Nature of Operations and Continuance of Business

Urban Barns Foods Inc. (the “Company”) was incorporated under the laws of the State of Nevada on May 21, 2007 as HL Ventures Inc.

On December 4, 2009, the Company closed a reverse takeover transaction with Urban Barns Foods Inc., a privately-held company incorporated on July 3, 2009 under the laws of the province of Alberta. In accordance with the transaction, the Company issued 125,000 shares of common stock to the shareholders of Urban Barns in exchange for 100% of the issued and outstanding shares of common stock of Urban Barns. As part of the acquisition, the Company also cancelled 102,500 shares of common stock held by management.

On June 2, 2011, the Company closed a reverse takeover transaction with Non Industrial Manufacture Inc. (“NIM”), a privately-held company incorporated on February 10, 2010, under the laws of the province of Alberta. In accordance with the transaction, the Company issued 2,500,000 shares of Class B common stock to the shareholders of Non Industrial in exchange for 100% of the issued and outstanding shares of common stock of Non Industrial.

The Company is a development stage company and is an urban produce production company that aims to be the supplier of choice for fresh and high-quality organic and conventional fruits and vegetables for urban consumers.

These financial statements have been prepared on the going concern basis, which assumes that the Company will be able to realize its assets and discharge its liabilities in the normal course of business. As at April 30, 2013, the Company has a working capital deficit of $384,649 an accumulated deficit of $2,141,890. The continued operations of the Company are dependent on its ability to generate future cash flows from operations or obtain additional financing. These factors raise substantial doubt about the Company’s ability to continue as a going concern. These consolidated financial statements do not include any adjustments to the recorded assets or liabilities that might be necessary should the Company be unable to continue as a going concern.

Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

The consolidated financial statements and the related notes of the Company are prepared in accordance with generally accepted accounting principles in the United States and are expressed in United States dollars. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Urban Barns Foods (Alberta) Inc., and Non-Industrial Manufacture Inc. All inter-company accounts and transactions have been eliminated. The Company’s fiscal year-end is July 31.

Use of Estimates

The preparation of these consolidated financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The Company regularly evaluates estimates and assumptions related to the useful life and recoverability of long-lived assets, valuation of convertible debentures, assumptions used to determine the fair value of stock-based compensation and derivative liabilities, and deferred income tax valuation allowances. The Company bases its estimates and assumptions on current facts, historical experience and various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the accrual of costs and expenses that are not readily apparent from other sources. The actual results experienced by the Company may differ materially and adversely from the Company’s estimates. To the extent there are material differences between the estimates and the actual results, future results of operations will be affected.

Significant Accounting Policies (continued)

Interim Financial Statements

These interim unaudited financial statements have been prepared on the same basis as the annual financial statements and in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the Company’s financial position, results of operations and cash flows for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for a full year or for any future period.

Cash and Cash Equivalents

The Company considers all highly liquid instruments with a maturity of three months or less at the time of issuance to be cash equivalents.

Property and Equipment

Property and equipment consists of production equipment and is stated at cost and amortized straight- line over five years.

Intangible assets

Intangible assets consist of patent development costs. Intangible assets acquired are initially recognized and measured at cost and amortized over its expected useful life once the patents are in use. Impairment tests are conducted annually or more frequently if events or changes in circumstances indicate that the asset may be impaired. The impairment test compares the carrying amount of the intangible asset with its fair value, and an impairment loss is recognized in income for the excess, if any. The amortization methods and estimated useful lives of intangible assets are reviewed annually.

Long-Lived Assets

In accordance with ASC 360, “Property, Plant and Equipment”, the Company tests long-lived assets or asset groups for recoverability when events or changes in circumstances indicate that their carrying amount may not be recoverable. Circumstances which could trigger a review include, but are not limited to: significant decreases in the market price of the asset; significant adverse changes in the business climate or legal factors; accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of the asset; current period cash flow or operating losses combined with a history of losses or a forecast of continuing losses associated with the use of the asset; and current expectation that the asset will more likely than not be sold or disposed significantly before the end of its estimated useful life. Recoverability is assessed based on the carrying amount of the asset and its fair value which is generally determined based on the sum of the undiscounted cash flows expected to result from the use and the eventual disposal of the asset, as well as specific appraisal in certain instances. An impairment loss is recognized when the carrying amount is not recoverable and exceeds fair value.

Revenue Recognition

The Company derives revenue from the sale of agricultural products. In accordance with ASC 605, Revenue Recognition, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the amount is fixed and determinable, risk of ownership has passed to the customer and collection is reasonably assured.

Inventory

Inventory is comprised of seeds for growing agricultural products and is recorded at the lower of cost or net realizable value on a first-in first-out basis. The Company establishes inventory reserves for estimated obsolete or unsaleable inventory equal to the difference between the cost of inventory and the estimated realizable value based upon assumptions about future and market conditions.

Significant Accounting Policies (continued)

Comprehensive Loss

ASC 220, Comprehensive Income, establishes standards for the reporting and display of comprehensive loss and its components in the financial statements. As at April 30, 2013 and July 31, 2012, the Company had no items that affected comprehensive loss.

Foreign Currency Translation

The Company’s functional and reporting currency is the U.S. dollar. Monetary assets and liabilities of integrated operations and other monetary assets and liabilities denominated in foreign currencies are translated to U.S. dollars at exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities are translated at historical rates. Revenues and expenses are translated at average rates for the period, except for amortization, which is translated on the same basis as the related asset. The resulting exchange gains or losses are recognized in income.

Loss Per Share

The Company computes net loss per share in accordance with ASC 260, “Earnings Per Share”, which requires presentation of both basic and diluted earnings per share (EPS) on the face of the income statement. Basic EPS is computed by dividing net income (loss) available to common shareholders (numerator) by the weighted average number of shares outstanding (denominator) during the period. Diluted EPS gives effect to all dilutive potential common shares outstanding during the period using the treasury stock method and convertible preferred stock using the if-converted method. In computing diluted EPS, the average stock price for the period is used in determining the number of shares assumed to be purchased from the exercise of stock options or warrants. Diluted EPS excludes all dilutive potential shares if their effect is anti-dilutive. As of April 30, 2013, the Company had 16,230,707 (July 31, 2012 – 1,722,222) potentially dilutive shares.

Financial Instruments and Fair Value Measures

ASC 820, “Fair Value Measurements and Disclosures” requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 820 establishes a fair value hierarchy based on the level of independent, objective evidence surrounding the inputs used to measure fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. ASC 820 prioritizes the inputs into three levels that may be used to measure fair value:

Significant Accounting Policies (continued)

Financial Instruments and Fair Value Measures (continued)

The Company’s financial instruments consist principally of cash, accounts payable and accrued liabilities, convertible debentures, derivative liabilities, and amount due to related parties. Pursuant to ASC 820, the fair value of cash is determined based on “Level 1” inputs, which consist of quoted prices in active markets for identical assets. The recorded values of all other financial instruments approximate their current fair values because of their nature and respective maturity dates or durations.

Stock-based Compensation

The Company records stock-based compensation in accordance with ASC 718, “Compensation – Stock Compensation”, using the fair value method. All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. Equity instruments issued to employees and the cost of the services received as consideration are measured and recognized based on the fair value of the equity instruments issued.

Recent Accounting Pronouncements

The Company has implemented all new accounting pronouncements that are in effect. These pronouncements did not have any material impact on the consolidated financial statements unless otherwise disclosed, and the Company does not believe that there are any other new accounting pronouncements that have been issued that might have a material impact on its financial position or results of operations.

Property and Equipment

Intangible Assets

Convertible Debentures

On January 4, 2012, the Company entered into a convertible promissory note agreement for $27,500, less deferred financing charges of $3,750 and common shares with a fair value of $1,250. Pursuant to the agreement, the loan is unsecured, bears interest at 8% per annum, and is due on October 6, 2012. The note is also convertible into common shares at a conversion price equal to 45% of the average of the three lowest closing prices for the Company’s common shares in the ten trading days prior to conversion, at the option of the note holder, commencing on July 2, 2012.

In accordance with ASC 470-20, “Debt with Conversion and Other Options”, the Company recognized the intrinsic value of the embedded beneficial conversion feature of $27,500. On July 16, 2012, the Company issued 1,061,947 common shares pursuant to the conversion of $12,000. On October 16, 2012, the Company issued 2,804,878 common shares pursuant to the conversion of $11,500. On November 8, 2012, the Company issued 554,348 common shares pursuant to the conversion of $4,000 and accrued interest of $1,100. During the period ended April 30, 2013, the Company recorded accretion expense of $15,298 (2012 - $nil).

On February 9, 2012, the Company entered into four convertible promissory note agreements for $85,000. Pursuant to the agreement, the loans are unsecured, bear interest at 8% per annum, and are due on November 9, 2012. The loans are convertible into common shares at a conversion price equal to 45% of the average of the three lowest closing prices for the Company’s common shares in the ten trading days prior to conversion, at the option of the note holders, commencing on August 5, 2012.

In accordance with ASC 470-20, “Debt with Conversion and Other Options”, the Company recognized the intrinsic value of the embedded beneficial conversion feature of $85,000. On August 28, 2012, the Company issued 18,826,134 common shares pursuant to the conversion of $85,000. During the period ended April 30, 2013, the Company recorded accretion expense of $85,000 (2012 - $nil).

On March 30, 2012, the Company entered into a convertible promissory note agreement for $32,500, less deferred financing charges of $5,750. Pursuant to the agreement, the loan is unsecured, bears interest at 8% per annum, and is due on January 4, 2013. The loan is convertible into common shares at a conversion price equal to 45% of the average of the three lowest closing prices for the Company’s common shares in the ten trading days prior to conversion, at the option of the note holder, commencing on September 26, 2012.

In accordance with ASC 470-20, “Debt with Conversion and Other Options”, the Company recognized the intrinsic value of the embedded beneficial conversion feature of $4,338. On October 16, 2012, the Company issued 6,692,158 common shares pursuant to the conversion of $27,438. During the period ended April 30, 2013, the Company recorded accretion expense of $32,500 (2012 - $nil). As at April 30, 2013, the carrying value of the convertible note was $5,062 (July 31, 2012 - $32,500).

Derivative Liabilities

As at April 30, 2013 and July 31, 2012, the following are the fair value of the derivative and the gain on the change in fair value of the derivatives:

Derivative Liabilities (continued)

The fair value of the derivative financial liabilities was determined using the Black-Scholes option pricing model using the following assumptions:

Related Party Transactions

As at April 30, 2013, the Company owed $77,427 (July 31, 2012 - $52,809) to directors and officers of the Company. The amounts owing are unsecured, non-interest bearing, and due on demand.

As at April 30, 2013, the Company owed $49,630 (July 31, 2012 - $nil) to directors and officers of the Company. The amounts owing are unsecured, bears interest expense at 8% and due on May 1, 2014. During the period ended April 30, 2013, the Company incurred interest expense of $1,654 (April 30, 2012 - $nil), which has been recorded in accounts payable and accrued liabilities.

As at April 30, 2013, the Company owed $nil (July 31, 2012 - $3,351) to a company controlled by an officer of the Company. The amounts owing are unsecured, non-interest bearing, and due on demand.

As at April 30, 2013, the Company owed $103,793 (July 31, 2012 - $nil) to a company controlled by an officer of the Company. The amounts owing are unsecured, bears interest expense at 8% and due on May 1, 2014. During the period ended April 30, 2013, the Company incurred interest expense of $4,144 (April 30, 2012 - $nil), which has been recorded in accounts payable and accrued liabilities.

As at April 30, 2013, the Company owed $39,600 (July 31, 2012 - $25,200) for amounts owing to the spouse of the President of the Company. The amounts owing are unsecured, non-interest bearing, and due on demand.

As at April 30, 2013, the Company owed $65,940 (July 31, 2012 - $98,162) to companies controlled by directors and officers of the Company, which has been recorded in accounts payable and accrued liabilities. The amounts owing are unsecured, non-interest bearing, and due on demand.

As at April 30, 2013, the Company had deferred compensation of $268,630 (July 31, 2012 - $nil) incurred to directors and officers of the Company.

During the nine months ended April 30, 2013, the Company incurred professional fees of $16,200 (April 30, 2012 - $18,060) to a person related to the President of the Company.

During the nine months ended April 30, 2013, the Company incurred travel expenses fees of $76,735 (April 30, 2012 - $32,849) to directors and officers of the Company.

During the nine months ended April 30, 2013, the Company incurred consulting fees of $121,370 (April 30, 2012 - $19,020) to directors and officers of the Company.

During the nine months ended April 30, 2013, the Company incurred rental fees of $20,736 (April 30, 2012 - $11,224) to a company controlled by an officer of the Company.

Common Stock

On August 6, 2012, the Company issued 120,000 shares of Class A common stock for consulting services with a fair value of $4,200, which was recorded in common stock issuable as of July 31, 2012.

On August 28, 2012, the Company issued 18,826,134 shares of Class A common stock pursuant to the conversion of $85,000 of convertible debentures, as described in Note 5(b).

On September 13, 2012, the Company issued 30,000,000 shares of Class A common stock for consulting services with a fair value of $300,000 to directors of the Company. As of April 30, 2013, $268,630 (July 31, 2012 - $nil) of the amount was recorded in deferred compensation.

On October 16, 2012, the Company issued 2,804,878 shares of Class A common stock pursuant to the conversion of $11,500 of the convertible debenture, as described in Note 5(a).

On October 16, 2012, the Company issued 6,692,158 shares of Class A common stock pursuant to the conversion of $27,438 of the convertible debenture, as described in Note 5(c).

On October 22, 2012, the Company issued 26,000,000 shares of Class A common stock at $0.01 per share for proceeds of $260,000. The Company paid a finders’ fee of $13,000 in conjunction with the private placement.

On October 23, 2012, the Company issued 2,000,000 shares of its Class A common stock at $0.025 per share for proceeds of $50,000. The Company incurred a finders’ fee of $2,500 in conjunction with the private placement.

On November 8, 2012, the Company issued 554,348 shares of Class A common stock pursuant to the conversion of $4,000 of the convertible debenture and $1,100 of accrued interest, as described in Note 5(a).

On November 21, 2012, the Company issued of 3,000,000 shares of Class A common stock for consulting services with a fair value of $120,000.

On March 6, 2013, the Company issued 128,500 shares of Class A common stock to settle accounts payable of $6,425.

On March 20, 2013, the Company issued 851,815 shares of Class A common stock for consulting services with a fair value of $15,403.

On March 25, 2013, the Company issued 269,916 shares of Class A common stock with a fair value of $16,195 to settle accounts payable of $14,238. The transaction resulted in a loss on settlement of debt of $1,957.

Stock Options

The Company has adopted a stock option plan pursuant to which options may be granted to directors, officers, employees and consultants of the Company to a maximum of 25,000,000 shares issued and outstanding at the time of the grant. The exercise price and the vesting terms of each option is equal to the market price on the date of the grant.

On November 1, 2012, the Company granted 15,000,000 stock options at an exercise price of $0.10 per share expiring on November 1, 2022. All stock options were vested immediately. The fair value for these stock options was $299,601, and was estimated at the date of grant using the Black-Scholes option-pricing model assuming a weighted average expected life of 10 years, a risk-free rate of 1.75%, an expected volatility of 215%, and a 0% dividend yield. The weighted average fair value of stock options granted was $0.10 per share.

Stock Options (continued)

On February 1, 2013, the Company granted 50,000 stock options to a consultant for services. The stock options have an exercise price of $0.10 per share, vests immediately, and expire on July 31, 2013. The fair value for these stock options was $1,450, and was estimated at the date of grant using the Black-Scholes option-pricing model assuming a weighted average expected life of 0.5 years, a risk-free rate of 0.11%, an expected volatility of 291%, and a 0% dividend yield. The weighted average fair value of stock options granted was $0.10 per share.

On February 1, 2013, the Company granted 200,000 stock options to a consultant for services. The stock options have an exercise price of $0.10 per share, vests immediately, and expire on January 31, 2014. The fair value for these stock options was $7,302, and was estimated at the date of grant using the Black-Scholes option-pricing model assuming a weighted average expected life of 1 year, a risk-free rate of 0.15%, an expected volatility of 259%, and a 0% dividend yield. The weighted average fair value of stock options granted was $0.10 per share.

On February 18, 2013, the Company granted 200,000 stock options to a consultant for services. The stock options have an exercise price of $0.10 per share, vests immediately, and expire on August 17, 2013. The fair value for these stock options was $5,799, and was estimated at the date of grant using the Black-Scholes option-pricing model assuming a weighted average expected life of 0.5 years, a risk-free rate of 0.13%, an expected volatility of 291%, and a 0% dividend yield. The weighted average fair value of stock options granted was $0.10 per share.

On April 24, 2013, the Company granted 400,000 stock options to a consultant for services. The stock options have an exercise price of $0.10 per share, vests immediately, and expire on April 23, 2014. The fair value for these stock options was $10,608, and was estimated at the date of grant using the Black-Scholes option- pricing model assuming a weighted average expected life of 1 year, a risk-free rate of 0.13%, an expected volatility of 244%, and a 0% dividend yield. The weighted average fair value of stock options granted was $0.10 per share.

The following table summarizes the continuity of the Company’s stock options:

Commitments

On June 25, 2012, the Company entered into an agreement with a director of the Company. In accordance with the terms and provisions of the agreement, the director agreed to aid with introductions to management of the Company with respect to the current round of financing of a minimum of $1,000,000 on a best efforts basis through various sources of capital.

Pursuant to the agreement, the Company agreed to the following terms and provisions:

The Company agreed to pay a finders' fee of 5% on actual funds raised or 2% via third parties with regards to private placements.

The Company agreed to pay a finders' fee in the amount of 3% on actual funds loaned or 1.5% via third parties with regards to debt financings.

The Company agreed to pay a scalable finders' fee of 5% on the first $2,000,000, 4% of the next $2,000,000 and 3% on the remaining amount of $4,000,000 if the Company is merged with any other private or public entity with regards to an introduction to a third party who wishes to acquire, merger or perform a business combination; and

The Company agreed to pay a scalable finders' fee of 5% on the first $2,000,000, 4% of the next $2,000,000 and 3% on the remaining amount of $4,000,000 if the Company is merged with any other private or public entity with regards to an introduction to a third party who wishes to acquire, merger or perform a business combination; and

The Company agreed to pay a monthly fee of $4,000 as compensation for his role as a member of the Board of Directors for a twelve-month term upon the closing of a minimum of $1,000,000 raised.

As of April 30, 2013, $7,500 of the finder’s fee was paid and $7,950 of the finder’s fee was recorded in due to related party loan.

On November 1, 2012, the Company entered into three consulting agreements with directors and officers of the Company. Each agreement pays each director and officer a consulting fee of $5,000 per month until November 1, 2017.

On December 1, 2012, the Company entered into a research agreement with McGill University (“McGill”), where McGill will perform testing, research and development towards improvements and efficiency gains on the Company’s patent-pending growing machines. Under the terms of the agreement, the Company will pay $500,000, where $25,000 is due upon the signing of the agreement (paid), $75,000 is due when the Company either completes financing or four growing machines, and $100,000 annually on January 1, 2014, 2015, 2016, and 2017. The agreement expires on January 1, 2018.

On February 4, 2013, the Company entered into a consulting agreement for consulting and financing services. Under the terms of the agreement, the consultant will provide assistance with consulting and obtaining additional financing for the Company in exchange for a finders’ fee of 8% in cash and 2% in common shares for all successful financing with a minimum funding of $500,000, and 3% in cash of total face value for successful closing of convertible debentures.

On February 15, 2013, the Company entered into a consulting agreement for consulting and financing services. Under the terms of the agreement, the consultant will provide assistance with consulting and obtaining additional financing for the Company in exchange for a finders’ fee of 5% in cash and 2.5% in share purchase warrants, exercisable at $0.10 per share and expiring twelve months from the grant date, for all funds raised, 3% in cash for closing of convertible debentures, and 1% in cash on the successful closing of a revolving credit facility.

Subsequent Events

On May 29, 2013, the Company entered into a memorandum of understanding with a non-related party for the purchase of cubic farming growing machines from the Company. Under the terms of the agreement, the non-related party will purchase a minimum of four cubic farming growing machines from the Company at a cost of Cdn$35,000 for the first ten machines, and Cdn$30,000 for the next twenty-five machines, as well as an exclusive license of Cdn$1,000 per machine subject to a maximum of Cdn$100,000 over a five year period. The agreement expires on August 30, 2013 and can be extended for a five-year period by mutual consent.