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. 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.

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 NIM in exchange for 100% of the issued and outstanding shares of common stock of NIM.

These consolidated 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, 2014, the Company has not generated significant revenues and has an accumulated deficit of $3,699,177. 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 (Canada) 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 collectability of accounts and amounts receivable, valuation of inventory, 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.

Accounts Receivable

Accounts receivable represents invoiced amounts to customers for the sale of agricultural products. Amounts are presented net of the allowance for doubtful accounts, which represents the Company’s best estimate of the amount of probable credit losses in the existing accounts receivable balance. The Company determines allowance for doubtful accounts based upon historical experience and current economic conditions. The Company reviews the adequacy of its allowance for doubtful accounts on a regular basis. As of April 30, 2014, the Company had no allowances for doubtful accounts.

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.

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.

Reclassification

Certain comparative figures have been reclassified to conform to the current year’s presentation.

Significant Accounting Policies (continued)

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. 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, 2014 and July 31, 2013, the Company had no items that affected comprehensive loss.

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, 2014 and July 31, 2013, 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.

Income Taxes

The Company accounts for income taxes using the asset and liability method in accordance with ASC 740, “Accounting for Income Taxes”. The asset and liability method provides that deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company records a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized.

As of April 30, 2014 and July 31, 2013, the Company did not have any amounts recorded pertaining to uncertain tax positions.

The Company files federal and provincial income tax returns in Canada and federal, state and local income tax returns in the U.S., as applicable. The Company may be subject to a reassessment of federal and provincial income taxes by Canadian tax authorities for a period of three years from the date of the original notice of assessment in respect of any particular taxation year. In certain circumstances, the U.S. federal statute of limitations can reach beyond the standard three year period. U.S. state statutes of limitations for income tax assessment vary from state to state. Tax authorities of Canada and U.S. have not audited any of the Company’s, or its wholly-owned subsidiary’s income tax returns for the years ended July 31, 2013 and 2012.

The Company recognizes interest and penalties related to uncertain tax positions in tax expense. During the years ended July 31, 2013 and 2012, there were no charges for interest or penalties.

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 at April 30, 2014, the Company had 22,660,822 (July 31, 2013 - 16,959,908) potentially dilutive shares outstanding.

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:

Level 1

Level 1 applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities.

Level 2

Level 2 applies to assets or liabilities for which there are inputs other than quoted prices that are observable for the asset or liability such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.

Level 3

Level 3 applies to assets or liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities.

The Company’s financial instruments consist principally of cash, accounts receivable, amounts receivable, accounts payable and accrued liabilities, convertible debentures, derivative liabilities, and amounts 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, with the exception of derivative liabilities which is a “Level 2” input.  

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.  

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 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 fair value of the embedded beneficial conversion feature of $32,500. 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, 2014, the Company recorded accretion expense of $nil (2013 - $32,500). As of April 30, 2014, the carrying value of the convertible note was $5,062 (July 31, 2013 - $5,062).

On June 12, 2013, the Company entered into a convertible promissory note agreement for $100,000, less deferred financing charges of $3,500. Pursuant to the agreement, the loans are unsecured, bear interest at 8% per annum, and are due on March 14, 2014. The loans are convertible into common shares at a conversion price equal to 61% of the average of the three lowest closing prices for the Company’s common shares in the thirty-five trading days prior to conversion, at the option of the note holder, commencing on December 9, 2013.

In accordance with ASC 470-20, “Debt with Conversion and Other Options”, the Company recognized the fair value of the embedded beneficial conversion feature of $44,281. On December 26, 2013, the Company issued 1,438,849 common shares pursuant to the conversion of $20,000. On January 6, 2014, the Company issued 2,158,273 common shares pursuant to the conversion of $30,000. On January 14, 2014, the Company issued 1,937,984 common shares pursuant to the conversion of $25,000. On January 23, 2014, the Company issued 2,566,372 common shares pursuant to the conversion of the remaining principal of $25,000 plus accrued interest of $4,000. During the period ended April 30, 2014, the Company recorded accretion expense of $44,281 (2013 - $nil). As of April 30, 2014, the carrying value of the convertible note was $nil.

On September 17, 2013, the Company entered into a convertible promissory note agreement for $32,500, less deferred financing charges of $2,500. Pursuant to the agreement, the loans are unsecured, bear interest at 8% per annum, and are due on June 19, 2014. The loans are convertible into common shares at a conversion price equal to 61% of the average of the three lowest closing prices for the Company’s common shares in the thirty-five trading days prior to conversion, at the option of the note holder, commencing on March 16, 2014.

In accordance with ASC 470-20, “Debt with Conversion and Other Options”, the Company recognized the fair value of the embedded beneficial conversion feature of $32,500. On March 21, 2014, the Company issued 1,271,186 common shares pursuant to the conversion of $15,000. On April 2, 2014, the Company issued 1,468,750 common shares pursuant to the conversion of the remaining principal of $17,500 plus accrued interest of $1,300. During the period ended April 30, 2014, the Company recorded accretion expense of $32,500 (2013 - $nil). As at April 30, 2014, the carrying value of the convertible note was $nil.

Derivative Liabilities

The conversion options of the convertible notes payable, as disclosed in Note 5, are required to be record as derivatives at their estimated fair values on each balance sheet date with changes in fair value reflected in the statements of operations.

The fair value of the derivative liabilities for the March 30, 2012 and June 12, 2013 convertible notes were $44,844 and $44,281 on vesting, respectively. The fair values as at April 30, 2014 and July 31, 2013 are as follows:

Related Party Transactions

As at April 30, 2014, the Company owed $7,992 (July 31, 2013 - $105,929) to directors and officers of the Company. The amounts owing are unsecured, non-interest bearing, and due on demand.

As at April 30, 2014, the Company owed $nil (July 31, 2013 - $48,605) to the former President of Company. During the period ended April 30, 2014, the Company incurred interest expense of $nil (July 31, 2013 - $2,623)

As at April 30, 2014, the Company owed $nil (July 31, 2013 - $101,649) to a company controlled by the former President of the Company. During the period ended April 30, 2014, the Company incurred interest expense of $5,291 (July 31, 2013 - $6,145).

As at April 30, 2014, the Company owed $nil (July 31, 2013 - $45,900) for amounts owing to the spouse of the former President of the Company. The amounts owing are unsecured, non-interest bearing, and due on demand.

As at April 30, 2014, the Company had $nil (July 31, 2013 - $1,726) of amounts owing from the Vice President of the Company. The amounts owing are unsecured, non-interest bearing, and due on demand.

As at April 30, 2014, the Company owed $nil (2013 - $77,255) to a company controlled by the former President of the Company, which has been recorded in accounts payable and accrued liabilities. The amount owing is unsecured, non-interest bearing, and due on demand.

Related Party Transactions (continued)

As at April 30, 2014, the Company had deferred compensation of $68,630 (July 31, 2013 - $256,027) incurred to directors and officers of the Company.

During the period ended April 30, 2014, the Company incurred consulting fees of $146,998 (2013 - $121,370) to directors and officers of the Company.

During the period ended April 30, 2014, the Company incurred travel fees of $62,696 (2013 - $76,735) to directors and officers of the Company.

During the period ended April 30, 2014, the Company incurred finders’ fees of $150,000 (2013 - $7,550) to a director of the Company. On October 21, 2013, the deferred compensation of $150,000 was expensed as the terms for the compensation expense were fulfilled.

During the period ended April 30, 2014, the Company issued 17,424,083 common shares with a fair value of $479,162 to settle amounts owing of $407,724 to officer and directors of the Company. The fair value of the common shares was determined using the end of day trading price of the Company’s common shares on the date of settlement. The Company recognized a loss of $71,438 on the settlement of debt.

During the period ended April 30, 2014, the Company issued 3,000,000 (2013 - nil) stock options with a fair value of $60,000 (2013 - $nil) to officers and directors of the Company.

Common Stock

On October 21, 2013, the Company issued 67,567,597 shares of Class A common stock at $0.0148 per share for proceeds of $1,000,000. The Company incurred a cash finders’ fee of $80,000 and issued 2,027,027 agents’ warrants with a fair value of $212,000 in conjunction with the private placement.

On December 26, 2013, the Company issued 1,438,849 shares of Class A common stock pursuant to the conversion of $20,000 of a convertible debenture, as described in Note 5(b).

On January 6, 2014, the Company issued 2,158,273 shares of Class A common stock pursuant to the conversion of $30,000 of a convertible debenture, as described in Note 5(b).

On January 14, 2014, the Company issued 1,937,984 shares of Class A common stock pursuant to the conversion of $25,000 of a convertible debenture, as described in Note 5(b).

On January 23, 2014, the Company issued 2,566,372 shares of Class A common stock pursuant to the conversion of $25,000 of a convertible debenture and $4,000 of accrued interest, as described in Note 5(b).

On March 21, 2014, the Company issued 1,271,186 shares of Class A common stock pursuant to the conversion of $15,000 of a convertible debenture, as described in Note 5(b).

On April 2, 2014, the Company issued 1,468,750 shares of Class A common stock pursuant to the conversion of $17,500 of a convertible debenture and $1,300 of accrued interest, as described in Note 5(b).

On April 8, 2013, the Company issued 21,367,521 shares of Class A common stock at $0.0234 per share for proceeds of $500,000.

On April 11, 2013, the Company issued 17,424,083 shares of Class A common stock at with a fair value of $479,162 to settle amounts owing to related parties. See Note 7(k).

Share Purchase Warrants

On November 1, 2013, the Company granted 2,027,027 brokers’ warrants pursuant to a financing agreement. The warrants have an exercise price of $0,07 per Class A common stock and expire on October 31, 2016. The fair value of the stock options were valued at $60,811 using the Black-Scholes option price model assuming a risk free rate of 0.61%, an expected life of 3 years, volatility of 539%, and no expected dividends.

The following table summarizes the continuity of share purchase warrants:

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 February 7, 2014, the Company granted 5,300,000 stock options to officers, directors, employees and consultants. The stock options vest immediately, have an exercise price of $0.10 per Class A common stock, and expire on February 6, 2024. The fair value of the stock options were valued at $212,000 using the Black Scholes option price model assuming a risk-free rate of 2.71%, an expected life of 10 years, volatility of 475%, and no expected dividends.

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

Stock Options (continued)

Additional information regarding stock options as of April 30, 2014, is as follows:

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 roles as a member of the Board of Directors for a one-year term upon the closing of a minimum of $1,000,000 raised.

On November 1, 2012, the Company entered into two 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 October 30, 2013, the parties amended the agreement whereby the Company will pay $75,000 on November 30, 2013 (paid) and $100,000 annually on October 1, 2014, 2015, 2016 and 2017.

On February 15, 2013, the Company entered into a consulting agreement for consulting and financing services for a period of one year. 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. This agreement expires on February 14, 2014.

Commitments (continued)

On June 11, 2013, the Company entered into a one year non-exclusive placement agent agreement. Under the terms of the agreement, the consultant will obtain financing for the Company in exchange for a finders’ fee of 10% in cash of equity funds raised up to $3,000,000 and 8% in cash of equity funds raised between $3,000,000 and $5,000,000, and 6% in cash of equity funds raised over $5,000,000. The Company also agreed to issue to the consultant warrants equal to 3% of the number of shares purchased by investors, which are exercisable at $0.07 per share for a period of 36 months from the issuance date.

Subsequent Event

We have evaluated subsequent events through the date of issuance of the financial statements, and did not have any material recognizable subsequent events after April 30, 2014.