Summary of Significant Accounting Policies

6 Months Ended

Dec. 31, 2016

Summary of Significant Accounting Policies

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited condensed financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and the rules of the Securities and Exchange Commission (“SEC”) applicable to interim reports of companies filing as a smaller reporting company. These financial statements should be read in conjunction with the audited financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2016 filed with the SEC on October 13, 2016. In the opinion of management, the accompanying condensed financial statements include all adjustments necessary in order to make the financial statements not misleading. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year or any other future period. Certain notes to the financial statements that would substantially duplicate the disclosures contained in the audited financial statements for the most recent fiscal year as reported in the Company’s Annual Report on Form 10-K have been omitted. The accompanying condensed balance sheet at June 30, 2016 has been derived from the audited balance sheet at June 30, 2016 contained in such Form 10-K.

Going Concern

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. The Company has incurred recurring losses from operations from inception and, at December 31, 2016, has $0 cash on hand and a working capital deficit of $5,303,045. As of December 31, 2016, the Company had an accumulated deficit of approximately $48.8 million. In addition, at December 31, 2016 the Company is in default on certain of its debt obligations as described in Note 3 below. As of the date of this filing, the Company had approximately $800 on hand.

The Company’s activities will necessitate significant uses of working capital during and beyond fiscal 2017. Additionally, the Company’s capital requirements will depend on many factors, including the success of its continued research and development efforts and the status of competitive products. The Company plans to continue financing its operations with cash received from financing activities. The Company engaged U.S. Capital Partners and Avalon Securities for a proposed issuance of up to $5.0 million of 8% Series A convertible preferred stock. The Company completed the due diligence phase and both firms presented the offering to potential accredited investors. At this time, potential accredited investors have indicated that they will await the issuance of a purchase order for the Company’s nano iron from an ammonia plant before considering investing in the Company’s 8% Series A convertible preferred stock. On February 2, 2017, the Company issued a convertible note for $68,000 (see Subsequent Events). The Company currently has sufficient cash for operations through February 2017. The Company will pursue the issuance of notes payable to provide cash for operations through either March 2017 or April 2017. Such cash will allow the Company to continue to pursue additional equity financing based on the receipt of a purchase order from an ammonia plant and/or additional debt financing alternatives. In addition, although a formal plan has not been adopted to do so, the Company is exploring possible opportunities to sell its assets pursuant to an asset purchase agreement. In this regard, the Company has had preliminary discussions with multiple parties that have expressed an interest in acquiring the Company’s assets. There can be no assurances that a purchase order will be received or that such additional financing will be obtained or that assets will be sold and the financial statements do not include any adjustments to reflect the outcome of this uncertainty. Should the Company not be able to obtain a purchase order, not be able to obtain additional equity or debt financing, or not be able to sell assets, then the Company would have no alternative but to file bankruptcy.

Use of Estimates

The accompanying financial statements are prepared in conformity with GAAP and require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements. The use of estimates may also affect the reported amounts of revenues and expenses during the reporting periods. Significant estimates made by management include among others, fair value of derivative liabilities, realization of capitalized assets, valuation of equity instruments, and deferred income tax asset valuation allowances. Actual results could differ from those estimates.

Revenue Recognition

The Company recognizes revenue when all four of the following criteria are met: (i) persuasive evidence that an arrangement exists; (ii) delivery of the products and/or services has occurred; (iii) the selling price is fixed or determinable; and (iv) collectability is reasonably assured. The Company does not grant customers the right to return the products after such products have been accepted. Amounts billed for shipping and handling are recorded as a component of net sales and the cost incurred for freight is included as a component of operating expenses in the statements of operations.

Cash and Cash Equivalents

The Company considers demand deposits, U.S. treasury securities and highly-liquid debt investments purchased with original maturities of three months or less to be cash equivalents. The Company did not have any cash equivalents as of December 31, 2016 and June 30, 2016.

The Company maintains its cash in major banks. From time to time, the Company’s cash balances exceed the Federal Deposit Insurance Corporation limit. The Company has not experienced and does not anticipate any losses relating to these amounts.

Inventory

Inventory consists primarily of manufactured nano materials and is comprised of raw materials, labor and manufacturing overhead. Inventory is stated at the lower of cost, determined on a first-in, first-out basis, or market. An inventory reserve is created when potentially slow-moving or obsolete inventories are identified in order to reflect the appropriate inventory value. While the Company’s inventory is not perishable and does not degrade with time, the Company recorded a reserve as its inventory was over one year old and there is no certainty that the inventory will be sold. At December 31, 2016 and June 30, 2016, inventory with cost values of $65,668 and $65,668, respectively, were fully reserved.

Property and Equipment

Property and equipment is stated at cost, less accumulated depreciation. Repairs and maintenance of equipment are charged to expense as incurred. Expenditures for major renewals and betterments that extend the useful lives of property and equipment are capitalized. Gains or losses on dispositions of property and equipment are included in the results of operations when realized. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, ranging from three to seven years. Leasehold improvements are amortized over the shorter of terms of the leases or their estimated useful lives.

Patents

Costs incurred in applying for patents relating to the Company’s process for production of nanopowders have been capitalized. Patents are amortized to reflect the pattern of economic benefits consumed, on a straight-line basis, over the estimated periods benefited. As of December 31, 2016, ten patents have been issued and two patent applications are pending approval. Amortization relating to issued patents was not significant during the periods presented. Additional significant costs may be required for the continued development of end-use applications for the Company’s technology. Patents costs are reviewed periodically as to if any patents are no longer being pursued and associated costs should be written off.

Impairment of Long-Lived Assets

Long-lived assets and intangible assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company evaluates potential impairment by comparing the carrying amount of the assets with the estimated undiscounted future cash flows associated with them. Should the review indicate that an asset is not recoverable, the Company’s carrying value of the asset would be reduced by the estimated shortfall to fair value.

Fair Value of Financial Instruments and Certain Other Assets and Liabilities

GAAP establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

●	Level 1: Observable inputs such as quoted prices in active markets;

●	Level 2: Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

●	Level 3: Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions

The Company’s financial instruments consist of cash, accounts receivable, accounts payable, accrued expenses, and debt. The carrying amounts of such assets and liabilities approximate their respective fair values because of the short-term nature of these items. The carrying amounts of the Company’s debt agreements approximate their fair values as interest approximates current market rates for similar instruments. Derivative liabilities recorded in connection with convertible debt agreements are reported at estimated fair value with changes in fair value reported in results of operations.

Other than derivative liabilities referenced above, the Company did not have any assets or liabilities that are measured at fair value on a recurring or nonrecurring basis during the six months ended December 31, 2016 and the year ended June 30, 2016.

The following details the fair value measurement within the fair value hierarchy of the Company’s financial assets and liabilities at December 31, 2016.

	Fair Value Measurement
	Total Fair Value		Level 1		Level 2		Level 3

Derivative liabilities	$	146,045	$	-	$	-	$	146,045

The following details the fair value measurement within the fair value hierarchy of the Company’s financial assets and liabilities at June 30, 2016.

	Fair Value Measurement
	Total Fair Value		Level 1		Level 2		Level 3

Derivative liabilities	$	7,387	$	-	$	-	$	7,387

There were no transfers among Level 1, Level 2 and Level 3 during the six months ended December 31, 2016 and the year ended June 30, 2016.

The fair values of derivative liabilities were estimated using the Black-Scholes-Merton pricing model and the following assumptions for the six months ended December 31, 2016 and the year ended June 30, 2016:

	December 31, 2016		June 30, 2016

Risk free interest rate	0.4% - 1.1	%	0.5% - 1.0	%
Expected term	0.25 - 5 years		1 - 5 years
Expected volatility	80.5% - 217.7	%	86.8% - 131.7	%
Dividend yield	-		-

The change in fair value of the derivative liabilities during the six months ended December 31, 2016 is summarized as follows:

Fair value at June 30, 2016		7,387
Change in fair value, net		138,658

Fair value at December 31, 2016	$	146,045

Derivative Liabilities

A derivative is an instrument whose value is “derived“ from an underlying instrument or index such as a future, forward, swap, option contract, or other financial instrument with similar characteristics, including certain derivative instruments embedded in other contracts and for hedging activities. As a matter of policy, we do not invest in separable financial derivatives or engage in hedging transactions. However, we have entered into certain financing transactions that involve financial equity instruments containing certain features that have resulted in the instruments being deemed derivatives. We may engage in other similar complex financing transactions in the future, but not with the intention to enter into derivative instruments. Derivatives are measured at fair value using the Black-Scholes-Merton model and marked to market through earnings. However, such new and/or complex instruments may have immature or limited markets. As a result, the pricing models used for valuation of derivatives often incorporate significant estimates and assumptions. Changes in these subjective assumptions can materially affect the estimate of the fair value of derivative liabilities and, consequently, the related amount recognized as loss due to change in fair value of derivative liabilities on the consolidated statement of operations. Furthermore, depending on the terms of a derivative, the valuation of derivatives may be removed from the financial statements upon exercise or conversion of the underlying instrument into some other security. The classification of a derivative instrument is reassessed at each balance sheet date. If the classification changes as a result of events during a reporting period, the instrument is reclassified as of the date of the event that caused the reclassification. There is no limit on the number of times a contract may be reclassified.

Research and Development Costs

Research and development costs are expensed as incurred. Costs incurred for research and development for new or improved processes to produce nanocatalysts as well as end use applications for the nanocatalysts are expensed until the production process or applications have been determined to be commercially viable. Costs incurred after the production process is viable and a working model of the equipment has been completed will be capitalized as long-lived assets.

Income Taxes

Deferred income taxes are recognized for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes represents the tax payable for the period, if any, and the change during the period in deferred tax assets and liabilities. The Company has determined that a full valuation allowance against the Company’s net deferred tax assets is appropriate.

Loss Per Share

The Company calculates basic loss per share by dividing the net loss attributable to common stockholders by the weighted-average number of common shares outstanding. Diluted loss per share is computed similar to basic loss per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if such additional common shares had been issued and were dilutive.

Potential common shares, consisting of options and warrants, totaling 14,886,642 and 13,008,048, have been excluded from the computations of diluted net loss per share because the effect would have been anti-dilutive for the three and six months ended December 31, 2016 and 2015, respectively.

Stock-Based Compensation

The Company measures all employee stock-based compensation awards using the Black-Scholes-Merton valuation model and allocates the related expense over the requisite service period. The expected volatility is based on the historical volatility of the Company’s stock as determined by its private placement offerings and recent market activity. The expected life of the award is based on the simplified method.

The Company accounts for nonemployee stock-based transactions using the fair value of the consideration received (i.e. the value of the goods or services) or the fair value of the equity instruments issued, whichever is more reliably measurable.

Risks and Uncertainties

The Company faces risks and uncertainties relating to its ability to successfully implement and fulfill its strategy. Among other things, these risks include the ability to obtain revenues; manage operations; competition; attract, retain and motivate qualified personnel; maintain and develop new strategic relationships; and the ability to anticipate and adapt to the changing nanotechnology market and any changes in government regulations.

Therefore, the Company may be subject to the risks of delays in consummating contracts with customers and suppliers, raising sufficient capital to achieve its objectives and other uncertainties, including financial, operational, technological, regulatory and other risks associated with an emerging business, including the potential risks of business failure. Technology and manufacturing companies with whom the Company is expected to compete, in general, are well capitalized. The Company is competing against entities with the financial and intellectual resources and expressed intent of performing rapid technological innovation. The Company’s resources are limited and must be allocated to focused objectives in order to succeed.

Subsequent Events

The Company has evaluated events subsequent to December 31, 2016 through the date that the accompanying condensed financial statements were filed with the Securities and Exchange Commission for transactions and other events which may require adjustment or disclosure in such financial statements. The Company did not have any material transactions or other events other than those discussed in Note 8 Subsequent Events below.

Recent Accounting Pronouncements

The FASB issued ASU 2016-2, Leases, which will require a lessee to recognize assets and liabilities for leases of more than 12 months. Both capital and operating leases will need to be recognized on the balance sheet. The guidance is effective for annual reporting periods beginning after December 15, 2018. The Company is currently evaluating the impact of this guidance on the financial statements.

In August 2014, the FASB issued ASU 2014-15, “Presentation of Financial Statements-Going Concern (Subtopic 205-40).“ This ASU provides guidance to determine when and how to disclose going-concern uncertainties in the financial statements. The new standard requires management to assess an entity’s ability to continue as a going concern, and to provide related footnote disclosure in certain circumstances. ASU 2014-15 will be effective for all entities in the first annual period ending after December 15, 2016. Earlier adoption is permitted. ASU 2014-15 will be effective for the Company for the year ending June 30, 2017. The Company does not believe that this pronouncement will have a significant impact on its financial statements.

In May 2014, the FASB issued ASU 2014-09, as amended by ASU 2015-14, “Revenue from Contracts with Customers (Topic 606),“ which is the new comprehensive revenue recognition standard that will supersede all existing revenue recognition guidance under U.S. GAAP. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to a customer in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In July 2015, the FASB issued ASU 2015-14 to defer the effective date by one year to December 15, 2017 for interim and annual reporting periods beginning after that date and permitted early adoption of the standard, but not before the original effective date of December 15, 2016. The Company is currently evaluating the impact of adopting this guidance.

QUANTUMSPHERE, INC. 10-Q