ARKANOVA ENERGY CORP.

Operating expenses increased by $581,512 during the year ended September 30, 2016 to $3,477,930 compared to $2,896,418 during the year ended September 30, 2015. The increase is largely due to increase of $345,233 in depletion expense as a result of changes in reserve estimate, offset by a decrease of $656,531 in impairment of oil and gas properties. We also recognized an impairment of $901,192 (2015 - $nil) on other receivables during the year ended September 30, 2016.

During the year ended September 30, 2014, our company received $1,395,000 of project advances, of which $310,000 was received from Aton and $1,085,000 was received from Knightwall Invest, Inc. (“Knightwall Invest”), related parties to our company. Of the $1,395,000, $582,886 was reallocated to oil and gas properties to offset against the costs for the other working interest partners. During the year ended September 30, 2015, our company received an additional $2,025,000 of project advances, of which $450,000 was received from Aton and $1,575,000 was received from Knightwall Invest. Of the $2,025,000, $593,341 was reallocated to oil and gas properties to offset against the costs for the other working interest partners. During the year ended September 30, 2016, our company did not receive any additional project advances from Aton and Knighwall Invest and $159,152 was reallocated to oil and gas properties to offset against the costs for the other working interest partners. At September 30, 2016, our company had $2,084,621 (2015 - $2,243,773) of project advances shown as a current liability on the consolidated balance sheet of which $463,249 (2015 - $498,616) was received from Aton and $1,621,372 (2015 - $1,745,157) was received from Knighwall Invest. At September 30, 2016, $1,335,379 of the total project advances of $3,420,000 was re-allocated to oil and gas properties to offset against the costs for the other working interest partners. These funds will be used for costs to be incurred on the waterflood project and on drilling of Bekkan Well.

Our company evaluated the November 1, 2014 modification under the guidance found in ASC 470-50 and ASC 470-60 and determined that the carrying value of the 2013 Note did not exceed the total future cash payments of the 2014 Note and that the notes were not substantially different. As a result, it was concluded that the revised terms constituted a debt modification rather than a debt extinguishment and no gain or loss was recorded.

Other receivables from related parties consist of the Company’s working interest partners, Aton Select Funds Limited (“Aton”) and Knightwall Invest, Inc.’s (“Knightwall”) portion of oil and gas income less their portion of expenses. During the year ended September 30, 2016, the Company recognized an impairment of $901,192 as there was uncertainty with regards to the collection of the receivables.

On November 1, 2014, the Company’s subsidiary entered into a Loan Modification Agreement with Aton, a related party to the Company, to borrow an additional $2,475,000 for a total loan amount of $14,963,861 which includes accrued interest of $677,836. In addition, the maturity date was extended from December 31, 2015 to December 31, 2016 and the ability of the Company to pay interest in shares of the Company’s common stock was terminated. On December 31, 2016, the Company renewed the note and extended the maturity date to December 31, 2017. As the note was renewed on a long term basis, the loan has been reclassified from current liabilities to long term liabilities at September 30, 2016.

Arkanova evaluated the November 1, 2014 modification under the guidance found in ASC 470-50 and ASC 470-60 and determined that the carrying value of the 2013 Note did not exceed the total future cash payments of the 2014 Note and that the notes were not substantially different. As a result, it was concluded that the revised terms constituted a debt modification rather than a debt extinguishment and no gain or loss was recorded.