16. Derivative Liabilities

9 Months Ended

Sep. 30, 2014

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Liabilities

As discussed in Note 14 under Convertible Debts, the Company issued convertible debts with variable conversion provisions. The conversion terms of the convertible debts are variable based on certain factors, such as the future price of the Company’s common stock. The number of shares of common stock to be issued is based on the future price of the Company’s common stock. As such, the number of shares of common stock issuable upon conversion of the debts is indeterminate. Pursuant to ASC 815-15 Embedded Derivatives, the fair values of the variable conversion debts and shares to be issued were recorded as derivative liabilities on the issuance date.

The fair values of the Company’s derivative liabilities were estimated at the issuance date and are revalued at each subsequent reporting date, using a lattice model. The Company recorded current derivative liabilities of $-0- and $-0- at September 30, 2014 and December 31, 2013, respectively. The change in fair value of the derivative liabilities resulted in a net loss of $777,664 and $-0- for the nine months ended September 30, 2014 and 2013, respectively, which has been reported as other income (expense) in the statements of operations. The net loss of $777,664 for the nine months ended September 30, 2014 consisted of a loss of $837,010 due to the value in excess of the face value of the convertible notes, as offset by a net gain in market value of $59,346 on the convertible debts.

The aforementioned accounting treatment resulted in a total debt discount equal to $422,240 and $-0- during the nine months ended September 30, 2014 and the year ended December 31, 2013, respectively. The discount was amortized using the effective interest method from the dates of issuance until the stated redemption date of the debts, or the accelerated dates of conversion. A total of $422,240 and $-0- was amortized during the nine months ended September 30, 2014 and 2013, respectively.

The following presents the derivative liability value by instrument type at September 30, 2014 and December 31, 2013, respectively:

		September 30, 2014		December 31, 2013
Convertible notes, Magna Group	$	–	$	–
Convertible debt, IBC Funds, LLC		–		–
	$	–	$	–

The following is a summary of changes in the fair market value of the derivative liability during the nine months ended September 30, 2014 and the years ended December 31, 2013, respectively:

	Derivative Liability Total
Balance, December 31, 2012	$	–
Increase in derivative value due to issuances of convertible promissory notes, Magna Group		–
Increase in derivative value due to issuances of debt, IBC Funds, LLC		–
Change in fair market value of derivative liabilities due to the mark to market adjustment		–
Debt conversions		–
Balance, December 31, 2013	$	–
Increase in derivative value due to issuances of convertible promissory notes, Magna Group		124,323
Increase in derivative value due to issuances of debt, IBC Funds, LLC		1,134,927
Change in fair market value of derivative liabilities due to the mark to market adjustment		(59,346	)
Debt conversions		(1,199,904	)
Balance, September 30, 2014	$	–

Key inputs and assumptions used to value the convertible debentures and warrants issued during the nine months ended September 30, 2014:

· Stock prices on all measurement dates were based on the fair market value and would fluctuate with projected volatility.

· The holders of the securities would convert monthly to the ownership limit starting at 4.99% increasing by 10% per month.

· The holders would automatically convert the note at the maximum of 3 times the conversion price if the Company was not in default.

· The monthly trading volume would reflect historical averages and would increase at 1% per month.

· The Company would redeem the notes based on availability of alternative financing, increasing 2% monthly to a maximum of 10%.

· The holder would automatically convert the note at maturity if the registration was effective and the Company was not in default.

· The computed volatility was projected based on historical volatility.

· The expected risk-free interest rate is based on the yield of the 1-year U.S. Treasury note.

· The estimated value represents the average or expected value from the Monte Carlo simulation. The simulation was specified to run until the expected value was within 1.0 percent of the true value using a 95% confidence interval. A total of 8,020,000 trials were necessary to reach the specified level of precision.