Note 12 - Financial Instruments

The secured convertible notes payable and the unsecured convertible notes payable, issued per a term sheet executed with an investor firm in November 2011(see Notes 6 and 13), are hybrid instruments which contain an embedded derivative feature which individually warrant separate accounting as a derivative instrument under paragraph 815-15-25-1 of the FASB Accounting Standards Codification. The embedded derivative feature has been bifurcated from the debt host contract, referred to as the "Compound Embedded Derivative Liability". The embedded derivative feature includes the conversion feature within the note and an early redemption option. The value of the embedded derivative liability was bifurcated from the debt host contract and recorded as a derivative liability, which resulted in a reduction of the initial carrying amount (as unamortized discount) of the notes. The unamortized discount is amortized to interest expense using the effective interest method over the life of the notes, or 12 months.

The secured convertible debentures issued to YA Global and Highgate, further assigned to Citco Global, and the unsecured convertible debentures issued to the investor firm, have been accounted for in accordance with paragraph 815-15-25-1 of the FASB Accounting Standards Codification and paragraph 815-40-25 of the FASB Accounting Standards Codification. The Company has identified the above instruments having derivatives that require evaluation and accounting under the relevant guidance applicable to financial derivatives. These compound embedded derivatives have been bifurcated from their respective host debt contracts and accounted for as derivative liabilities in accordance with paragraph 815-40-25 of the FASB Accounting Standards Codification. When multiple derivatives exist within convertible notes, they have been bundled together as a single hybrid compound instrument. The compound embedded derivatives within the secured convertible notes have been recorded at fair value at the date of issuance; and are marked-to-market each reporting period with changes in fair value recorded to the Company's statement of operations as "Derivative instrument expense, net". The Company has utilized a third party valuation consultant to fair value the compound embedded derivatives using a layered discounted probability-weighted cash flow approach. The fair value of the derivative liabilities are subject to the changes in the trading value of the Company's common stock, as well as other factors. As a result, the Company's financial statements may fluctuate from quarter-to-quarter based on factors, such as the price of the Company's stock at the balance sheet date and the amount of shares converted by note holders. Consequently, the financial position and results of operations may vary from quarter-to-quarter based on conditions other than operating revenues and expenses.

Summary of Fair Value of Financial Assets and Liabilities Measured on a Recurring Basis

Financial assets and liabilities measured at fair value on a recurring basis are summarized below and disclosed on the balance sheets:


			Fair Value Measurement Using
	Carrying Value		Level 1			Level 2			Level 3		Total
Derivative warrant liabilities	$	334,605		$	-		$	-	$	334,605		$	334,605

Summary of the Changes in Fair Value of Level 3 Financial Liabilities

The table below provides a summary of the changes in fair value, including net transfers in and/or out, of all financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the year ended December 31, 2011:


	Fair Value Measurement Using Level 3 Inputs
		Derivative warrants				Total

Balance, December 31, 2009			$	518,666			$	518,666
Total gains or losses (realized/unrealized)
Included in net (income) loss				(66,053	)			(66,053	)
Included in other comprehensive income				-				-
Purchases, issuances and settlements				(27,942)				(27,942)
Transfers in and/or out of Level 3				-				-
Balance, December 31, 2010			$	424,671			$	424,671
Total gains or losses (realized/unrealized)
Included in net (income) loss				(163,745	)			(163,745	)
Included in other comprehensive income				-				-
Purchases, issuances and settlements				73,679				73,679
Transfers in and/or out of Level 3				-				-
Balance, December 31, 2011			$	334,605			$	334,605