  
  Fair value on the date of issuance recorded as debt discounts
    1,645,816  
  Fair value on the date of issuance recognized as loss on derivatives
    1,673,759  
  Fair value on the date of issuance reclassified from equity
    6,026  
  Resolution of derivatives
    (1,685,616 )
  Gain on change in fair value of derivatives
    (229,571 )
Fair value as of December 31, 2014
  $ 1,765,695