1. Organization and Significant Accounting Policies

9 Months Ended

Sep. 30, 2014

Basis of Presentation and Significant Accounting Policies

Organization – Paxton Energy, Inc. was organized under the laws of the State of Nevada on June 30, 2004. On January 27, 2012, Paxton Energy, Inc. changed its name to Worthington Energy, Inc. (the “Company”). On October 2, 2013 the Company effected a 1-for-50 reverse common stock split. All references in these consolidated financial statements and related notes to numbers of shares of common stock, prices per share of common stock, and weighted average number of shares of common stock outstanding prior to the reverse stock splits have been adjusted to reflect the reverse stock splits on a retroactive basis for all periods presented, unless otherwise noted.

Nature of Operations – As further described in Note 2 to these consolidated financial statements, the Company commenced acquiring working interests in oil and gas properties in June 2005. We are in the business of acquiring, exploring and developing oil and gas-related assets. The Company was considered to be in the exploration stage through March 31, 2014. In June 2014, as discussed in Note, 2, the Financial Accounting Standards Board (FASB) issued new guidance that removed incremental financial reporting requirements from generally accepted accounting principles in the United States for development and exploration stage entities. The Company early adopted this new guidance effective June 30, 2014, as a result of which all inception-to-date financial information and disclosures have been omitted from this report.

Condensed Interim Consolidated Financial Statements – The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, these condensed consolidated financial statements do not include all of the information and disclosures required by generally accepted accounting principles for complete financial statements. In the opinion of the Company’s management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to fairly present the Company’s consolidated financial position as of September 30, 2014, and its consolidated results of operations and cash flows for the three and nine months ended September 30, 2014 and 2013. The results of operations for the nine months ended September 30, 2014, may not be indicative of the results that may be expected for the year ending December 31, 2014. The condensed consolidated financial statements included in this report on Form 10-Q should be read in conjunction with the audited financial statements of Worthington Energy, Inc., and the notes thereto for the year ended December 31, 2013, included in its annual report on Form 10-K filed with the SEC on April 16, 2014.

Going Concern – The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company has not had significant revenue and is still considered to be in the exploration stage. At September 30, 2014, the Company has a working capital deficit of $6,417,318 and a stockholders’ deficiency of $5,828,867 and a significant portion of the Company’s debt is in default. The Company also used cash of $357,130 in its operating activities during the nine months ended September 30, 2014 and $228,024 during the year ended December 31, 2013. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern. The Company’s independent registered public accounting firm, in its report on the Company’s December 31, 2013 financial statements, has raised substantial doubt about the Company’s ability to continue as a going concern.

The Company is currently seeking debt and equity financing to fund potential acquisitions and other expenditures, although it does not have any contracts or commitments for either at this time. The Company will have to raise additional funds to continue operations and, while it has been successful in doing so in the past, there can be no assurance that it will be able to do so in the future. The Company’s continuation as a going concern is dependent upon its ability to obtain necessary additional funds to continue operations and the attainment of profitable operations. The Company hopes that working capital will become available via financing activities currently contemplated with regards to its intended operating activities. There can be no assurance that such funds, if available, can be obtained, or if obtained, on terms reasonable to the Company. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern and do not include any adjustments that may result from the outcome of this uncertainty.

Principles of Consolidation – The accompanying consolidated financial statements present the financial position, results of operations, and cash flows of Worthington Energy, Inc. and of PaxAcq Inc., a wholly-owned subsidiary. Intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates – In preparing these consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements and the reported amount of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Significant estimates and assumptions included in the Company’s consolidated financial statements relate to the valuation of long-lived assets, accrued other liabilities, and valuation assumptions related to share-based payments and derivative liability.

Oil and Gas Properties – The Company follows the full cost method of accounting for oil and gas properties. Under this method, all costs associated with acquisition, exploration, and development of oil and gas reserves, including directly related overhead costs and related asset retirement costs, are capitalized. Costs capitalized include acquisition costs, geological and geophysical expenditures, lease rentals on undeveloped properties, and costs of drilling and equipping productive and nonproductive wells. Drilling costs include directly related overhead costs. Capitalized costs are categorized either as being subject to amortization or not subject to amortization.

All capitalized costs of oil and gas properties, including the estimated future costs to develop proved reserves, will be amortized, on the unit-of-production method using estimates of proved reserves. At September 30, 2014 and December 31, 2013, there were no capitalized costs subject to amortization. Investments in unproved properties and major development projects are not amortized until proved reserves associated with the projects can be determined. If the results of an assessment indicate that the properties are impaired, the amount of the impairment is charged to operations. The Company has not yet obtained a reserve report on its producing properties in Kansas because the properties are considered to be in the exploration stage.

In addition, properties subject to amortization will be subject to a “ceiling test,” which basically limits such costs to the aggregate of the “estimated present value,” based on the projected future net revenues from proved reserves, discounted at 10% per annum to present value of future net revenues from proved reserves, based on current economic and operating conditions, plus the lower of cost or fair market value of unproved properties.

Sales of proved and unproved properties are accounted for as adjustments of capitalized costs with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and gas, in which case the gain or loss is recognized in the results of operations. Abandonments of properties are accounted for as adjustments of capitalized costs with no loss recognized.

Asset Retirement Obligation – The Company accounts for its future asset retirement obligations (“ARO”) by recording the fair value of the liability during the period in which it was incurred. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The increase in carrying value of a property associated with the capitalization of an ARO is included in oil and gas properties in the balance sheets. The ARO consists of costs related to the plugging of wells, removal of facilities and equipment, and site restoration on its oil and gas properties. The asset retirement liability is accreted to operating expense over the useful life of the related asset. As of September 30, 2014 and December 31, 2013, the Company had an ARO of $195,512 and $37,288, respectively.

Revenue Recognition – All revenues are derived from the sale of produced crude oil and natural gas. Revenue and related production taxes and lease operating expenses are recorded in the month the product is delivered to the purchaser. Normally, payment for the revenue, net of related taxes and lease operating expenses, is received from the operator of the well approximately 45 days after the month of delivery.

Stock-Based Compensation – The Company recognizes compensation expense for stock-based awards to employees expected to vest on a straight-line basis over the requisite service period of the award based on their grant date fair value. The Company estimates the fair value of stock options using a Black-Scholes option pricing model which requires management to make estimates for certain assumptions regarding risk-free interest rate, expected life of options, expected volatility of stock and expected dividend yield of stock.

The Company accounts for equity instruments issued in exchange for the receipt of goods or services from other than employees and non-employee directors in accordance with Accounting Standards Codification (ASC) 505-50, Equity-Based Payments to Non-Employees. Costs are measured at the estimated fair market value of the consideration received or the estimated fair value of the equity instruments issued, whichever is more reliably measurable. The value of equity instruments issued for consideration for other than employee services is determined on the earlier of a performance commitment or completion of performance by the provider of goods or services. The fair value of the equity instrument is charged directly to share-based compensation expense and credited to paid-in capital.

Basic and Diluted Loss per Common Share – Basic loss per common share amounts are computed by dividing net loss by the weighted-average number of shares of common stock outstanding during each period. Diluted loss per share amounts are computed assuming the issuance of common stock for potentially dilutive common stock equivalents. As of September 30, 2014 and 2013 there were options, warrants, and stock awards to acquire 2,493,270 and 2,029,594 shares of common stock outstanding and promissory notes and debentures convertible into an aggregate of 32,865,133,013 and 697,345,978 shares of common stock outstanding. The table below shows the calculation of basic and diluted earnings (loss) per shares:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
Basic:
Weighted average common shares outstanding		2,746,329,490			36,845,556			1,376,242,204			16,003,402
Net income (loss)	$	(298,599	)	$	(750,729	)	$	2,744,108		$	(2,057,150	)
Earnings (loss) per common share, basic	$	(0.00	)	$	(0.02	)	$	0.00		$	(0.13	)


Diluted:
Weighted average common shares outstanding		2,746,329,490			36,845,556			1,376,242,204			16,003,402
Dilutive effect of conversion of convertible debt		–			–			32,865,133,013			–
Assumed average common shares outstanding		2,746,329,490			36,845,556			34,241,375,217			16,003,402

Net income (loss)	$	(298,599	)	$	(750,729	)	$	2,744,108		$	(2,057,150	)
Deduct change in fair value of derivative liabilities		–			–			(1,231,086	)
Add interest and financing costs on convertible debentures		–			–			750,298			–
Add amortization of discounts on convertible debentures		–			–			405,522			–
Net income (loss) for diluted earnings (loss) per common shares	$	(298,599	)	$	(750,729	)	$	2,668,842		$	(2,057,150	)
Earnings (loss) per common share, diluted	$	(0.00	)	$	(0.02	)	$	0.00		$	(0.13	)

Fair Values of Financial Instruments – The carrying amounts reported in the consolidated balance sheets for cash, accounts payable, accrued liabilities, payable to Ironridge Global IV, Ltd., and payable to former officer approximate fair value because of the immediate or, short-term maturity of these financial instruments. The carrying amounts reported for unsecured convertible promissory notes payable, secured notes payable, and convertible debentures approximate fair value because the underlying instruments are at interest rates which approximate current market rates. The fair value of derivative liabilities are estimated based on a probability weighted average Black Scholes-Merton pricing model.

For assets and liabilities measured at fair value, the Company uses the following hierarchy of inputs:

Level one – Quoted market prices in active markets for identical assets or liabilities;

Level two – Inputs other than level one inputs that are either directly or indirectly observable; and

Level three – Unobservable inputs developed using estimates and assumptions, which are developed by the reporting entity and reflect those assumptions that a market participant would use.

Liabilities measured at fair value on a recurring basis at September 30, 2014 are summarized as follows:

	Level 1		Level 2		Level 3		Total
Derivative liability - conversion feature of debentures and related warrants	$	–	$	–	$	–	$	–

Derivative liability - embedded conversion feature and reset provisions of notes	$	–	$	2,316,353	$	–	$	2,316,353

Liabilities measured at fair value on a recurring basis at December 31, 2013 are summarized as follows:

	Level 1		Level 2		Level 3		Total

Derivative liability - conversion feature of debentures and related warrants	$	–	$	5,467,223	$	–	$	5,467,223

Derivative liability - embedded conversion feature and reset provisions of notes	$	–	$	2,441,192	$	–	$	2,441,192

Derivative Financial Instruments – The Company evaluates its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the statements of operations. For stock-based derivative financial instruments, the Company uses a probability weighted average Black-Scholes-Merton pricing model to value the derivative instruments. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.

Recently Accounting Pronouncements

In April 2014, the FASB issued Accounting Standards Update No. 2014-08 (ASU 2014-08), Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360). ASU 2014-08 amends the requirements for reporting discontinued operations and requires additional disclosures about discontinued operations. Under the new guidance, only disposals representing a strategic shift in operations or that have a major effect on the Company's operations and financial results should be presented as discontinued operations. This new accounting guidance is effective for annual periods beginning after December 15, 2014. The Company is currently evaluating the impact of adopting ASU 2014-08 on the Company's results of operations or financial condition.

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09 (ASU 2014-09), Revenue from Contracts with Customers. ASU 2014-09 will eliminate transaction- and industry-specific revenue recognition guidance under current U.S. GAAP and replace it with a principle based approach for determining revenue recognition. ASU 2014-09 will require that companies recognize revenue based on the value of transferred goods or services as they occur in the contract. The ASU also will require additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective for reporting periods beginning after December 15, 2016, and early adoption is not permitted. Entities can transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption. Management is currently assessing the impact the adoption of ASU 2014-09 and has not determined the effect of the standard on our ongoing financial reporting.

In June 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-10 (ASU 2014-10), Development Stage Entities (Topic 915): Elimination of Certain Financial Reporting Requirements, Including an Amendment to Variable Interest Entities Guidance in Topic 810, Consolidation. ASU 2014-10 eliminates the requirement to present inception-to-date information about income statement line items, cash flows, and equity transactions, and clarifies how entities should disclosure the risks and uncertainties related to their activities. ASU 2014-10 also eliminates an exception provided to development stage entities in Consolidations (ASC Topic 810) for determining whether an entity is a variable interest entity on the basis of the amount of investment equity that is at risk. The presentation and disclosure requirements in Topic 915 will no longer be required for interim and annual reporting periods beginning after December 15, 2014, and the revised consolidation standards will take effect in annual periods beginning after December 15, 2015. Early adoption is permitted. The Company adopted the provisions of ASU 2014-10 effective for its financial statements for the interim period ended June 30, 2014, and will no longer present the inception-to-date information formally required.

In August 2014, the FASB issued Accounting Standards Update No. 2014-15 (ASU 2014-15), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, which provides guidance on determining when and how to disclose going-concern uncertainties in the financial statements. The new standard requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. An entity must provide certain disclosures if conditions or events raise substantial doubt about the entity’s ability to continue as a going concern. The ASU applies to all entities and is effective for annual periods ending after December 15, 2016, and interim periods thereafter, with early adoption permitted. The Company is currently evaluating the impact the adoption of ASU 2014-15 on the Company’s financial statement presentation and disclosures.

In November 2014, the FASB issued Accounting Standards Update No. 2014-16 (ASU 2014-16), Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity. The amendments in this ASU do not change the current criteria in U.S. GAAP for determining when separation of certain embedded derivative features in a hybrid financial instrument is required. The amendments clarify that an entity should consider all relevant terms and features, including the embedded derivative feature being evaluated for bifurcation, in evaluating the nature of the host contract. The ASU applies to all entities that are issuers of, or investors in, hybrid financial instruments that are issued in the form of a share and is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted.

In January 2015, the FASB issued Accounting Standards Update (ASU) No. 2015-01 (Subtopic 225-20) - Income Statement - Extraordinary and Unusual Items. ASU 2015-01 eliminates the concept of an extraordinary item from GAAP. As a result, an entity will no longer be required to segregate extraordinary items from the results of ordinary operations, to separately present an extraordinary item on its income statement, net of tax, after income from continuing operations or to disclose income taxes and earnings-per-share data applicable to an extraordinary item. However, ASU 2015-01 will still retain the presentation and disclosure guidance for items that are unusual in nature and occur infrequently. ASU 2015-01 is effective for periods beginning after December 15, 2015. The adoption of ASU 2015-01 is not expected to have a material effect on the Company’s consolidated financial statements. Early adoption is permitted.

In February, 2015, the FASB issued Accounting Standards Update (ASU) No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. ASU 2015-02 provides guidance on the consolidation evaluation for reporting organizations that are required to evaluate whether they should consolidate certain legal entities such as limited partnerships, limited liability corporations, and securitization structures (collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions). ASU 2015-02 is effective for periods beginning after December 15, 2015. The adoption of ASU 2015-02 is not expected to have a material effect on the Company’s consolidated financial statements. Early adoption is permitted

Other recent accounting pronouncements issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public Accountants, and the Securities and Exchange Commission did not or are not believed by management to have a material impact on the Company's present or future consolidated financial statements.

WORTHINGTON ENERGY, INC. 10-Q