MANAGEMENT’S RESPONSIBILITY

TransAlta’s
management is responsible for presentation and preparation of the annual
consolidated financial statements, management’s discussion and analysis
(MD&A) and all other information in this annual report.

The
accompanying consolidated financial statements have been prepared in accordance
with Canadian generally accepted accounting principles and the requirements of
the Securities and Exchange Commission (SEC) in the U.S., as applicable.

The
MD&A has been prepared in accordance with the requirements of securities
regulators, including National Instruments 44-101 and 51-102 of the Canadian
Securities Administrators, as well as Item 303 of Regulation S-K of the
Securities Exchange Act, and their related published requirements.

The
consolidated financial statements and information in the MD&A necessarily
include amounts based on informed judgments and estimates of the expected
effects of current events and transactions with appropriate consideration for
materiality. In addition, in preparing financial information, the corporation
must interpret the requirements described above, make determinations as to the
relevancy of information to be included, and make estimates and assumptions that
affect reported information. The MD&A also includes information regarding
the estimated impact of current transactions and events, sources of liquidity
and capital resources, operating trends, risks and uncertainties. Actual results
in the future may differ materially from management’s present assessment of this
information because future events and circumstances may not occur as expected.

The
financial information presented elsewhere in this annual report is consistent
with that in the consolidated financial statements.

To meet
its responsibility for reliable and accurate financial statements, management
has established systems of internal control that are designed to provide
reasonable assurance that financial information is relevant, reliable and
accurate, and that assets are safeguarded and transactions are executed in
accordance with management’s authorization. These systems are monitored by
management and by internal auditors. In addition, the internal auditors perform
appropriate tests and related audit procedures.

The
consolidated financial statements have been examined by Ernst & Young LLP,
independent chartered accountants. The external auditors’ responsibility is to
express a professional opinion on the fairness of management’s consolidated
financial statements. The auditors’ report outlines the scope of their
examination and sets forth their opinion.

The Audit
and Environment (A&E) Committee of the Board of Directors is comprised of
independent directors. The A&E Committee meets regularly with management,
the internal auditors and the external auditors to satisfy itself that each is
properly discharging its responsibilities, and to review the consolidated
financial statements and MD&A. The A&E Committee reports its findings to
the Board of Directors for consideration when approving the consolidated
financial statements for issuance to the shareholders. The A&E Committee
also recommends, for review by the Board of Directors and approval of
shareholders, the appointment of the external auditors. The internal and
external auditors have full and free access to the A&E Committee.

TransAlta’s Chief
Executive Officer and Chief Financial Officer have certified TransAlta
Corporation’s annual disclosure documents in the U.S., as required by the U.S.
Sarbanes-Oxley Act, and in Canada by the Canadian securities regulators.



**STEPHEN
      G. SNYDER**
    **IAN
      A. BOURNE**PRESIDENT
      & CHIEF EXECUTIVE OFFICER
    EXECUTIVE
      VICE-PRESIDENT & CHIEF FINANCIAL OFFICERFEBRUARY 17,
      2005


6
2Tr a n s A l t a C o r p o r a t i o n A R / 0 4

---

AUDITORS’ REPORT

To the
Shareholders of TransAlta Corporation

We have
audited the consolidated balance sheets of TransAlta Corporation as at December
31, 2004 and 2003 and the consolidated statements of earnings and retained
earnings and cash flows for each of the years in the three year period ended
December 31, 2004. These financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We
conducted our audits in accordance with Canadian generally accepted auditing
standards and the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform an audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation.

In our
opinion, these consolidated financial statements present fairly, in all material
respects, the financial position of the Company as at December 31, 2004 and 2003
and the results of its operations and its cash flows for each of the years in
the three year period ended December 31, 2004 in accordance with Canadian
generally accepted accounting principles. We also report that, in our opinion,
these principles have been applied, except for changes in the method of
accounting for preferred shares, employee share purchase plan loans and mineral
rights as explained in Note 1(R)to the consolidated financial
statements, on a basis consistent with that of the preceding year.



CHARTERED
ACCOUNTANTS

CALGARY,
CANADA

FEBRUARY
25, 2005

C
o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s6
3

---

CONSOLIDATED STATEMENTS OF EARNINGS
& RETAINED EARNINGS

Year ended
      Dec. 31
    
    2004
    
    2003
    
    2002(in millions
      of Canadian dollars except per share amounts)
    
    
    
    (Restated,
      Note 1)
    
    (Restated,
      Note 1)Revenues
    
    $
    2,838.3
    
    $
    2,520.9
    
    $
    1,814.9Trading
      purchases
    
    
    (197.7
    )
    
    (97.4
    )
    
    (91.0
    )Fuel and
      purchased power
    
    
    (1,231.3
    )
    
    (1,067.4
    )
    
    (664.6
    )Gross
      margin
    
    
    1,409.3
    
    
    1,356.1
    
    
    1,059.3Operations,
      maintenance and administration
    
    
    572.7
    
    
    559.3
    
    
    420.5Depreciation
      and amortization (Note 2)
    
    
    377.3
    
    
    339.0
    
    
    243.0Taxes, other
      than income taxes
    
    
    20.8
    
    
    23.1
    
    
    27.4Operating
      expenses
    
    
    970.8
    
    
    921.4
    
    
    690.9Gain on sale
      of Sheerness Generating Station (Note 4)
    
    
    –
    
    
    (191.5
    )
    
    –Gain on sale
      of Meridian Cogeneration Facility (Note 4)
    
    
    (17.7
    )
    
    –
    
    
    –Gain on sale
      of TransAlta Power partnership units (Note 4)
    
    
    (44.8
    )
    
    (15.2
    )
    
    –Gain on sale
      of land (Note 4)
    
    
    –
    
    
    (10.5
    )
    
    –Asset
      impairment charges (Notes 6 and 7)
    
    
    –
    
    
    90.3
    
    
    152.5Prior period
      regulatory decision (Note 16)
    
    
    22.9
    
    
    –
    
    
    3.3(39.6
    )
    
    (126.9
    )
    
    155.8Operating
      income
    
    
    478.1
    
    
    561.6
    
    
    212.6Other income
      (expense)
    
    
    –
    
    
    (3.2
    )
    
    0.1Foreign
      exchange gain (loss)
    
    
    0.7
    
    
    (4.7
    )
    
    1.2Net interest
      expense (Note 11)
    
    
    (222.1
    )
    
    (220.7
    )
    
    (117.6
    )Earnings
      before non-controlling interests and income taxes
    
    
    256.7
    
    
    333.0
    
    
    96.3Non-controlling
      interests (Note 13)
    
    
    46.0
    
    
    34.2
    
    
    20.1Earnings
      before income taxes
    
    
    210.7
    
    
    298.8
    
    
    76.2Income tax
      expense (Note 17)
    
    
    50.1
    
    
    64.6
    
    
    9.4Earnings
      from continuing operations
    
    
    160.6
    
    
    234.2
    
    
    66.8Earnings from
      discontinued operations, net of tax (Note 3)
    
    
    –
    
    
    –
    
    
    12.8Gain on
      disposal of discontinued operations, net of tax (Notes 3 and
      4)
    
    
    9.6
    
    
    –
    
    
    120.0Net
      earnings
    
    
    170.2
    
    
    234.2
    
    
    199.6Common
      share dividends
    
    
    (192.7
    )
    
    (185.0
    )
    
    (169.0
    )Adjustment
      arising from normal course issuer bid(Note 14)
    
    
    (1.1
    )
    
    –
    
    
    (27.0
    )Retained
      earningsOpening
      balance
    
    
    933.9
    
    
    884.7
    
    
    881.1Closing
      balance
    
    $
    910.3
    
    $
    933.9
    
    $
    884.7Weighted
      average common shares outstanding in the year
    
    
    192.7
    
    
    185.3
    
    
    169.6Basic
      earnings per shareEarnings from
      continuing operations
    
    $
    0.83
    
    $
    1.26
    
    $
    0.39Earnings from
      discontinued operations
    
    
    –
    
    
    –
    
    
    0.07Net
      earnings from operations
    
    
    0.83
    
    
    1.26
    
    
    0.46Gain on
      disposal of discontinued operations, net of tax
    
    
    0.05
    
    
    –
    
    
    0.71Net
      earnings
    
    $
    0.88
    
    $
    1.26
    
    $
    1.17Diluted
      earnings per share(Note 14)Earnings from
      continuing operations
    
    $
    0.83
    
    $
    1.26
    
    $
    0.39Earnings from
      discontinued operations
    
    
    –
    
    
    –
    
    
    0.07Net
      earnings from operations
    
    
    0.83
    
    
    1.26
    
    
    0.46Gain on
      disposal of discontinued operations, net of tax
    
    
    0.05
    
    
    –
    
    
    0.71Net
      earnings
    
    $
    0.88
    
    $
    1.26
    
    $
    1.17See
      accompanying notes.


6
4   Tr a n s A l t a C o r p o r a t i o n A R / 0 4

---

CONSOLIDATED BALANCE SHEETS

Dec.
    31
    
    2004
    
    2003(in millions
      of Canadian dollars)
    
    
    
    (Restated,
      Note 1)ASSETS(Note 11)Current
      assetsCash and cash
      equivalents
    
    $
    137.1
    
    $
    155.0Accounts
      receivable (Notes 4 and 21)
    
    
    429.1
    
    
    420.1Prepaid
      expenses
    
    
    54.7
    
    
    53.8Price risk
      management assets (Note 19)
    
    
    61.4
    
    
    68.4Future income
      tax assets (Note 17)
    
    
    21.5
    
    
    29.4Income taxes
      receivable
    
    
    60.1
    
    
    108.9Inventory
    
    
    39.9
    
    
    47.0Current
      portion of other assets (Note 9)
    
    
    192.7
    
    
    49.4996.5
    
    
    932.0Restricted
      cash(Note 4)
    
    
    8.9
    
    
    9.9Investments(Note 5)
    
    
    3.0
    
    
    5.0Long-term
      receivables(Note 6)
    
    
    –
    
    
    120.1Property,
      plant and equipment(Note 7)Cost
    
    
    8,865.4
    
    
    8,693.2Accumulated
      depreciation
    
    
    (2,621.0
    )
    
    (2,307.7
    )6,244.4
    
    
    6,385.5Goodwill(Note 4)
    
    
    142.2
    
    
    149.6Intangible
      assets(Note 8)
    
    
    392.3
    
    
    477.2Future
      income tax assets(Note 17)
    
    
    132.0
    
    
    90.3Price risk
      management assets(Note 19)
    
    
    32.5
    
    
    31.6Other
      assets(Note 9)
    
    
    181.2
    
    
    280.8Total
      assets
    
    $
    8,133.0
    
    $
    8,482.0LIABILITIES
      AND SHAREHOLDERS’ EQUITYCurrent
      liabilitiesShort-term
      debt (Note 10)
    
    $
    34.4
    
    $
    119.8Accounts
      payable and accrued liabilities
    
    
    432.3
    
    
    501.2Price risk
      management liabilities (Note 19)
    
    
    49.9
    
    
    64.3Income taxes
      payable
    
    
    6.9
    
    
    –Future income
      tax liabilities (Note 17)
    
    
    11.1
    
    
    4.6Dividends
      payable
    
    
    19.3
    
    
    14.9Deferred
      credits and other current liabilities (Note 12)
    
    
    133.4
    
    
    24.1Current
      portion of long-term debt – recourse (Note 11)
    
    
    538.1
    
    
    138.5Current
      portion of long-term debt – non-recourse (Note 11)
    
    
    49.6
    
    
    45.31,275.0
    
    
    912.7Long-term
      debt – recourse(Note 11)
    
    
    1,939.8
    
    
    2,428.1Long-term
      debt – non-recourse(Note 11)
    
    
    530.4
    
    
    534.2Preferred
      securities(Note 11)
    
    
    175.0
    
    
    475.0Deferred
      credits and other long-term liabilities(Note 12)
    
    
    391.3
    
    
    487.6Future
      income tax liabilities(Note 17)
    
    
    703.9
    
    
    686.1Price risk
      management liabilities(Note 19)
    
    
    28.5
    
    
    29.9Non-controlling
      interests(Note 13)
    
    
    616.4
    
    
    477.9Common
      shareholders’ equityCommon shares
      (Note 14)
    
    
    1,611.9
    
    
    1,555.7Retained
      earnings
    
    
    910.3
    
    
    933.9Cumulative
      translation adjustment
    
    
    (49.5
    )
    
    (39.1
    )2,472.7
    
    
    2,450.5Total
      liabilities and shareholders' equity
    
    $
    8,133.0
    
    $
    8,482.0Contingencies(Notes 6, 16 and 23)Subsequent
      events(Note 25)Commitments(Note 22)See
      accompanying notes.
  On behalf of
      the Board:
    
    
    **WILLIAM
      D. ANDERSON**DIRECTOR






C
o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s6
5

---

CONSOLIDATED STATEMENTS OF CASH
FLOWS

Year ended
      Dec. 31
    
    2004
    
    2003
    
    2002(in millions
      of Canadian dollars)
    
    
    
    (Restated,
      Note 1)
    
    (Restated,
      Note 1)Operating
      activitiesNet
      earnings
    
    $
    170.2
    
    $
    234.2
    
    $
    199.6Depreciation
      and amortization (Note 2)
    
    
    411.8
    
    
    378.1
    
    
    276.8California
      receivable provision (Note 6)
    
    
    22.9
    
    
    –
    
    
    –Gain on sale
      of TransAlta Power partnership units (Note 4)
    
    
    (44.8
    )
    
    (15.2
    )
    
    –Non-controlling
      interests
    
    
    46.0
    
    
    34.2
    
    
    20.1Writedown of
      investments (Note 5)
    
    
    –
    
    
    6.2
    
    
    –Asset
      retirement obligation accretion (Note 12)
    
    
    19.3
    
    
    22.0
    
    
    18.7Future income
      taxes (Note 17)
    
    
    17.8
    
    
    27.4
    
    
    (54.4
    )Unrealized
      loss (gain) from energy marketing activities
    
    
    (9.7
    )
    
    (18.6
    )
    
    31.7Asset
      retirement obligation costs settled (Note 12)
    
    
    (19.7
    )
    
    (26.5
    )
    
    (14.5
    )Foreign
      exchange loss (gain)
    
    
    (0.7
    )
    
    4.7
    
    
    (1.2
    )Asset
      impairment charge
    
    
    –
    
    
    90.3
    
    
    152.5Loss (gain)
      on sale of assets
    
    
    (15.1
    )
    
    (202.0
    )
    
    15.6Gain on
      disposal of discontinued operations
    
    
    (9.6
    )
    
    –
    
    
    (120.0
    )Other
      non-cash items
    
    
    –
    
    
    3.2
    
    
    (15.2
    )588.4
    
    
    538.0
    
    
    509.7Change in
      non-cash operating working capital balances
    
    
    25.0
    
    
    (11.1
    )
    
    (111.1
    )Cash flow
      from operating activities
    
    
    613.4
    
    
    526.9
    
    
    398.6Investing
      activitiesLong-term
      receivables
    
    
    90.8
    
    
    –
    
    
    165.3Additions to
      property, plant and equipment
    
    
    (365.8
    )
    
    (555.7
    )
    
    (945.8
    )Proceeds on
      sale of property, plant and equipment (Note 4)
    
    
    43.2
    
    
    226.7
    
    
    2.3Proceeds on
      sale of TransAlta Power partnership units (Note 4)
    
    
    116.5
    
    
    37.2
    
    
    –Investments
    
    
    –
    
    
    –
    
    
    (6.1
    )Restricted
      cash (Note 4)
    
    
    1.1
    
    
    46.7
    
    
    –Acquisitions
      (Note 4)
    
    
    –
    
    
    (323.4
    )
    
    (40.1
    )Proceeds on
      sale of long-term investments (Note 5)
    
    
    –
    
    
    21.6
    
    
    –Reduction in
      advance to TransAlta Power (Note 4)
    
    
    2.0
    
    
    –
    
    
    –Realized
      foreign exchange gains on net investments (Note 19)
    
    
    47.8
    
    
    194.1
    
    
    4.2Deferred
      charges and other
    
    
    (1.0
    )
    
    11.8
    
    
    (29.8
    )Proceeds on
      sale of discontinued operations (Note 3)
    
    
    –
    
    
    –
    
    
    818.0Cash flow
      used in investing activities
    
    
    (65.4
    )
    
    (341.0
    )
    
    (32.0
    )Financing
      activitiesRepayment of
      short-term debt
    
    
    (85.4
    )
    
    (170.2
    )
    
    (247.1
    )Repayment of
      long-term debt
    
    
    (292.2
    )
    
    (601.1
    )
    
    (454.5
    )Dividends on
      common shares
    
    
    (135.4
    )
    
    (158.3
    )
    
    (115.5
    )Issuance of
      long-term debt
    
    
    2.7
    
    
    544.6
    
    
    611.3Redemption of
      common shares
    
    
    (2.3
    )
    
    –
    
    
    (49.9
    )Net proceeds
      on issuance of common shares
    
    
    3.4
    
    
    265.0
    
    
    1.8Distributions
      to subsidiary’s non-controlling limited partner
    
    
    (48.4
    )
    
    (38.9
    )
    
    (24.5
    )Deferred
      financing charges and other
    
    
    (1.2
    )
    
    (6.6
    )
    
    (7.6
    )Cash flow
      used in financing activities
    
    
    (558.8
    )
    
    (165.5
    )
    
    (286.0
    )Cash flow
      from operating, investing and financing activities
    
    
    (10.8
    )
    
    20.4
    
    
    80.6Effect of
      translation on foreign currency cash
    
    
    (7.1
    )
    
    (8.7
    )
    
    0.7Increase in
      cash and cash equivalents
    
    
    (17.9
    )
    
    11.7
    
    
    81.3Cash and cash
      equivalents, beginning of year
    
    
    155.0
    
    
    143.3
    
    
    62.0Cash and cash
      equivalents, end of year
    
    $
    137.1
    
    $
    155.0
    
    $
    143.3Cash taxes
      paid
    
    $
    4.6
    
    $
    34.1
    
    $
    123.1Cash interest
      paid
    
    $
    253.4
    
    $
    232.8
    
    $
    210.8See
      accompanying notes.


6
6   Tr a n s A l t a C o r p o r a t i o n A R / 0 4

---

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS( T A B U L A
R   D O L L A R   A M O U N T S   I N 
 M I L L I O N S   O F   C A N A D I A N   D
O L L A R S ,   E X C E P T   A SO T H E R W I S
E   N O T E D )

**1.
SUMMARY OF SI** **G** **NIFICANT
ACCOUNTIN** **G** **POLICIES**
 
 **A.
Consolidation**
 
 These
consolidated financial statements have been prepared by management in accordance
with Canadian generally accepted accounting principles (Canadian GAAP). These
accounting principles are different in some respects from United States
generally accepted accounting principles (U.S. GAAP). The significant
differences are described in Note 26.


The
consolidated financial statements include the accounts of TransAlta Corporation
(TransAlta or the corporation), all subsidiaries and the proportionate share of
the accounts of jointly controlled corporations.

B. Use
of Estimates and Measurement Uncertainty

The
preparation of financial statements in accordance with GAAP requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the period. Actual results could differ from those estimates due to
factors such as fluctuations in interest rates, currency exchange rates,
inflation levels and commodity prices, changes in economic conditions and
legislative and regulatory changes (Notes 7, 18, 19 and 23).

C.
Revenue Recognition

The
majority of the corporation’s revenues are derived from the sale of physical
power and from energy marketing and trading activities. Revenues under long-term
electricity and thermal sales contracts generally include one or more of the
following components: fixed capacity payments for being available, energy
payments for generation of electricity, incentives or penalties for exceeding or
not meeting availability targets, excess energy payments for power generation
above committed capacity and ancillary services. Each is recognized upon output,
delivery or satisfaction of specific targets, all as specified by contractual
terms. Revenues from non-contracted capacity are comprised of energy payments
for each MWh produced at market prices, and are recognized upon delivery.

Derivatives used in
trading activities include physical and financial swaps, forward sales
contracts, futures contracts and options, which are used to earn trading
revenues and to gain market information. These derivatives are accounted for
using the fair value method of accounting. Derivatives, other than real-time
physical contracts, are presented on a net basis in the statements of earnings.
The initial recognition of fair value and subsequent changes in fair value
affect reported earnings in the period the change occurs. The fair values of
those instruments that remain open at the balance sheet date represent
unrealized gains or losses and are presented on the balance sheets as price risk
management assets and liabilities. Non-derivative contracts are accounted for
using the accrual method.

To be
consistent with the U.S. Financial Accounting Standards Board (FASB) Emerging
Issues Task Force (EITF) pronouncement 03-11,Reporting
Realized Gains and Losses on Derivative Instruments That Are Subject to FASB
Statement 133, Accounting for Derivative Instruments and Hedging Activities, and
Not Held for Trading Purposes,TransAlta has concluded that real-time
physical contracts meet the definition of derivative contracts held for delivery
and therefore realized gains and losses are reported gross in the consolidated
statements of earnings.

The
majority of the corporation’s derivatives have quoted market prices or
over-the-counter quotes are available from brokers. However, some derivatives
are not traded on an active exchange or extend beyond the time period for which
exchange-based quotes are available, requiring the use of internal valuation
techniques or models (mark-to-model accounting).

D.
Discontinued Operations

The
results of discontinued operations are presented net of tax on a one-line basis
in the consolidated statements of earnings. Interest expense, direct corporate
overheads and income taxes are allocated to discontinued operations. General
corporate overheads are not allocated to discontinued operations.

E.
Inventory

The
corporation’s inventory balance represents fuel which is valued at the lower of
cost and market value, defined as net replacement value. Inventory cost is
determined using moving average cost. The costing method used is direct costing,
which is determined as the sum of all applicable expenditures and charges
directly or indirectly incurred in bringing an inventory item to its existing
condition and location.

F.
Property, Plant and Equipment

The
corporation’s investment in property, plant and equipment (PP&E) is stated
at original cost at the time of construction, purchase or acquisition. Original
cost includes items such as materials, labour, interest and other appropriately
allocated costs. As costs are expended for new construction, the entire amount
is capitalized as PP&E on the consolidated balance sheet and is subject to
depreciation upon

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commencement of
commercial operations. The cost of routine maintenance and repairs, such as
inspections and corrosion removal, and the replacement of minor parts, are
charged to expense as incurred. Certain expenditures relating to replacement of
components incurred during major maintenance are capitalized and amortized over
the estimated benefit period of such expenditures. A component is a tangible
portion of the asset that can be separately identified as an asset and
depreciated over its own expected useful life, and is expected to provide a
benefit of greater than one year.

The
estimate of the useful life of PP&E is based on current facts and past
experience, and takes into consideration existing long-term sales agreements and
contracts, current and forecasted demand and the potential for technological
obsolescence. The useful life is used to estimate the rate at which the PP&E
is depreciated or amortized. These estimates are subject to revision in future
periods based on new or additional information. Depreciation and amortization is
calculated using straight-line, declining balance and unit of production
methods. Coal rights are amortized on a unit of production basis, based on the
estimated mine reserve.

TransAlta
capitalizes interest on capital invested in projects under construction. Upon
commencement of commercial operations, capitalized interest, as a portion of the
total cost of the plant, is amortized over the estimated useful life of the
plant.

On an
annual basis, and when indicators of impairment exist, TransAlta determines
whether the net carrying amount of PP&E is recoverable from future
undiscounted cash flows. Factors that could indicate an impairment exists
include significant underperformance relative to historical or projected future
operating results, significant changes in the manner or use of the assets,
significant negative industry or economic trends, or a change in the strategy
for the corporation’s overall business. In some cases, these events are clear.
However, in many cases, a clearly identifiable event indicating possible
impairment does not occur. Instead, a series of individually insignificant
events occur over a period of time leading to an indication that an asset may be
impaired. This can be further complicated where TransAlta is not the operator of
the facility. Events can occur in these situations that may not be known until a
date subsequent to their occurrence.

The
corporation’s businesses, the markets and business environment are continually
monitored, and judgments and assessments are made to determine whether an event
has occurred that indicates possible impairment. If such an event has occurred,
an estimate is made of future undiscounted cash flows from the PP&E. If the
total of the undiscounted future cash flows, excluding financing charges with
the exception of plants that have specifically dedicated debt, is less than the
carrying amount of the PP&E, an asset impairment must be recognized in the
financial statements. The amount of the impairment charge to be recognized is
calculated by subtracting the fair value of the asset from the carrying value of
the asset. Fair value is the amount at which an item could be bought or sold in
a current transaction between willing parties, and is estimated by calculating
the present value of expected future cash flows related to the asset.

G.
Goodwill

Goodwill
is the cost of an acquisition less the fair value of the net assets of an
acquired business. Goodwill and certain intangibles are no longer subject to
amortization, but are instead tested for impairment at least annually, or more
frequently if an analysis of events and circumstances indicate that a possible
impairment may arise earlier. These events could include a significant change in
financial position of the reporting unit to which the goodwill relates or
significant negative industry or economic trends. To test for impairment, the
fair value of the reporting units to which the goodwill relates is compared to
the carrying values of the reporting units. The corporation determined that the
fair values of the reporting units, based on historical cash flows and estimates
of future cash flows, exceeded their carrying values. There was no impairment of
goodwill at Dec. 31, 2004, 2003 or 2002.

H.
Intangible Assets

Intangible
assets consist of power sale contracts, with rates higher than market rates at
the date of acquisition, acquired in the purchase of CE Generation LLC (CE Gen),
a jointly controlled enterprise (Note 4).Sale contracts are valued at
cost and are amortized on a straight-line basis over the remaining contract
period, which ranges from seven to 30 years.

I.
Asset Retirement Obligations

Effective
Jan. 1, 2003, TransAlta early adopted the new Canadian Institute of Chartered
Accountants (CICA) standard for accounting for asset retirement obligations.
Under the new standard, the corporation recognizes asset retirement obligations
in the period in which they are incurred if a reasonable estimate of a fair
value can be determined. The associated asset retirement costs are capitalized
as part of the carrying amount of the long-lived asset. The liability is
accreted over the estimated time period until settlement of the obligation and
the asset is depreciated over the estimated useful life of the asset.
Previously, future site restoration costs for coal and hydro plants were
recognized over the estimated life of the plant on a straight-line basis.
Reclamation costs for mining assets were recognized on a unit-of-production
basis. No provision for future site restoration for gas generation plants had
been recorded as the costs of restoration were expected to be offset by the
salvage value of the related plant.

TransAlta
recorded an asset retirement obligation for all generating facilities, as it is
legally required to remove the facilities at the end of their useful lives and
restore the plant and mine sites to their original condition. For the hydro
facilities, the corporation is required to remove the generating equipment, but
is not legally required to remove the structures. TransAlta has recognized legal
obligations arising from

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government
legislation, written agreements between entities and case law. The asset
retirement liabilities are recognized when the asset retirement obligation is
incurred. Asset retirement liabilities for coal mines are incurred over time, as
new areas are mined, and a portion of the liability is settled over time as
areas are reclaimed prior to final pit reclamation.

The effect
of this change in accounting policy was recorded retroactively with restatement
of prior periods.

J.
Investments

Investments in
shares of companies over which the corporation exercises significant influence
are accounted for using the equity method. Other investments are carried at
cost. If there is other than a temporary decline in the value of the investment,
it is written down to net realizable value.

K.
Other Assets

Deferred
license fees and deferred contract costs are amortized on a straight-line basis
over the useful life of the related assets or long-term contracts.

Financing
costs for the issuance of long-term debt and preferred securities are amortized
to earnings on a straight-line basis over the term of the related issue.

Other
costs capitalized on the balance sheet include project development costs, which
includes external, direct and incremental costs that are necessary for
completion of a potential acquisition or construction project. Business
development costs are included in operating expenses until construction of a
plant or acquisition of an investment is likely to occur, there is reason to
believe that future costs are recoverable and that efforts will result in future
value to the corporation, at which time the future costs are included in
PP&E or investments. The appropriateness of the carrying value of these
costs is evaluated each reporting period, and unrecoverable amounts of
capitalized costs for projects no longer probable of occurring are charged to
expense in the current period.

L.
Income Taxes

The
corporation uses the liability method of accounting for income taxes for its
operations. Under the liability method, income taxes are recognized for the
differences between financial statement carrying values and the respective
income tax basis of assets and liabilities (temporary differences), and the
carry forward of unused tax losses. Future income tax assets and liabilities are
measured using income tax rates expected to apply in the years in which
temporary differences are expected to be recovered or settled. The effect on
future income tax assets and liabilities of a change in tax rates is included in
earnings in the period the change is substantively enacted. Future income tax
assets are evaluated annually and if realization is not considered ‘more likely
than not’, a valuation allowance is provided.

M.
Employee Future Benefits

The
corporation accrues its obligations under employee benefit plans and the related
costs, net of plan assets. The cost of pensions and other post-employment and
post-retirement benefits earned by employees is actuarially determined using the
projected benefit method pro-rated on services and management’s best estimate of
expected plan investment performance, salary escalation, retirement ages of
employees and expected health care costs. The defined benefit pension plans are
based on an employee’s final average earnings and years of service. Pension
benefits will increase annually by two per cent. For the purpose of calculating
the expected return on plan assets, those assets are valued at quoted market
value. The discount rate used to calculate the interest cost on the accrued
benefit obligation is determined by reference to market interest rates at the
balance sheet date on high-quality debt instruments with cash flows that match
the timing and amount of expected benefit payments. Past service costs from plan
amendments are amortized on a straight-line basis over the estimated average
remaining service period of employees active at the date of amendment (EARSL).
The excess of the net cumulative unamortized actuarial gain or loss over 10 per
cent of the greater of the accrued benefit obligation and the market value of
plan assets is amortized over the estimated average remaining service period of
the active employees. When the restructuring of a benefit plan gives rise to
both a curtailment and settlement of obligations, the curtailment is accounted
for prior to the settlement. Transition obligations and assets arising from the
prospective adoption of new accounting standards are amortized over EARSL.

N.
Foreign Currency Translation

The
corporation’s self-sustaining foreign operations are translated using the
current rate method. Translation gains and losses are deferred and included in
the cumulative translation adjustment (CTA) account in shareholders’ equity.
Foreign currency denominated monetary and non-monetary assets and liabilities
are translated at exchange rates in effect on the balance sheet date.

Transactions
denominated in foreign currencies are translated at the exchange rate on the
transaction date. The resulting exchange gains and losses on these items are
included in net earnings.

O.
Derivatives and Financial Instruments

Derivatives used in
trading activities are described in Note 1(C).

Physical
and financial swaps, forward sales contracts, futures contracts and options are
used to hedge the corporation’s exposure to fluctuations in electricity and
natural gas prices related to output from the plants. Under Canadian GAAP, if
hedging criteria are met (described

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9

---

below),
gains and losses on these derivatives are deferred and recognized in earnings in
the same period and financial statement caption as the hedged exposure
(settlement accounting). The derivatives are not recorded on the balance sheet.

Cross-currency
interest rate swaps, foreign currency forward contracts and foreign currency
long-term debt are used to hedge exposure to changes in the carrying values of
the corporation’s net investments in foreign operations as a result of changes
in foreign exchange rates. Under Canadian GAAP, gains and losses on the
principal component of the cross-currency interest rate swaps as well as gains
and losses on the forward sales contracts and foreign currency long-term debt
are deferred and included in CTA, a separate component of shareholders’ equity.
The principal component of the cross-currency interest rate swaps is deferred
and recorded in other assets (Note 9)or deferred credits and other
long-term liabilities (Note 12)as appropriate. The forward sales
contracts are not recognized on the balance sheet in accordance with Canadian
GAAP.

Foreign
currency forward contracts are used to hedge the foreign exchange exposures
resulting from anticipated contracts and firm commitments denominated in foreign
currencies. Under Canadian GAAP, if hedge criteria are met, these derivatives
are not recognized on the balance sheet. Upon settlement of the derivative, any
gain or loss on the forward contracts is deferred and included in other assets
(Note 9)or deferred credits and other long-term liabilities (Note
12),and is included in the cost of the asset when the asset is purchased
and depreciated over the asset’s estimated useful life (settlement accounting).

Interest
rate swaps are used to manage the impact of fluctuating interest rates on
existing debt. These instruments are not recognized on the balance sheet under
Canadian GAAP. Interest rate swaps require the periodic exchange of payments
without the exchange of the notional principal amount on which the payments are
based. If hedge criteria are met, interest expense on the debt is adjusted to
include the payments made or received under the interest rate swaps (settlement
accounting).

To be
accounted for as a hedge under both Canadian and U.S. GAAP, a derivative must be
designated and documented as a hedge, and must be effective at inception and on
an ongoing basis. The documentation defines all relationships between hedging
instruments and hedged items, as well as the corporation’s risk management
objective and strategy for undertaking various hedge transactions. The process
includes linking derivatives to specific assets and liabilities on the balance
sheet or to specific firm commitments or anticipated transactions. The
corporation also formally assesses, both at the hedge’s inception and on an
ongoing basis, whether the derivatives used are highly effective in offsetting
changes in fair values or cash flows of hedged items. Hedge effectiveness of
cash flows is achieved if the derivatives’ cash flows substantially offset the
cash flows of the hedged item and the timing of the cash flows is similar. Hedge
effectiveness of fair values is achieved if changes in the fair value of the
derivative substantially offset changes in the fair value of the item hedged. In
a highly effective hedging relationship, U.S. GAAP requires any hedge
ineffectiveness to be recognized in earnings in the current period. If the above
hedge criteria are not met, the derivative is accounted for on the balance sheet
at fair value, with the initial fair value and subsequent changes in fair value
recorded in earnings in the period of change.

If a
derivative that has been accorded hedge accounting matures, expires, is sold,
terminated or cancelled, and is not replaced as part of the corporation’s
hedging strategy, the termination gain or loss is deferred and recognized when
the gain or loss on the item hedged is recognized. If a designated hedged item
matures, expires, is sold, extinguished or terminated, and the hedged item is no
longer probable of occurring, any previously deferred amounts associated with
the hedging item are recognized in current earnings along with the corresponding
gains or losses recognized on the hedged item. If a hedging relationship is
terminated or ceases to be effective, hedge accounting is not applied to
subsequent gains or losses. Any previously deferred amounts are carried forward
and recognized in earnings in the same period as the hedged item.

P.
Stock-based Compensation Plans

The
corporation has three types of stock-based compensation plans comprised of two
stock option-based plans, and a Performance Share Ownership Plan (PSOP),
described in Note 15.On Jan. 1, 2002, the corporation retroactively
adopted the new CICA standard for stock-based compensation. The new standard
requires that stock-based payments to non-employees, direct awards of stock and
awards that call for settlement in cash or other assets be accounted for using
the fair value method of accounting. The fair value method is encouraged for
other stock-based compensation plans, but other methods of accounting, such as
the intrinsic value method, are permitted. Under the fair value method,
compensation expense is measured at the grant date at fair value and recognized
over the service period. Under the intrinsic value method, compensation expense
is determined as the difference between the market price of the underlying stock
and the exercise price of the equity instrument granted on the date of the
grant. If the intrinsic value method is used, disclosure is made of earnings and
per share amounts as if the fair value method had been used. Effective Jan. 1,
2003, the corporation elected to prospectively use the fair value method of
accounting for stock-based compensation arrangements. No awards were granted in
2003 or 2004. Note 15provides pro forma measures of net earnings and
earnings per share had compensation expense been recognized for awards granted
prior to 2003 based on the estimated fair value of the options on the grant date
in accordance with the fair value method of accounting for stock-based
compensation.

Stock
grants under PSOP are accrued in corporate operations, maintenance and
administration expense as earned to the balance sheet date, based upon the
percentile ranking of the total shareholder return of the corporation’s common
shares in comparison to the total

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shareholder returns
of a selected group of publicly traded companies. Compensation expense under the
phantom stock option plan is recognized in operations, maintenance and
administration expense for the amount by which the quoted market price of
TransAlta’s shares exceed the option price, and adjusted for changes in each
period for changes in the excess over the option price. If stock options or
stock are repurchased from employees, the excess of the consideration paid over
the carrying amount of the stock option or stock cancelled is charged to
retained earnings.

Q. Cash
and Cash Equivalents

Cash and
cash equivalents are comprised of cash and highly liquid investments with
original maturities of three months or less.

R.
Changes in Accounting Standards

The CICA
established a new standard on the disposal of long-lived assets and discontinued
operations. This standard became effective May 1, 2003, however TransAlta early
adopted the standard on Jan. 1, 2003 with retroactive restatement. The standard
requires that a long-lived asset to be disposed of other than by sale shall
continue to be classified as held and used until it is disposed of. Certain
criteria must be met before a long-lived asset can be classified as held for
sale. The standard also defines discontinued operations more broadly than
previously and prohibits the inclusion of future operating losses in a loss
recognized upon classification of a long-lived asset as held for sale. The
impact of adopting this standard was not material to the consolidated financial
statements.

In the
fourth quarter of 2003, in response to changes in accounting standards in the
U.S. with respect to derivative instruments not held for trading, the
corporation adopted a policy that all gains and losses on real-time physical
trading contracts be shown gross in the statements of earnings. Prior period
amounts have been restated.

Effective
Jan. 1, 2004, TransAlta early adopted the amended CICA standard on the
presentation of liabilities and equity. The standard addresses the situation in
which an entity has a contractual obligation of a fixed amount or an amount that
fluctuates in part or in full in response to changes in a variable other than
the market price of the entity’s own equity instruments, but the entity must, or
can, settle the obligation by delivery of its own equity instruments (the number
of which depends on the amount of the obligation). Such an obligation is a
financial liability of the entity.

TransAlta
has presented the corporation’s preferred securities as financial liabilities on
the consolidated balance sheets. Preferred securities distributions are included
in interest expense on the consolidated statements of earnings (Note 11)and therefore included as a deduction in arriving at net earnings. This
change in accounting policy was recorded retroactively with restatement and as a
result, preferred securities distributions, net of tax, have been reduced to nil
in each of 2004, 2003 and 2002, net interest expense for the year ended Dec. 31,
2004 was increased by $44.5 million (2003 – $36.8 million, 2002 – $34.9
million), and income tax expense for the year ended Dec. 31, 2004 was decreased
by $15.0 million (2003 – $13.8 million, 2002 – $14.0 million). The liability
component of the preferred securities has increased to $475.0 million from
$450.8 million as at Dec. 31, 2003 as a result of this restatement.

Effective
Jan. 1, 2004, the corporation has prospectively presented employee share
purchase plan loans as a deduction from shareholders’ equity. The impact of this
new accounting treatment is not material to the consolidated financial
statements.

In March
2004, the U.S. Financial Accounting Standards Board (FASB) Emerging Issues Task
Force (EITF) reached a consensus on EITF Issue No. 04-02, Whether Mineral
Rights are Tangible or Intangible Assets,that mineral rights, as defined in
the Issue, are tangible assets. As a result of this decision, TransAlta accounts
for coal rights under both Canadian and U.S. GAAP as tangible assets. Prior
period amounts have been reclassified from intangible assets to tangible assets
(Dec. 31, 2003 – $58.5 million). There was no effect on net earnings as a result
of the reclassification.

**2.
SE****G****MENT DISCLOSURES**
****
**A.
Description of Reportable Segments**


The
corporation has two reportable segments: Generation and Energy Marketing. Both
segments are supported by the corporate group. A third business segment,
Transmission, was reclassified as a discontinued operation following the
announcement of the agreement to dispose of the segment on July 4, 2001. The
operation was sold on April 29, 2002 (Notes 3 and 4). The business
segments are strategic business units that offer different products and
services, and each is managed separately. The corporate group provides finance,
treasury, legal, human resources and other administrative support to the
business segments. Corporate overheads are allocated to the business segments to
the extent they are not directly attributable to discontinued operations.

Each
business segment assumes responsibility for its operating results measured as
operating income.

The
Generation segment owns coal, gas, wind, geothermal and hydro power plants in
Canada, the U.S., Mexico and Australia, and generates its revenue from the sale
of electricity, steam and ancillary services. Generation expenses include Energy
Marketing’s intersegment charge for energy marketing and financial risk
management services in the amount of $26.0 million (2003 – $24.8 million, 2002 –
$8.7 million).

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The Energy
Marketing segment derives revenue from the wholesale trading of electricity and
other energy-related commodities and physical and financial contracts in Canada
and the U.S. Expenses are net of intersegment charges to the Generation segment
for the provision of energy marketing and financial risk management services as
stated in the previous paragraph.

The
accounting policies of the segments are the same as those described in Note
1.Intersegment transactions are accounted for on a cost recovery basis that
approximates market rates. Segment revenues are net of intersegment
transactions.

**B. Reported
Segment Profit or Loss and Segment Assets**
****
***I.
Earnings Information***


EnergyYear ended
      Dec. 31, 2004
    
    Generation
    
    Marketing
    
    Corporate
    
    TotalRevenues
    
    $
    2,593.8
    
    $
    244.5
    
    $
    –
    
    $
    2,838.3Trading
      purchases
    
    
    –
    
    
    (197.7
    )
    
    –
    
    
    (197.7
    )Fuel and
      purchased power
    
    
    (1,231.3
    )
    
    –
    
    
    –
    
    
    (1,231.3
    )Gross
      margin
    
    
    1,362.5
    
    
    46.8
    
    
    –
    
    
    1,409.3Operations,
      maintenance and administration
    
    
    501.2
    
    
    5.3
    
    
    66.2
    
    
    572.7Depreciation
      and amortization
    
    
    363.3
    
    
    2.0
    
    
    12.0
    
    
    377.3Taxes, other
      than income taxes
    
    
    20.8
    
    
    –
    
    
    –
    
    
    20.8Operating
      expenses
    
    
    885.3
    
    
    7.3
    
    
    78.2
    
    
    970.8Gain on sale
      of TransAlta Power partnership units
    
    
    44.8
    
    
    –
    
    
    –
    
    
    44.8Gain on sale
      of Meridian Cogeneration Facility
    
    
    17.7
    
    
    –
    
    
    –
    
    
    17.7Prior period
      regulatory decision
    
    
    –
    
    
    (22.9
    )
    
    –
    
    
    (22.9
    )Operating
      income (loss) before corporate allocations
    
    
    539.7
    
    
    16.6
    
    
    (78.2
    )
    
    478.1Corporate
      allocations
    
    
    69.7
    
    
    8.5
    
    
    (78.2
    )
    
    –Operating
      income
    
    $
    470.0
    
    $
    8.1
    
    $
    –
    
    $
    478.1Foreign
      exchange gain
    
    
    
    
    
    
    
    
    
    
    
    0.7Net interest
      expense
    
    
    
    
    
    
    
    
    
    
    
    (222.1
    )Earnings
      from continuing operations before income taxes and non-controlling
      interests
    
    
    
    
    
    
    
    
    
    
    $
    256.7

EnergyYear ended
      Dec. 31, 2003
    
    Generation
    
    Marketing
    
    Corporate
    
    TotalRevenues
    
    $
    2,412.2
    
    $
    108.7
    
    $
    –
    
    $
    2,520.9Trading
      purchases
    
    
    –
    
    
    (97.4
    )
    
    –
    
    
    (97.4
    )Fuel and
      purchased power
    
    
    (1,067.4
    )
    
    –
    
    
    –
    
    
    (1,067.4
    )Gross
      margin
    
    
    1,344.8
    
    
    11.3
    
    
    –
    
    
    1,356.1Operations,
      maintenance and administration
    
    
    480.0
    
    
    14.9
    
    
    64.4
    
    
    559.3Depreciation
      and amortization
    
    
    321.6
    
    
    3.1
    
    
    14.3
    
    
    339.0Taxes, other
      than income taxes
    
    
    23.1
    
    
    –
    
    
    –
    
    
    23.1Operating
      expenses
    
    
    824.7
    
    
    18.0
    
    
    78.7
    
    
    921.4Asset
      impairment charges
    
    
    (90.3
    )
    
    –
    
    
    –
    
    
    (90.3
    )Gain on land
      sale
    
    
    10.5
    
    
    –
    
    
    –
    
    
    10.5Gain on sale
      of TransAlta Power partnership units
    
    
    15.2
    
    
    –
    
    
    –
    
    
    15.2Gain on sale
      of Sheerness Generating Station
    
    
    191.5
    
    
    –
    
    
    –
    
    
    191.5Operating
      income (loss) before corporate allocations
    
    
    647.0
    
    
    (6.7
    )
    
    (78.7
    )
    
    561.6Corporate
      allocations
    
    
    69.9
    
    
    8.8
    
    
    (78.7
    )
    
    –Operating
      income (loss)
    
    $
    577.1
    
    $
    (15.5
    )
    $
    –
    
    $
    561.6Other
      expense
    
    
    
    
    
    
    
    
    
    
    
    (3.2
    )Foreign
      exchange loss
    
    
    
    
    
    
    
    
    
    
    
    (4.7
    )Net interest
      expense
    
    
    
    
    
    
    
    
    
    
    
    (220.7
    )Earnings
      from continuing operations before income taxes and non-controlling
      interests
    
    
    
    
    
    
    
    
    
    
    $
    333.0


**7
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EnergyYear ended
      Dec. 31, 2002
    
    Generation
    
    Marketing
    
    Corporate
    
    TotalRevenues
    
    $
    1,674.9
    
    $
    140.0
    
    $
    –
    
    $
    1,814.9Trading
      purchases
    
    
    –
    
    
    (91.0
    )
    
    –
    
    
    (91.0
    )Fuel and
      purchased power
    
    
    (664.6
    )
    
    –
    
    
    –
    
    
    (664.6
    )Gross
      margin
    
    
    1,010.3
    
    
    49.0
    
    
    –
    
    
    1,059.3Operations,
      maintenance and administration
    
    
    346.7
    
    
    15.1
    
    
    58.7
    
    
    420.5Depreciation
      and amortization
    
    
    220.3
    
    
    2.5
    
    
    20.2
    
    
    243.0Taxes, other
      than income taxes
    
    
    27.3
    
    
    0.1
    
    
    –
    
    
    27.4Operating
      expenses
    
    
    594.3
    
    
    17.7
    
    
    78.9
    
    
    690.9Asset
      impairment and equipment cancellation charges
    
    
    (152.5
    )
    
    –
    
    
    –
    
    
    (152.5
    )Prior period
      regulatory decisions
    
    
    (3.3
    )
    
    –
    
    
    –
    
    
    (3.3
    )Operating
      income (loss) before corporate allocations
    
    
    260.2
    
    
    31.3
    
    
    (78.9
    )
    
    212.6Corporate
      allocations
    
    
    70.6
    
    
    8.3
    
    
    (78.9
    )
    
    –Operating
      income
    
    $
    189.6
    
    $
    23.0
    
    $
    –
    
    $
    212.6Other
      income
    
    
    
    
    
    
    
    
    
    
    
    0.1Foreign
      exchange gain
    
    
    
    
    
    
    
    
    
    
    
    1.2Net interest
      expense
    
    
    
    
    
    
    
    
    
    
    
    (117.6
    )Earnings
      from continuing operations before income taxes and non-controlling
      interests
    
    
    
    
    
    
    
    
    
    
    $
    96.3
  II.
      Selected Balance Sheet InformationEnergyDec. 31,
      2004
    
    Generation
    
    Marketing
    
    Corporate
    
    TotalGoodwill
    
    $
    112.7
    
    $
    29.5
    
    $
    –
    
    $
    142.2Total segment
      assets
    
    $
    7,198.3
    
    $
    229.5
    
    $
    705.2
    
    $
    8,133.0Dec. 31,
      2003Goodwill
    
    $
    120.3
    
    $
    29.3
    
    $
    –
    
    $
    149.6Total segment
      assets
    
    $
    7,594.6
    
    $
    232.4
    
    $
    655.0
    
    $
    8,482.0
  III.
      Selected Cash Flow InformationEnergy
    
    
    
    DiscontinuedYear ended
      Dec. 31, 2004
    
    Generation
    
    Marketing
    
    Corporate
    
    Operations
    
    TotalCapital
      expenditures
    
    $
    352.4
    
    $
    2.3
    
    $
    11.1
    
    $
    –
    
    $
    365.8Year ended
      Dec. 31, 2003Capital
      expenditures
    
    $
    542.4
    
    $
    0.8
    
    $
    12.5
    
    $
    –
    
    $
    555.7Acquisitions
    
    $
    323.4
    
    $
    –
    
    $
    –
    
    $
    –
    
    $
    323.4Year ended
      Dec. 31, 2002Capital
      expenditures
    
    $
    909.1
    
    $
    4.2
    
    $
    10.7
    
    $
    21.8
    
    $
    945.8Acquisitions
    
    $
    40.1
    
    $
    –
    
    $
    –
    
    $
    –
    
    $
    40.1
  Year ended
      Dec. 31
    
    2004
    
    2003
    
    2002Depreciation
      and amortization expense for reportable segments
    
    $
    377.3
    
    $
    339.0
    
    $
    243.0Mining
      equipment depreciation, included in fuel and purchased
    power
    
    
    53.3
    
    
    47.1
    
    
    37.1Accretion
      expense, included in depreciation and amortization expense
    
    
    (19.3
    )
    
    (22.0
    )
    
    (22.8
    )Discontinued
      operations
    
    
    –
    
    
    –
    
    
    15.6Other
    
    
    0.5
    
    
    14.0
    
    
    3.9Depreciation
      and amortization expense per statements of cash flows
    
    $
    411.8
    
    $
    378.1
    
    $
    276.8


C
o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s7
3

---

**C.
Geographic Information**
 
 ***I.
Revenues***
 Year ended
      Dec. 31
    
    2004
    
    2003
    
    2002Canada
    
    $
    1,662.7
    
    $
    1,412.4
    
    $
    1,207.6U.S.
    
    
    833.0
    
    
    918.8
    
    
    532.9Mexico
    
    
    252.1
    
    
    107.4
    
    
    –Australia
    
    
    90.5
    
    
    82.3
    
    
    74.4$
    2,838.3
    
    $
    2,520.9
    
    $
    1,814.9


Revenues
are attributed to countries based on the location of customers. The Mexican
plants commenced commercial operations in 2003.

***II.
Property, Plant and Equipment and Goodwill***
Year ended
      Dec. 31
    
    2004
    
    2003
    
    2004
    
    2003Canada
    
    $
    3,858.5
    
    $
    3,764.0
    
    $
    56.5
    
    $
    56.5U.S.
    
    
    1,657.2
    
    
    1,830.3
    
    
    85.7
    
    
    93.1Mexico
    
    
    542.0
    
    
    589.3
    
    
    –
    
    
    –Australia
    
    
    186.7
    
    
    201.9
    
    
    –
    
    
    –$
    6,244.4
    
    $
    6,385.5
    
    $
    142.2
    
    $
    149.6


**3.
DISCONTINUED OPERATIONS**
 ****
 **A.
Transmission**
 ****
 In June
2004, a settlement was reached to finalize the sale of the Transmission
operations. In April 2002, TransAlta’s Transmission operations were sold for
proceeds of $820.7 million. The disposal resulted in an after-tax gain on sale
of $120.0 million that was recorded in the second and fourth quarters of 2002.
During the second quarter of 2004, final working capital adjustments were made
to reflect post-closing adjustments and other provisions related to closing
costs, which resulted in an additional $9.6 million after-tax gain, bringing the
final gain on the sale of the Transmission operations to $129.6 million.


B.
Statements of Earnings

Interest
is allocated to discontinued operations based on the ratio of assets to be
discontinued, net of directly attributable debt, to the total assets of the
entity, net of debt that can be directly attributed to the discontinued
operation or to particular continuing operations of the corporation. The
statements of earnings amounts applicable to discontinued operations are as
follows:

Year ended
      Dec. 31
    
    2002Revenues
    
    $
    55.8Operating
      expenses
    
    
    (30.8
    )Operating
      income
    
    
    25.0Net interest
      expense
    
    
    (2.4
    )Earnings
      before income taxes
    
    
    22.6Income
      taxes
    
    
    (9.8
    )Earnings
      before gain on disposal
    
    $
    12.8C. Balance
      Sheets


At Dec.
31, 2004 and 2003, all of the corporation’s discontinued operations had been
sold.

7 4Tr a n
s A l t a C o r p o r a t i o n A R / 0 4

---

**4.
ACQUISITIONS AND DISPOSALS**
 ****
 **A.
Acquisitions**
 
 On Jan. 29, 2003,
the corporation acquired a 50 per cent interest in CE Gen for US$240.0 million
(Cdn$366.6 million). The acquisition was accounted for using the purchase method
of accounting. CE Gen is controlled jointly by TransAlta and MidAmerican Energy
Holdings Company (MidAmerican). As such, the financial results of CE Gen
subsequent to the acquisition date are proportionately consolidated with those
of TransAlta and are included in the Generation segment. The purchase price was
finalized in the second quarter of 2003 and is presented below:


Net assets
      acquired at assigned valuesWorking
      capital, including cash of $43.2 million
    
    $
    60.3Restricted
      cash
    
    
    57.9Current
      income tax receivable
    
    
    2.4Property,
      plant and equipment
    
    
    414.6Intangibles
    
    
    610.5Goodwill
    
    
    108.9Note
      receivable
    
    
    90.0Non-recourse
      long-term debt, including current portion
    
    
    (717.4
    )Future income
      tax liability
    
    
    (216.0
    )Non-controlling
      interests
    
    
    (44.6
    )Total
    
    $
    366.6ConsiderationCash
    
    $
    366.6


Acquired
intangibles relate to the fair value of power sale contracts. The amount is
being amortized on a straight-line basis over the remaining contract period
(Note 8).

Goodwill
resulted from the purchase of PP&E with no tax basis.

The
restricted cash is comprised of debt service funds, which are legally restricted
and require the maintenance of specific minimum balances equal to the next debt
service payment, and amounts restricted for capital and maintenance
expenditures. The amount of restricted cash acquired has been reduced subsequent
to the acquisition primarily as a result of TransAlta issuing a letter of credit
in lieu of holding the restricted cash (Note 11).

Supplemental pro
forma information for the year ended Dec. 31, 2002, as though the CE Gen
purchase had been completed at Jan.1, 2002, is as follows:

Year ended
      Dec. 31(unaudited)
    
    2002Revenues
    
    $
    2,117.1Earnings from
      continuing operations
    
    $
    99.8Net earnings
      applicable to common shareholders
    
    $
    211.7Earnings per
      share from continuing operations
    
    $
    0.42Earnings per
      share
    
    $
    1.13


On Dec. 6,
2002, the corporation completed a step acquisition of Vision Quest Windelectric
Inc. (Vision Quest). The initial acquisitions between 2000 and 2002 resulted in
41 per cent ownership of Vision Quest for $13.5 million, accounted for using the
equity method. Book values of the corporation’s proportionate interest at the
time of the initial acquisitions approximated fair values. The final step of the
acquisition brought TransAlta’s ownership to 100 per cent and TransAlta’s total
investment in Vision Quest to $68.8 million. The results of Vision Quest’s
operations have been included in the Generation segment of the consolidated
financial statements. At the time of acquisition, Vision Quest operated 124 wind
turbines with 119 MW of gross generating capacity in operation (82 MW net
ownership interest).

The
aggregate purchase price included the previous investments of $13.5 million,
plus $21.3 million of cash and 745,791 common shares valued at $14.2 million. In
addition, a loan of $19.8 million was previously advanced to Vision Quest. The
value of the common shares issued was determined based on the average market
price of TransAlta’s common shares for the five days before and after the terms
of the acquisition were agreed to and announced. In 2004, 36,698 (2003 – 91,478)
of these shares were issued and 8,111 will be issued in 2005.

C
o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s7
5

---

The
transaction was accounted for using the purchase method. The purchase price was
finalized in the first quarter of 2003, and is presented below:

Net assets
      acquired at assigned valuesWorking
      capital, including cash of $8.2 million
    
    $
    6.5Property,
      plant and equipment
    
    
    70.1Goodwill
    
    
    27.2Power
      purchase arrangement
    
    
    2.5Short-term
      debt
    
    
    (32.2
    )Future income
      tax liability
    
    
    (4.7
    )Interest rate
      swaps
    
    
    (0.6
    )Total
    
    $
    68.8ConsiderationInitial
      investments
    
    $
    13.5Cash,
      including previous advances of $19.8 million
    
    
    41.1Common
      shares
    
    
    14.2Total
    
    $
    68.8


On Dec. 6,
2002, the corporation purchased the remaining 15 per cent interest in the
Southern Cross Energy Partnership, located in Western Australia, for AUD$8.5
million (Cdn$7.2 million). At the time of acquisition, book values approximated
fair values. The partnership is included in the Generation segment.

B.
Disposals

On Dec. 1,
2004, TransAlta completed the sale of its 50 per cent interest in the
220-megawatt Meridian Cogeneration Facility located in Lloydminster,
Saskatchewan to TransAlta Cogeneration, L.P. (TA Cogen, owned 50.01% by
TransAlta and 49.99% by TransAlta Power), for its fair value of $110.0 million.
TA Cogen financed the acquisition through the use of $50.0 million of cash on
hand, by issuance of $30.0 million of units to each of TransAlta Energy
Corporation (TEC) and TransAlta Power L.P. (TransAlta Power) and by issuing an
advance to TEC for $30.0 million. TransAlta recorded a gain of $11.5 million
after-tax or $0.06 per common share ($17.7 million pre-tax).

On July
31, 2003, TransAlta completed the sale of its 50 per cent interest in the
two-unit 756 MW coal-fired Sheerness Generating Station to TA Cogen for $630.0
million. TransAlta received cash proceeds of $149.9 million, $315.0 million in
TA Cogen units and $165.1 million in TransAlta Power units. As part of the
financing, and concurrent with the sale, TransAlta Power issued 17.75 million
partnership units and 17.75 million warrants to the public for gross proceeds of
$165.1 million, and 17.75 million partnership units to TransAlta for gross
proceeds of $165.1 million. As a result of the unit issuance, TransAlta’s
ownership interest in TransAlta Power on July 31, 2003 was approximately 26 per
cent. Each warrant, when exercised, was exchangeable for one TransAlta Power
unit at any time until Aug. 3, 2004. As the warrants were exercised, TransAlta
sold TransAlta Power units back to TransAlta Power for $9.30 per unit, reducing
its ownership interest in TransAlta Power and increasing cash proceeds. As a
result of exercising warrants and the subsequent sale of TransAlta Power units
by the corporation, TransAlta’s ownership interest in TransAlta Power was
reduced to 0.01% held by TransAlta Power Ltd., the general partner of TransAlta
Power, as at Dec. 31, 2004.

As a
result of the sale, TransAlta realized a gain on sale of $191.5 million recorded
in the third quarter of 2003, which included the realization of the $119.8
million 1998 deferred gain. Proceeds from the sale of the Sheerness Generating
Station were used to repay debt. For the year ended Dec. 31, 2004, TransAlta
recognized $44.8 million (2003 – $15.2 million) of dilution gains on the
exercise of warrants and subsequent sale of units. Prior to Aug. 3, 2004, 10.4
million warrants were exercised while a further 0.3 million units were sold in
the third quarter subsequent to the expiry of the warrants. In the fourth
quarter of 2004, TransAlta sold 7.1 million units for net proceeds of $64.0
million.

On Dec.
31, 2003, TransAlta completed the sale of 539 acres of undeveloped land at
Seebe, Alberta for $11.0 million, resulting in a pre-tax gain on sale of $10.5
million.

On May 9,
2003, TransAlta sold the Calgary head office building for $65.8 million, which
was an agreed upon value. TransAlta is leasing the property for a term of 20
years. The lease is accounted for as an operating lease.

7
6Tr a n s A l t a C
o r p o r a t i o n A R / 0 4

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5 .
INVESTMENTS

Year ended Dec. 31
    
    2004
    
    2003Investment in
      distributed generation companies
    
    **$**
    ****3.0
    
    $
    5.0


In 2004,
the corporation disposed of its investment in Simmax Corporation for gross
proceeds of $1.0 million and recorded a loss of $1.0 million on the transaction.

In 2003,
as a result of its annual review of its long-term investments, the corporation
recorded a $6.2 million charge to recognize an other than temporary decline in
fair value. The charge is included in corporate operations, maintenance and
administration expenses.

Also in
2003, the corporation sold its 8.82 per cent interest in the Goldfields gas
pipeline for proceeds of AUD$24.1 million (Cdn$21.6 million), which approximated
book value.

6.
      LONG-TERM RECEIVABLESYear ended
      Dec. 31
    
    2004
    
    2003Note
      receivable
    
    $
    –
    
    $
    78.6California
      receivable
    
    
    6.6
    
    
    32.2Other
    
    
    –
    
    
    9.36.6
    
    
    120.1Less current
      portion included in accounts receivable
    
    
    (6.6
    )
    
    –$
    –
    
    $
    120.1


The note
receivable represented amounts advanced to MidAmerican affiliates by CE Gen.
During the first quarter of 2004, CE Gen collected amounts advanced to the Zinc
Recovery Project. TransAlta’s portion of the proceeds was $90.8 million. Funds
collected were used to repay a portion of the CE Gen secured bonds included in
long-term debt.

At Dec.
31, 2000, TransAlta made a provision of US$28.8 million to account for potential
refund liabilities relating to energy sales in California. On Dec. 12, 2002, a
U.S. Federal Energy Regulatory Commission (FERC) Administrative Law Judge issued
proposed findings of fact that recommended TransAlta refund US$9.0 million for
electricity sales made to the California Independent System Operator (CAISO) and
US$13.0 million for electricity sales made to the California Power Exchange
(CALPX). In March 2003, FERC ordered the CAISO to review reference power and gas
prices which are used to determine mitigated market clearing prices and refund
obligations. On March 17, 2004, the CAISO released its preliminary adjusted
prices. Based on these prices, the estimated refund liability now owed by
TransAlta is US$46.0 million, being US$27.6 million to the CAISO, US$17.9
million to the CALPX and US$0.5 million to the Automated Power Exchange.
Therefore, in March 2004, TransAlta recorded an additional pre-tax provision of
US$17.2 million (Cdn$22.9 million). The after-tax impact was Cdn$14.9 million.
The final adjusted prices were released in October 2004 and were substantially
the same as those released on March 17, 2004. The remaining receivable has been
reclassified to current accounts receivable as collection is expected within the
next 12 months.

FERC has
provided TransAlta with an opportunity to petition for relief from refund
obligations. To be successful in such a petition for relief TransAlta will be
required to demonstrate that, as a result of the refund methodology, it has
suffered operating losses in respect of California transactions during the
refund period. TransAlta has prepared a petition for relief from the refund
obligation that may be filed once FERC provides stakeholders with a direction on
the filing of such positions. While the outcome of this filing cannot be
determined at this time, any such relief would be accounted for only at the time
that it is obtained from FERC.

The impact
of prior period regulatory decisions relating to prior reporting periods is
recorded when the effect of such decisions is known, without adjustment to the
financial statements of prior periods.

C
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7

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7. PROPERTY,
PLANT AND EQUIPMENT

Year ended
      Dec. 31
    
    
    
    2004
    
    2003Accumulated
    
    
    
    
    
    AccumulatedDepreciation
    
    
    
    depreciation
      &
    
    Net
      book
    
    
    
    depreciation
      &
    
    Net
      bookrates
    
    Cost
    
    amortization
    
    value
    
    Cost
    
    amortization
    
    valueThermal
      generation
    
    
    3%-33
    %
    $
    3,129.4
    
    $
    1,078.4
    
    $
    2,051.0
    
    $
    3,172.2
    
    $
    966.8
    
    $
    2,205.4Thermal
      environmental equipment
    
    
    4%-13
    %
    
    621.5
    
    
    253.1
    
    
    368.4
    
    
    591.5
    
    
    234.4
    
    
    357.1Mining
      property & equipment
    
    
    4%-33
    %
    
    732.6
    
    
    353.4
    
    
    379.2
    
    
    730.3
    
    
    317.3
    
    
    413.0Gas
      generation
    
    
    2%-50
    %
    
    2,706.1
    
    
    568.0
    
    
    2,138.1
    
    
    2,732.3
    
    
    514.6
    
    
    2,217.7Geothermal
      generation
    
    
    3%-33
    %
    
    394.6
    
    
    85.1
    
    
    309.5
    
    
    395.3
    
    
    35.2
    
    
    360.1Hydro
      generation
    
    
    2%-5
    %
    
    343.5
    
    
    189.1
    
    
    154.4
    
    
    339.0
    
    
    181.1
    
    
    157.9Wind
      generation
    
    
    2%-3
    %
    
    206.8
    
    
    10.7
    
    
    196.1
    
    
    105.9
    
    
    5.5
    
    
    100.4Capital
      spares and other
    
    
    2%-50
    %
    
    249.7
    
    
    51.4
    
    
    198.3
    
    
    164.3
    
    
    25.3
    
    
    139.0Assets under
      construction
    
    
    –
    
    
    334.7
    
    
    –
    
    
    334.7
    
    
    316.1
    
    
    –
    
    
    316.1Coal rights
      1
    
    
    –
    
    
    73.9
    
    
    18.4
    
    
    55.5
    
    
    73.8
    
    
    15.3
    
    
    58.5Land
    
    
    –
    
    
    41.3
    
    
    –
    
    
    41.3
    
    
    40.5
    
    
    –
    
    
    40.5Transmission
      systems
    
    
    2%-20
    %
    
    31.3
    
    
    13.4
    
    
    17.9
    
    
    32.0
    
    
    12.2
    
    
    19.8$
    8,865.4
    
    $
    2,621.0
    
    $
    6,244.4
    
    $
    8,693.2
    
    $
    2,307.7
    
    $
    6,385.51Coal rights are amortized on a unit of production basis, based on
      the estimated mine reserve.

Year ended
      Dec. 31
    
    2004
    
    2003
    
    2002Capitalized
      interest
    
    $
    20.0
    
    $
    45.2
    
    $
    79.1


In
September 2003, the corporation concluded that the book value of its turbine
inventory was unlikely to be recovered. As a result, TransAlta recorded an $84.7
million pre-tax impairment charge to write the turbines down to fair value,
included in gas generation. Fair value was based on quoted market prices.

In the
fourth quarter of 2003, TransAlta recorded a $5.6 million pre-tax impairment
charge on the Binghamton plant to reduce the plant’s book value to fair value,
based on the present value of expected future cash flows.

In
November 2002, the corporation implemented a phased decommissioning of its 537
MW coal-fired Wabamun facility. As a result of this decision, the corporation
recorded a $110.0 million pre-tax impairment charge during 2002, included in
thermal generation equipment. The fair value of the facility was determined by
estimating the present value of expected future cash flows.

In
November 2002, the corporation cancelled orders for four natural gas turbines
and, as a result, recorded a $42.5 million pre-tax impairment charge for
contract termination costs. The costs consisted of progress payments made to
date.

8. INTANGIBLE
ASSETS

Year ended
      Dec. 31
    
    
    
    
    
    2004
    
    
    
    
    
    2003Accumulated
    
    Net
      book
    
    
    
    Accumulated
    
    Net
      bookCost
    
    amortization
    
    value
    
    Cost
    
    amortization
    
    valueSales
      contracts 1
    
    $
    488.7
    
    $
    96.4
    
    $
    392.3
    
    $
    530.6
    
    $
    53.4
    
    $
    477.21Sales contracts are amortized on a straight-line basis over the
      remaining contract period, which ranges from seven to 30 years at the date
      of acquisition.

9. OTHER
      ASSETSYear ended
      Dec. 31
    
    2004
    
    2003Cross-currency
      interest rate swaps and foreign currency forward contracts*(Note
      19)*
    
    $
    240.2
    
    $
    169.5Interest rate
      swaps (Note 19)
    
    
    44.4
    
    
    51.3Deferred
      financing costs
    
    
    29.1
    
    
    44.9Deferred
      license fees
    
    
    27.1
    
    
    29.9Deferred
      contract costs
    
    
    21.1
    
    
    21.0Deferred
      project development costs and other
    
    
    2.3
    
    
    2.7Long-term gas
      transportation deals
    
    
    9.7
    
    
    10.9**373.9**
    
    
    330.2Less current
      portion
    
    
    (192.7
    )
    
    (49.4
    )$
    181.2
    
    $
    280.8


Deferred
financing costs are costs associated with the issuance of long-term debt and
preferred securities and are being amortized on a straight-line basis over the
term of the related issue.

7
8Tr a n s A l t a C
o r p o r a t i o n A R / 0 4

---

Deferred
license fees consist primarily of an Australian license that is being amortized
on a straight-line basis over the useful life of the power station assets to
which the license relates.

Deferred
contract costs consist of prepayments related to long-term contracts, which are
being amortized on a straight-line basis over the term of the related contracts.

10.
      SHORT-TERM DEBTYear ended
      Dec. 31
    
    
    
    
    
    2004
    
    
    
    
    
    2003Outstanding
    
    
    Interest(1)
    
    
    Outstanding
    
    
    Interest(1)Commercial
      paper
    
    $
    34.4
    
    
    2.6
    %
    $
    61.1
    
    
    3.0
    %Bank
      debt
    
    
    –
    
    
    –
    
    
    58.7
    
    
    3.2
    %$
    34.4
    
    
    
    
    $
    119.8


*1 Interest is an average rate weighted by principal amounts
outstanding before the effect of hedging.*
**
**11. LON****G****-TERM
DEBT**
****
**A. Amounts Outstanding**


Year ended
      Dec. 31
    
    
    
    2004
    
    
    
    2003Outstanding
    
    Interest(1)
    
    Outstanding
    
    Interest(1)Debentures,
      due 2005 to 2033 2
    
    $
    1,388.5
    
    
    6.5
    %
    $
    1,513.4
    
    
    6.5
    %Senior notes,
      US$600.0 million 3
    
    
    733.6
    
    
    6.3
    %
    
    796.4
    
    
    6.3
    %Non-recourse
      debt 4
    
    
    580.0
    
    
    6.9
    %
    
    579.5
    
    
    7.6
    %Bank credit
      facility – Campeche, US$127.9 million (2003 – US$133.6 million)
      5
    
    
    –
    
    
    –
    
    
    177.7
    
    
    2.5
    %Notes payable
      – Windsor plant, due 2003 to 2014 6
    
    
    55.0
    
    
    7.4
    %
    
    58.7
    
    
    7.4
    %Preferred
      securities, due 2048 to 2050 7
    
    
    475.0
    
    
    7.8
    %
    
    475.0
    
    
    7.8
    %Commercial
      paper 8
    
    
    –
    
    
    –
    
    
    13.7
    
    
    1.4
    %Capital lease
      obligation, due 2004 to 2006 9
    
    
    0.8
    
    
    8.0
    %
    
    6.7
    
    
    9.1
    %$
    3,232.9
    
    
    
    
    $
    3,621.1Less current
      portion
    
    
    587.7
    
    
    
    
    
    183.8$
    2,645.2
    
    
    
    
    $
    3,437.3


1
    Interest
      is an average rate weighted by principal amounts outstanding before the
      effect of hedging.2
    Debentures:
      The debentures bear interest at fixed rates ranging from 5.5 per cent to
      8.6 per cent. A floating charge on the property and assets of TransAlta
      Utilities (TAU) has been provided as collateral for $448.4 million of the
      debentures as at Dec. 31, 2004. The interest rate on $375.0 million of the
      2002 amount has been converted to floating rates based on bankers’
      acceptance rates using receive fixed pay floating interest rate swaps
      maturing in 2006 to 2011(Note 19). Debentures of $100.0 million
      maturing in 2023 and $50.0 million maturing in 2033 are redeemable at the
      option of the holder in 2008 and 2009, respectively. Another debenture of
      $150.0 million maturing in 2005 is extendable until 2030 at the option of
      the holder.3
    Senior
      notes: In November 2003, the corporation issued debt of US$300.0 million
      through a prospectus supplement to a US$1.0 billion shelf prospectus filed
      on May 14, 2002. The notes bear an interest rate of 5.75 per cent and
      mature in 2013. Of the 2003 debt issue, US$200.0 million has been
      converted to a floating rate based on LIBOR using interest rate swaps
      maturing in 2013. In June 2002, the corporation issued debt of US$300.0
      million under the US$1.0 billion shelf prospectus. The notes bear interest
      at 6.75 per cent and mature on July 15, 2012. All senior notes have been
      designated as a hedge of the corporation’s net investment in U.S. and
      Mexican operations(Note 19).4
    Non-recourse
      debt: The debt consists of project financing debt, debt securities and
      senior secured bonds of CE Gen. The related assets have been pledged as
      security for the project financing debt. Maturity dates range from 2004 to
      2008, and the interest rates range from LIBOR plus 1.25 per cent to 8.31
      per cent. The debt securities are non-recourse, have maturity dates
      ranging from 2005 to 2018 and interest rates ranging from 7.37 per cent to
      8.30 per cent. The senior secured bonds of $198.4 million are also
      non-recourse to the corporation, bear interest at 7.42 per cent, and are
      due in 2018. In April 2004, the Campeche plant in Mexico was pledged as
      collateral and the corporation was relieved of its guarantee. At that
      time, the US$133.6 million of debt became non-recourse to the corporation
      (see 5). The value of this debt at Dec. 31, 2004 was US$127.9
      million.5
    Bank
      credit facility: In December 2000, the corporation established a US$133.6
      million 16-year credit facility for the financing of the construction of a
      gas-fired plant in Campeche, Mexico. The outstanding borrowing totalled
      US$133.6 million with an interest rate of LIBOR plus 0.875 per cent during
      construction and LIBOR plus 2.25 per cent effective Sept. 30, 2003,
      increasing to LIBOR plus 3.25 per cent by 2016. In March 2003, 70 per cent
      of the floating portion of the facility was converted to a fixed rate of
      7.4 per cent with a forward starting swap(Note 19). The plant
      began commercial operations in May 2003. During construction and until
      certain conditions were met, the corporation had provided a guarantee to
      the lenders for the completion of the plant. In April 2004, the Campeche
      plant in Mexico was pledged as collateral and the corporation was relieved
      of its guarantee. At that time, the US$133.6 million of debt became
      non-recourse to the corporation. The value of this debt at Dec. 31, 2004
      is US$127.9 million.6
    Notes
      payable – Windsor Plant: The Windsor plant notes bear interest at fixed
      rates and are recourse to the corporation through a standby letter of
      credit.7
    Preferred
      securities: The preferred securities consist of $175.0 million 7.75% and
      $125.0 million 8.15% due in 2048 and $175.0 million 7.50% due in 2050. The
      $300.0 million are subordinated and unsecured and the corporation may
      redeem the preferred securities in whole or in part in 2004 at a
      redemption price equal to 100 per cent of the principal amount of the
      preferred securities plus accrued and unpaid distributions thereon to the
      date of such redemption. In 1999, the corporation monetized a portion of
      this redemption feature by writing pay fixed swaptions exercisable in 2004
      having a notional amount of $75.0 million and a weighted average interest
      rate of 6.1 per cent. These swaptions matured in March 2004 (Dec. 31, 2003
      fair value of $6.1 million). The $175.0 million are subordinated and
      unsecured and the corporation may redeem the preferred securities in whole
      or in part in 2006 at a redemption price equal to 100 per cent of the
      principal amount of the preferred securities plus accrued and unpaid
      distributions thereon to the date of such redemption. The corporation may
      elect to defer coupon payments on the preferred securities and settle
      deferred coupon payments in either cash or common shares of the
      corporation. Historically, the coupon payments have been in cash;
      therefore, the preferred securities have no dilutive effect on earnings
      per share. Supplemental diluted earnings per share for 2004 from
      continuing operations and net earnings as though the coupon payments were
      settled with shares were $0.87 (2003 – $1.22, 2002 – $0.44) and $0.91
      (2003 – $1.22, 2002 – $1.12). Interest accretion at the coupon rate is
      included in interest expense.8
    Commercial
      paper: There is no amount outstanding at Dec. 31, 2004 (2003 – US$10.3
      million). Under the terms of TransAlta’s credit facility, the corporation
      has the ability and intent to maintain these borrowings beyond one year.
      The corporation had designated this 2003 amount of commercial paper as a
      long-term hedge of a portion of its net investment in U.S. and Mexican
      operations.9
    Capital
      lease obligation: Certain coal mining assets of TAU have been provided as
      collateral. The obligation bears interest at a fixed
    rate.


C
o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s7
9

---

B.
      Principal Repayments2005
    
    $
    587.72006
    
    
    409.22007
    
    
    61.12008
    
    
    169.62009
    
    
    252.12010 and
      thereafter
    
    
    1,753.2Total
    
    $
    3,232.9C.
      Interest Expense


TransAlta
has included the corporation’s preferred securities in long-term debt on the
consolidated balance sheets (Note 1). Preferred securities distributions
are included in interest expense as shown below:

Year ended
      Dec. 31
    
    2004
    
    2003
    
    2002Interest on
      recourse and non-recourse debt
    
    $
    207.9
    
    $
    234.1
    
    $
    172.9Interest on
      preferred securities
    
    
    44.5
    
    
    36.8
    
    
    34.9Interest
      income
    
    
    (10.3
    )
    
    (5.0
    )
    
    (8.7
    )Interest
      allocated to discontinued operations
    
    
    –
    
    
    –
    
    
    (2.4
    )Capitalized
      interest
    
    
    (20.0
    )
    
    (45.2
    )
    
    (79.1
    )Net interest
      expense
    
    $
    222.1
    
    $
    220.7
    
    $
    117.6D. Guarantees


In the
normal course of operations, TransAlta and certain of its subsidiaries enter
into agreements to provide financial or performance assurances to third parties.
These include guarantees, letters of credit and surety bonds that are entered
into to support or enhance cred-itworthiness in order to facilitate the
extension of sufficient credit for Energy Marketing trading activities, treasury
hedging, Generation construction projects, equipment purchases and mine
reclamation obligations.

At Dec.
31, 2004, the corporation had letters of credit outstanding of $187.6 million,
US$197.7 million and 171.9 million Mexican pesos (total Canadian dollar
equivalent $447.3 million). The letters of credit were issued to counterparties
that have credit exposure to certain subsidiaries. If a subsidiary does not pay
amounts due under the covered contract, the counterparty may present its claim
for payment to the financial institution, which in turn will request payment
from the corporation. Any amounts owed by the corporation’s subsidiaries are
reflected in the consolidated balance sheet. All letters of credit expire in
2005 and 2006.

The
corporation had a surety bond in the amount of US$181.6 million in support of
asset retirement obligations at the Centralia mine outstanding at Dec. 31, 2004.
Asset retirement obligations are included in deferred credits and other
long-term liabilities (Note 12).The surety bond expires in 2005.

TransAlta
has provided guarantees of subsidiaries’ obligations under contracts that
facilitate physical and financial transactions in various derivatives. To the
extent liabilities related to these guaranteed contracts exist for trading
activities, they are included in the consolidated balance sheet. To the extent
liabilities exist related to these guaranteed contracts for hedges, they are not
recognized on the consolidated balance sheet. The guarantees provided for under
all contracts facilitating physical and financial transactions in various
derivatives at Dec. 31, 2004 were a maximum of $1.6 billion. In addition, the
corporation has a number of unlimited guarantees. The fair value of the trading
and hedging positions under contracts where TransAlta has a net liability at
Dec. 31, 2004, under the limited and unlimited guarantees, was $345.2 million
(2003 – $381.3 million).

TransAlta
has also provided guarantees of subsidiaries’ obligations to perform and make
payments under various other contracts. The amount guaranteed under these
contracts at Dec. 31, 2004 was a maximum of $662.5 million (2003 – $828.6
million). To the extent actual obligations exist under the performance
guarantees at Dec. 31, 2004, they are included in accounts payable and accrued
liabilities.

The
corporation has approximately $1.35 billion of undrawn collateral available to
secure these exposures.

During
construction and until certain conditions were met, the corporation provided a
guarantee to the lenders of the Campeche plant. On April 5, 2004, the guarantee
was released and the US$133.6 million of debt related to the plant became
non-recourse to the corporation.

8
0Tr a n s A l t a C
o r p o r a t i o n A R / 0 4

---

12.
DEFERRED CREDITS AND OTHER LONG-TERM LIABILITIES

Year ended
      Dec. 31
    
    2004
    
    2003Asset
      retirement obligation
    
    $
    243.4
    
    $
    258.2Deferred
      revenues and other
    
    
    44.4
    
    
    43.8Power
      purchase arrangement in limited partnership
    
    
    31.4
    
    
    29.9Accrued
      benefit liability (Note 18)
    
    
    58.2
    
    
    54.1Cross-currency
      interest rate swaps and foreign currency forward contracts (Note
      19)
    
    
    136.1
    
    
    112.0Fair value of
      swap transaction with limited partnership
    
    
    4.9
    
    
    7.9Long-term gas
      transportation deals
    
    
    6.3
    
    
    5.8524.7
    
    
    511.7Less current
      portion
    
    
    (133.4
    )
    
    (24.1
    )$
    391.3
    
    $
    487.6

A
      reconciliation between the opening and closing asset retirement obligation
      balances is provided below:Balance, Dec.
      31, 2002
    
    $
    264.9Liabilities
      incurred in period
    
    
    9.3Liabilities
      settled in period
    
    
    (26.5
    )Accretion
      expense
    
    
    22.0Acquisition
      of CE Gen
    
    
    5.2Change in
      foreign exchange rates
    
    
    (16.7
    )Balance, Dec.
      31, 2003
    
    $
    258.2Liabilities
      incurred in period
    
    
    21.8Liabilities
      settled in period
    
    
    (19.7
    )Accretion
      expense
    
    
    19.3Revisions in
      estimated cash flows
    
    
    (21.9
    )Change in
      foreign exchange rates
    
    
    (14.3
    )Balance,
      Dec. 31, 2004
    
    $
    243.4


TransAlta
estimates the undiscounted amount of cash flow required to settle the asset
retirement obligations is approximately $1.3 billion, which will be incurred
between 2005 and 2072. The majority of the costs will be incurred between 2020
and 2030. A discount rate of eight per cent was used to calculate the carrying
value of the asset retirement obligations. At Dec. 31, 2004, the corporation had
a surety bond in the amount of US$181.6 million in support of future retirement
obligations at the Centralia mine.

The power
purchase arrangement represents the fair value adjustments for the Sheerness
Generating Station to deliver power at less than the prevailing market price at
the time of the acquisition of the plant by TA Cogen.

13.
      NON-CONTROLLINGINTERESTSA.Statement
      of EarningsYear ended
      Dec. 31
    
    
    2004
    
    
    2003
    
    
    2002TransAlta
      Power’s limited partnership interest in TA Cogen (Note
21)
    
    $
    31.5
    
    $
    21.3
    
    $
    19.0Other
      shareholders’ interests
    
    
    14.5
    
    
    12.9
    
    
    1.1$
    46.0
    
    $
    34.2
    
    $
    20.1

B.Balance
      Sheets – Other Non-controlling InterestsYear ended
      Dec. 31
    
    2004
    
    2003TransAlta
      Power’s limited partnership interest in TA Cogen
    
    $
    582.4
    
    $
    440.4Other
      shareholders’ interests
    
    
    34.0
    
    
    37.5$
    616.4
    
    $
    477.9


Other
shareholders’ interests represents the 25 per cent interest in the Saranac
Partnership not owned by CE Gen.

C
o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s8 1

---

**14. COMMON
SHARES**
 
 **A. Issued
and Outstanding**
 
 The
corporation is authorized to issue an unlimited number of voting common shares
without nominal or par value.


Year ended
      Dec. 31
    
    2004
    2003
    2002Common
    
    
    
    Common
    
    
    
    Commonshares
    
    
    
    shares
    
    
    
    shares(millions)
    
    Amount
    
    (millions)
    
    Amount
    
    (millions)
    
    AmountIssued and
      outstanding, beginning of year
    
    
    190.7
    
    $
    1,555.7
    
    
    169.8
    
    $
    1,226.2
    
    
    168.3
    
    $
    1,170.9Issued as a
      public offering and other
    
    
    –
    
    
    –
    
    
    17.3
    
    
    270.4
    
    
    –
    
    
    –Issued under
      dividend reinvestment and share purchase plan
    
    
    3.4
    
    
    55.3
    
    
    3.3
    
    
    54.6
    
    
    2.7
    
    
    53.4Issued on
      purchase of Vision Quest
    
    
    –
    
    
    0.7
    
    
    0.1
    
    
    1.7
    
    
    0.6
    
    
    11.6Issued for
      cash under stock option plans
    
    
    0.1
    
    
    1.1
    
    
    0.1
    
    
    1.4
    
    
    0.1
    
    
    1.8Issued under
      Performance Share Ownership Plan
    
    
    –
    
    
    1.1
    
    
    0.1
    
    
    1.4
    
    
    0.1
    
    
    1.9Repurchased
      by the corporation
    
    
    (0.1
    )
    
    (1.2
    )
    
    –
    
    
    –
    
    
    (2.0
    )
    
    (13.4
    )Employee
      share purchase loans
    
    
    –
    
    
    (0.8
    )
    
    –
    
    
    –
    
    
    –
    
    
    –194.1
    
    $
    1,611.9
    
    
    190.7
    
    $
    1,555.7
    
    
    169.8
    
    $
    1,226.2


At Dec.
31, 2004, the corporation had 194.1 million (2003 – 190.7 million, 2002 – 169.8
million) common shares issued and outstanding plus outstanding employee stock
options to purchase an additional 2.9 million shares (2003 – 3.1 million, 2002 –
3.2 million).

In
February 2004, TransAlta announced a normal course issuer bid to repurchase up
to 3.0 million common shares for cancellation. In 2004, 143,500 shares were
repurchased. No shares were repurchased during 2003. In 2002, the corporation
purchased for cancellation 2.0 million common shares. The $1.1 million in 2004
and the $27.0 million in 2002 in excess of the repurchase price over the average
net book value of the common shares was charged to retained earnings.

In March
2003, the corporation issued 15.0 million common shares for gross proceeds of
$240.0 million, with issue costs of $8.0 million. The offering included an
option for the underwriters to purchase a further 2.25 million common shares for
$36.0 million. This option was exercised on April 17, 2003, with issue costs of
$3.0 million.

B.
Shareholder Rights Plan

The
primary objective of the shareholder rights plan is to provide the corporation’s
Board of Directors sufficient time to explore and develop alternatives for
maximizing shareholder value if a takeover bid is made for the corporation and
to provide every shareholder with an equal opportunity to participate in such a
bid. The plan was originally approved in 1992, and has been revised from time to
time for conformity with current practices.

When an
acquiring shareholder acquires 20 per cent or more of the outstanding common
shares of the corporation and that shareholder does not make a bid for all of
the common shares outstanding, each shareholder other than the acquiring
shareholder may receive one right for each common share owned. Each right will
entitle the holder to acquire an additional $160 worth of common shares for $80.

C.
Dividend Reinvestment and Share Purchase Plan

Under the
terms of the dividend reinvestment and share purchase plan, participants are
able to purchase additional common shares by reinvesting dividends. Common
shares will be issued from treasury. In 2004, 3.4 million (2003 – 3.3 million,
2002 – 2.7 million) common shares were purchased under this program for $55.3
million (2003 – $54.6 million, 2002 – $53.4 million).

D. Diluted
      Earnings Per Share (EPS)Year ended
      Dec. 31
    
    
    2004
    
    
    
    2003
    
    
    
    2002Numerator
    
    Denominator
    
    Numerator
    
    Denominator
    
    Numerator
    
    DenominatorBasic EPS
      from continuing operations
    160.6
    
    192.7
    
    234.2
    
    185.3
    
    66.8
    
    169.6Impact of
      PSOP
    –
    
    0.1
    
    –
    
    0.1
    
    –
    
    0.1Diluted EPS
      from continuing operations
    160.6
    
    192.8
    
    234.2
    
    185.4
    
    66.8
    
    169.7


Options to
purchase common shares were not included in the computation of diluted EPS as
the exercise price of the options was greater than the average market price of
the common shares during the periods. The impact of settling preferred
securities’ coupon payments in shares did not have a dilutive effect on EPS from
continuing operations in 2002.

8
2Tr a n s A l t a C
o r p o r a t i o n A R / 0 4

---

1 5.
STOCK-BASED COMPENSATION PLANS

At Dec.
31, 2004, the corporation had three types of stock-based compensation plans and
an employee share purchase plan.

The
corporation is authorized to grant employees options to purchase up to an
aggregate of 13.0 million common shares at prices based on the market price of
the shares as determined on the grant date. The corporation has reserved 13.0
million common shares for issue.

**A. Fixed
Stock Option Plans**
****
***I.
Management Plan*** The
granting of options under this fixed stock option plan was discontinued in 1997.
Options were granted under this plan to certain eligible employees. The options
could not be exercised until one year after grant and thereafter at an amount
not exceeding 20 per cent of the grant per year on a cumulative basis until the
sixth year, after which the entire grant may be exercised until the tenth year,
which is the expiry date.


II.
Canadian Employee Plan

This plan
came into effect in 2000 and was offered to all full-time and part-time
employees in Canada at or below the level of manager. Options granted under this
plan may not be exercised until one year after grant and thereafter at an amount
not exceeding 25 per cent of the grant per year on a cumulative basis until the
fifth year, after which the entire grant may be exercised until the tenth year,
which is the expiry date.

III.
Alberta Distribution and Retail (D&R) Plan

This plan
came into effect in 2000 and was offered to all full-time and part-time
employees of the Alberta D&R business segment. Options granted under this
plan could not be exercised until the date of the closing of the Alberta D&R
sale on August 31, 2000, after which the entire grant could be exercised for up
to three years after the closing. The outstanding options under this plan at
Dec. 31, 2003 expired in January 2004.

IV.
U.S. Plan

This plan
came into effect in 2001 and was offered to all full-time and part-time
employees in the U.S. at or below the level of manager. Options granted under
this plan may not be exercised until one year after grant and thereafter at an
amount not exceeding 25 per cent of the grant per year on a cumulative basis
until the fifth year, after which the entire grant may be exercised until the
tenth year, which is the expiry date.

V.
Australian Phantom Plan

This plan
came into effect in 2001 and was offered to all full-time and part-time
employees in Australia, excluding directors and officers. Options under this
plan are not physically granted; rather, employees receive the equivalent value
of shares in cash when exercised. Options granted under this plan may not be
exercised until one year after grant and thereafter at an amount not exceeding
25 per cent of the grant per year on a cumulative basis until the fifth year,
after which the entire grant may be exercised until the tenth year, which is the
expiry date.

Management
    
    Canadian
    
    Alberta
    
    U.S.
    
    Australianplan
    
    employee
      plan
    
    D&R
      plan
    
    employee
      plan
    
    phantom
      planNumber
    
    Weighted
    
    Number
    
    Weighted
    
    Number
    
    Weighted
    
    Number
    
    Weighted
    
    Number
    
    Weightedof
      share
    
    average
    
    of
      share
    
    average
    
    of
      share
    
    average
    
    of
      share
    
    average
    
    of
      share
    
    averageoptions
    
    exercise
    
    options
    
    exercise
    
    options
    
    exercise
    
    options
    
    exercise
    
    options
    
    exercise(millions)
    
    price
    
    (millions)
    
    price
    
    (millions)
    
    price
    
    (millions)
    
    price
    
    (millions)
    
    priceOutstanding,
      Jan.1, 2002
    
    
    0.2
    
    $
    14.84
    
    
    1.3
    
    $
    22.27
    
    
    0.1
    
    $
    14.20
    
    
    0.8
    
    $
    14.19
    
    
    –
    
    $
    –Granted
    
    
    –
    
    
    –
    
    
    0.7
    
    
    20.92
    
    
    –
    
    
    –
    
    
    0.4
    
    
    12.51
    
    
    0.1
    
    
    22.00Exercised
    
    
    (0.1
    )
    
    14.57
    
    
    (0.1
    )
    
    14.23
    
    
    –
    
    
    –
    
    
    –
    
    
    –
    
    
    –
    
    
    –Cancelled or
      expired
    
    
    –
    
    
    –
    
    
    (0.3
    )
    
    22.98
    
    
    –
    
    
    –
    
    
    (0.1
    )
    
    13.53
    
    
    –
    
    
    –Outstanding,
      Dec. 31, 2002
    
    
    0.1
    
    $
    14.91
    
    
    1.6
    
    $
    21.89
    
    
    0.1
    
    $
    14.20
    
    
    1.1
    
    $
    13.61
    
    
    0.1
    
    $
    22.00Granted
    
    
    –
    
    
    –
    
    
    0.1
    
    
    17.11
    
    
    –
    
    
    –
    
    
    –
    
    
    –
    
    
    –
    
    
    –Exercised
    
    
    –
    
    
    –
    
    
    –
    
    
    –
    
    
    (0.1
    )
    
    14.20
    
    
    –
    
    
    –
    
    
    –
    
    
    –Cancelled or
      expired
    
    
    –
    
    
    –
    
    
    (0.1
    )
    
    21.39
    
    
    –
    
    
    –
    
    
    –
    
    
    –
    
    
    –
    
    
    –Outstanding,
      Dec. 31, 2003
    
    
    0.1
    
    $
    14.91
    
    
    1.6
    
    $
    21.18
    
    
    –
    
    $
    –
    
    
    1.1
    
    $
    13.61
    
    
    0.1
    
    $
    22.00Granted
    
    
    –
    
    
    –
    
    
    –
    
    
    –
    
    
    –
    
    
    –
    
    
    –
    
    
    –
    
    
    –
    
    
    –Exercised
    
    
    –
    
    
    –
    
    
    (0.1
    )
    
    –
    
    
    –
    
    
    –
    
    
    –
    
    
    –
    
    
    –
    
    
    –Cancelled or
      expired
    
    
    –
    
    
    –
    
    
    –
    
    
    22.52
    
    
    –
    
    
    –
    
    
    (0.1
    )
    
    13.47
    
    
    –
    
    
    –Outstanding,
      Dec. 31, 2004
    
    
    0.1
    
    $
    14.91
    
    
    1.5
    
    $
    21.93
    
    
    –
    
    $
    –
    
    
    1.0
    
    $
    13.56
    
    
    0.1
    
    $
    22.00


C
o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s8
3

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Options
      outstanding
    
    Options
      exercisableRange of
      exercise prices
    
    Number
      outstanding at Dec. 31, 2004(millions)
    
    Weighted
      average remaining contractual life (years)
    
    Weighted
      average exercise price
    
    Number
      exercisable at Dec. 31, 2004 (millions)
    
    Weighted
      average exercise price$13.12 -
      $18.00
    
    
    0.8
    
    
    5.8
    
    $
    13.71
    
    
    0.5
    
    $
    13.84$18.01 -
      $23.00
    
    
    1.4
    
    
    6.7
    
    
    16.89
    
    
    0.9
    
    
    17.24$27.70
    
    
    0.5
    
    
    6.3
    
    
    27.70
    
    
    0.4
    
    
    27.70$13.12 -
      $27.70
    
    
    2.7
    
    
    6.3
    
    $
    17.99
    
    
    1.8
    
    $
    18.40B.Performance
      Stock Option Plan


In 1999,
the corporation expanded enrolment in the share option program to include all
Canadian employees of the corporation, excluding the level of director and
above, by issuing stock options with an expiry date of 2009 and vesting
dependent upon achieving certain earnings per share targets.

Year ended
Dec. 31

**2004**
    
    2003
    
    2002Number of
      share options (millions)
    
    Weighted
      average exercise price
    
    Number of
      share options (millions)
    
    Weighted
      average exercise price
    
    Number of
      share options (millions)
    
    Weighted
      average exercise priceOutstanding,
      beginning of year
    
    
    **0.2**
    
    **$**
    **22.44**
    
    
    0.2
    
    $
    22.44
    
    
    0.4
    
    $
    22.31Exercised
    
    
    **–**
    
    
    **–**
    
    
    –
    
    
    –
    
    
    (0.1
    )
    
    15.16Cancelled or
      expired
    
    
    **–**
    
    
    **–**
    
    
    –
    
    
    –
    
    
    (0.1
    )
    
    22.99Outstanding,
      end of year
    
    
    **0.2**
    
    **$**
    **22.44**
    
    
    0.2
    
    $
    22.44
    
    
    0.2
    
    $
    22.44







At Dec.
31, 2004, the corporation had 13,008 options under this plan with an exercise
price of $14.15 and a weighted average remaining contractual life of 5.0 years
and 203,800 options with an exercise price of $23.05 and a weighted average
remaining contractual life of 4.1 years outstanding. At Dec. 31, 2004, all
outstanding options had vested.


C.
Performance Share Ownership Plan (PSOP)

Under the
terms of the PSOP, which commenced in 1997, the corporation was authorized to
grant to employees and directors up to an aggregate of 2.0 million common
shares. The number of common shares which could be issued under both the PSOP
and the share option plans, however, could not exceed 6.0 million common shares.
Participants in the PSOP receive awards which, after three years, make them
eligible to receive a set number of common shares or cash equivalent up to the
maximum of the award amount plus any accrued dividends thereon. The actual
number of common shares or cash equivalent a participant may receive is
determined by the percentile ranking of the total shareholder return over three
years of the corporation’s common shares amongst a selected group of publicly
traded companies. Until Dec. 31, 2001, where common shares were awarded, such
shares were then held in trust and therefore could not be disposed of for a
period of two additional years.

On Dec.
31, 2001, the plan was modified so that after three years, once the PSOP
eligibility has been determined, 50 per cent of the shares may be released to
the participant, while the remaining 50 per cent will be held in trust for one
additional year. In addition, the number of common shares the corporation is
authorized to grant under the terms of the PSOP was increased to 4.0 million
common shares and the maximum number of common shares which may be issued under
both the PSOP and share option plans was increased to 13.0 million common
shares.

Year ended
      Dec. 31
    
    2004
    
    2003
    
    2002Number of
      awards outstanding; beginning of year
    
    
    1.5
    
    
    1.3
    
    
    0.9Granted
    
    
    0.4
    
    
    0.7
    
    
    0.6Awarded
    
    
    –
    
    
    (0.1
    )
    
    (0.1
    )Cancelled or
      expired
    
    
    (0.4
    )
    
    (0.4
    )
    
    (0.1
    )Number of
      awards outstanding; end of year
    
    
    1.5
    
    
    1.5
    
    
    1.3


In 2004,
PSOP compensation expense was $3.4 million (2003 – $nil, 2002 – $5.3 million),
which is included in operations, maintenance and administration expense in the
statements of earnings. In 2002, 84,578 common shares were issued at $21.60 per
share. In 2003, 83,300 common shares were issued at $17.11 per share. In 2004,
16,457 common shares were issued at $17.11 per share and 44,846 common shares
were issued at $18.53 per share.

8
4Tr a n s A l t a C
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D.
Employee Share Purchase Plan

Under the
terms of the employee share purchase plan, the corporation will extend an
interest-free loan (up to 30 per cent of an employee’s base salary) to employees
below executive level and allow for payroll deductions over a three-year period
to repay the loan. Executives are no longer eligible for this program in
accordance with the Sarbanes-Oxley legislation. The corporation will purchase
these common shares on the open market on behalf of employees at prices based on
the market price of the shares as determined on the date of purchase. Employee
sales of these shares are handled in the same manner. At Dec. 31, 2004, accounts
receivable from employees under the plan totalled $0.8 million (2003 – $0.9
million).

E.
Stock-Based Compensation

As
disclosed in Note 1(P),the corporation adopted the intrinsic value
method of accounting for stock-based compensation effective Jan.1, 2002. On
Jan.1, 2003, the corporation adopted the fair value method of accounting for
stock-based compensation prospectively, under which a compensation expense is
measured at the grant date and recognized over the service period. No awards
were granted in 2004 or 2003. The following table provides pro forma measures of
net earnings and earnings per share had compensation expense been recognized
based on the estimated fair value of the options on the grant date in accordance
with the fair value method of accounting for stock-based compensation for grants
made in 2002:

Year ended
      Dec. 31
    
    2004
    
    2003
    
    2002Reported net
      earnings
    
    $
    170.2
    
    $
    234.2
    
    $
    199.6Compensation
      expense
    
    
    1.7
    
    
    2.6
    
    
    3.7Pro forma net
      earnings
    
    $
    168.5
    
    $
    231.6
    
    $
    195.9Reported
      basic earnings per share
    
    $
    0.88
    
    $
    1.26
    
    $
    1.17Compensation
      expense per share
    
    
    0.01
    
    
    0.01
    
    
    0.02Pro forma
      basic earnings per share
    
    $
    0.87
    
    $
    1.25
    
    $
    1.15Reported
      diluted earnings per share
    
    $
    0.88
    
    $
    1.26
    
    $
    1.17Compensation
      expense per share
    
    
    0.01
    
    
    0.01
    
    
    0.02Pro forma
      diluted earnings per share
    
    $
    0.87
    
    $
    1.25
    
    $
    1.15


The
estimated fair value of these stock options granted in 2002 and prior was
determined using the binomial model using the following assumptions, resulting
in a weighted-average fair value of $4.25 in 2002.

2002Risk-free
      interest rate
    
    
    5.9
    %Expected hold
      period to exercise (years)
    
    
    7.0Volatility in
      the price of the corporation’s shares
    
    
    28.3
    %


16.
PRIOR PERIOD REGULATORY DECISION

At Dec.
31, 2000, the corporation had made a provision of US$28.8 million against
US$58.0 million of receivables outstanding related to sales to the California
market. US$5.0 million of this amount was received during 2001. In March 2004,
TransAlta recorded an additional pre-tax provision of US$17.2 million ($22.9
million). However, ultimate collection of the remaining balance remains
uncertain.

On April
16, 2002, the Alberta Energy and Utilities Board (EUB) rendered a negative
decision of $3.3 million pre-tax with respect to TransAlta’s hydro bidding
strategy in 2000.

C
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5

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17.
INCOME TAXES

The
corporation follows Canadian GAAP for non-regulated entities for all electricity
generation operations and, as a result, future income taxes have been recorded
for all operations.

A.
      Statements of EarningsI. Rate
      Reconciliations
Year ended
      Dec. 31
    
    2004
    
    2003
    
    2002Earnings from
      continuing operations before income taxes
    
    $
    210.7
    
    $
    298.8
    
    $
    76.2Statutory
      Canadian federal and provincial income tax rate
    
    
    33.9
    %
    
    36.8
    %
    
    39.3
    %Expected
      taxes on income
    
    $
    71.4
    
    $
    109.8
    
    $
    29.9Increase
      (decrease) in income taxes resulting from:Lower
      effective foreign tax rates
    
    
    (19.2
    )
    
    (22.9
    )
    
    (19.9
    )Benefit
      of favourable audit outcome
    
    
    (6.8
    )
    
    –
    
    
    –Utilization
      of previously unrecognized tax losses
    
    
    –
    
    
    –
    
    
    (11.2
    )Resource
      allowance net of non-deductible royalties
    
    
    (1.6
    )
    
    (2.5
    )
    
    (3.1
    )Manufacturing
      and processing rate reduction
    
    
    (1.7
    )
    
    (3.5
    )
    
    (3.5
    )Non-taxable
      portion of gain on disposal of assets
    
    
    –
    
    
    (22.7
    )
    
    –Non-deductible
      costs and other
    
    
    (1.2
    )
    
    (2.2
    )
    
    4.6Large
      corporations tax (net of surtax)
    
    
    10.3
    
    
    9.5
    
    
    8.0Asset
      impairment and equipment cancellation recognized at lower rate
    
    
    –
    
    
    1.8
    
    
    6.3Effect
      of tax rate changes
    
    
    (7.8
    )
    
    (4.4
    )
    
    (1.7
    )Unrecognized
      future income tax assets
    
    
    6.7
    
    
    1.7
    
    
    –Income tax
      expense
    
    $
    50.1
    
    $
    64.6
    
    $
    9.4Effective tax
      rate
    
    
    23.8
    %
    
    21.6
    %
    
    12.3
    %


The
corporation’s operations are complex, and the computation and provision for
income taxes involves tax interpretations, regulations and legislation that are
continually changing. The corporation’s tax filings are subject to audit by
taxation authorities. The outcome of some audits may change the tax liability of
the corporation. Management believes it has adequately provided for income taxes
based on all information currently available.

II.
      Components of Income Tax ExpenseYear ended
      Dec. 31
    
    2004
    
    2003
    
    2002Current tax
      expense
    
    $
    36.1
    
    $
    51.0
    
    $
    77.8Future income
      tax (benefit) expense related to the originationand reversal
      of temporary differences
    
    
    21.8
    
    
    17.9
    
    
    (55.5
    )Future income
      tax (benefit) expense resulting from changes in tax rates or
laws
    
    
    (7.8
    )
    
    (4.3
    )
    
    (1.7
    )Utilization
      of previously unrecognized tax losses
    
    
    –
    
    
    –
    
    
    (11.2
    )Income tax
      expense
    
    $
    50.1
    
    $
    64.6
    
    $
    9.4
B. Balance
      SheetsSignificant
      components of the corporation’s future income tax assets and liabilities
      are as follows:
Year ended
      Dec. 31
    
    2004
    
    2003Net operating
      and capital loss carryforwards
    
    $
    275.7
    
    $
    188.0Asset
      retirement obligations
    
    
    88.9
    
    
    79.1Unrealized
      losses on electricity trading contracts
    
    
    29.7
    
    
    62.8Property,
      plant and equipment
    
    
    (949.4
    )
    
    (866.4
    )Unrealized
      gains on electricity trading contracts
    
    
    (36.4
    )
    
    (68.3
    )Other
      deductible temporary differences
    
    
    30.0
    
    
    33.8$
    (561.5
    )
    $
    (571.0
    )


8
6Tr a n s A l t a C
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Presented in
      the balance sheet as follows:Year ended
      Dec. 31
    
    
    2004
    
    
    2003AssetsCurrent
    
    $
    21.5
    
    $
    29.4Long-term
    
    
    132.0
    
    
    90.3LiabilitiesCurrent
    
    
    (11.1
    )
    
    (4.6
    )Long-term
    
    
    (703.9
    )
    
    (686.1
    )$
    (561.5
    )
    $
    (571.0
    )


As at Dec.
31, 2004, there are income tax loss carryforwards of $66.6 million (2003 – $80.3
million) for which no tax benefit has been recognized. These losses begin to
expire in 2012.

**18.
EMPLOYEE FUTURE BENEFITS**
****
**A.
Description**
**** The
corporation has registered pension plans in Canada and the U.S. covering
substantially all employees of the corporation in these countries and specific
named employees working internationally. These plans have defined benefit and
defined contribution options and, in Canada, there is an additional supplemental
defined benefit plan for certain employees. The defined benefit option of the
registered pension plans has been closed for new employees for all periods
presented.


The latest
actuarial valuations of the registered and supplemental pension plans were as at
Dec. 31, 2004. The measurement date used to determine plan assets and accrued
benefit obligation was Dec. 31, 2004. The effective date of the next required
valuation for funding purposes is Dec. 31, 2007. The supplemental pension plan
is solely the obligation of the corporation. The corporation is not obligated to
fund the supplemental plan but is obligated to pay benefits under the terms of
the plan as they come due. The corporation has posted a letter of credit in the
amount of $38.5 million to secure the obligations under the supplemental plan.

The
corporation provides other health and dental benefits to the age of 65 for both
disabled members (other post-employment benefits) and retired members (other
post-retirement benefits). The latest actuarial valuation of these other plans
was as at April 30, 2002. The measurement date used to determine the accrued
benefit obligation was also April 30, 2002. The effective date of the next
required valuation for funding purposes is Dec. 31, 2005.

B. Costs
      RecognizedYear ended
      Dec. 31, 2004
    
    Registered
    
    Supplemental
    
    Other
    
    TotalCurrent
      service cost
    
    $
    4.2
    
    $
    1.1
    
    $
    0.6
    
    $
    5.9Interest
      cost
    
    
    20.5
    
    
    2.1
    
    
    1.0
    
    
    23.6Actual return
      on plan assets
    
    
    (33.4
    )
    
    –
    
    
    –
    
    
    (33.4
    )Actuarial
      (gains) losses in 2004
    
    
    14.4
    
    
    (1.5
    )
    
    0.2
    
    
    13.1Plan
      amendments in 2004
    
    
    –
    
    
    –
    
    
    3.8
    
    
    3.8Difference
      between expected return and actual return on plan assets
    
    
    9.6
    
    
    –
    
    
    –
    
    
    9.6Difference
      between actuarial (gain) loss recognized for the year and actual actuarial
      (gain) loss on accrued benefit obligation for the
    year
    
    
    (12.3
    )
    
    2.0
    
    
    0.3
    
    
    (10.0
    )Difference
      between amortization of past service costs for the year and actual plan
      amendments for the year
    
    
    0.1
    
    
    (0.1
    )
    
    (3.8
    )
    
    (3.8
    )Amortization
      of net transition obligation (asset)
    
    
    (9.2
    )
    
    0.3
    
    
    –
    
    
    (8.9
    )Defined
      benefit (income) cost
    
    
    (6.1
    )
    
    3.9
    
    
    2.1
    
    
    (0.1
    )Defined
      contribution option expense of registered pension plan
    
    
    9.0
    
    
    –
    
    
    –
    
    
    9.0Net
      expense
    
    $
    2.9
    
    $
    3.9
    
    $
    2.1
    
    $
    8.9


C
o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s8
7

---

Year ended
      Dec. 31, 2003
    
    Registered
    
    Supplemental
    
    Other
    
    TotalCurrent
      service cost
    
    $
    3.8
    
    $
    1.4
    
    $
    0.6
    
    $
    5.8Interest
      cost
    
    
    21.0
    
    
    2.2
    
    
    1.1
    
    
    24.3Actual return
      on plan assets
    
    
    (35.9
    )
    
    –
    
    
    –
    
    
    (35.9
    )Actuarial
      (gains) losses in 2003
    
    
    21.5
    
    
    (0.7
    )
    
    0.5
    
    
    21.3Difference
      between expected return and actual return on plan assets
    
    
    12.3
    
    
    –
    
    
    –
    
    
    12.3Difference
      between actuarial (gain) loss recognized for the year andactual
      actuarial (gain) loss on accrued benefit obligation for the year
    
    
    (20.2
    )
    
    1.3
    
    
    (0.1
    )
    
    (19.0
    )Difference
      between amortization of past service costs for theyear and
      actual plan amendments for the year
    
    
    0.1
    
    
    (0.1
    )
    
    –
    
    
    –Amortization
      of net transition obligation (asset)
    
    
    (9.1
    )
    
    0.3
    
    
    –
    
    
    (8.8
    )Defined
      benefit (income) cost
    
    
    (6.5
    )
    
    4.4
    
    
    2.1
    
    
    –Defined
      contribution option expense of registered pension plan
    
    
    9.7
    
    
    –
    
    
    –
    
    
    9.7Net
      expense
    
    $
    3.2
    
    $
    4.4
    
    $
    2.1
    
    $
    9.7  Year ended
      Dec. 31, 2002
    
    Registered
    
    Supplemental
    
    Other
    
    TotalCurrent
      service cost
    
    $
    4.0
    
    $
    1.0
    
    $
    0.6
    
    $
    5.6Interest
      cost
    
    
    21.7
    
    
    1.9
    
    
    1.0
    
    
    24.6Actual return
      on plan assets
    
    
    7.7
    
    
    –
    
    
    –
    
    
    7.7Actuarial
      (gains) losses in 2002
    
    
    9.9
    
    
    6.6
    
    
    1.4
    
    
    17.9Settlement
      upon sale of Transmission operation
    
    
    3.8
    
    
    –
    
    
    (0.5
    )
    
    3.3Difference
      between expected return and actual return on plan assets
    
    
    (34.5
    )
    
    –
    
    
    –
    
    
    (34.5
    )Difference
      between actuarial (gain) loss recognized for the year andactual
      actuarial (gain) loss on accrued benefit obligation for the year
    
    
    (9.7
    )
    
    (6.4
    )
    
    (0.9
    )
    
    (17.0
    )Difference
      between amortization of past service costs for theyear and
      actual plan amendments for the year
    
    
    –
    
    
    –
    
    
    –
    
    
    –Amortization
      of net transition obligation (asset)
    
    
    (9.2
    )
    
    0.3
    
    
    –
    
    
    (8.9
    )Defined
      benefit (income) cost
    
    
    (6.3
    )
    
    3.4
    
    
    1.6
    
    
    (1.3
    )Defined
      contribution option expense of registered pension plan
    
    
    9.2
    
    
    –
    
    
    –
    
    
    9.2Net
      expense
    
    $
    2.9
    
    $
    3.4
    
    $
    1.6
    
    $
    7.9  In 2004 and
      2003, the entire net expense related to continuing operations while in
      2002, $3.6 million related to discontinued operations.C. Status
      of Plans  Year ended
      Dec. 31, 2004
    
    Registered
    
    Supplemental
    
    OtherFair value of
      plan assets
    
    $
    352.0
    
    $
    1.4
    
    $
    –Accrued
      benefit obligation
    
    
    379.0
    
    
    36.6
    
    
    21.7Funded status
      – plan deficit
    
    
    (27.0
    )
    
    (35.2
    )
    
    (21.7
    )Amounts not
      yet recognized in financial statements:Unrecognized
      past service costs
    
    
    0.5
    
    
    (0.5
    )
    
    3.8Unamortized
      transition (asset) obligation
    
    
    (55.0
    )
    
    3.0
    
    
    –Unamortized
      net actuarial gains
    
    
    57.1
    
    
    6.6
    
    
    6.2Total
      recognized in financial statements:Accrued
      benefit liability
    
    $
    (24.4
    )
    $
    (26.1
    )
    $
    (11.7
    )Amortization
      period in years (EARSL)
    
    
    9
    
    
    9
    
    
    11  Year ended
      Dec. 31, 2003
    
    Registered
    
    Supplemental
    
    OtherFair value of
      plan assets
    
    $
    351.9
    
    $
    0.9
    
    $
    –Accrued
      benefit obligation
    
    
    366.6
    
    
    36.5
    
    
    18.0Funded status
      – plan deficit
    
    
    (14.7
    )
    
    (35.6
    )
    
    (18.0
    )Amounts not
      yet recognized in financial statements:Unrecognized
      past service costs
    
    
    0.6
    
    
    (0.5
    )
    
    –Unamortized
      transition (asset) obligation
    
    
    (64.2
    )
    
    3.3
    
    
    –Unamortized
      net actuarial gains
    
    
    55.7
    
    
    7.9
    
    
    6.9Total
      recognized in financial statements:Accrued
      benefit liability
    
    $
    (22.6
    )
    $
    (24.9
    )
    $
    (11.1
    )Amortization
      period in years (EARSL)
    
    
    9
    
    
    9
    
    
    12


8
8Tr a n s A l t a C
o r p o r a t i o n A R / 0 4

---

The
accrued benefit liability is included in accounts payable and accrued
liabilities on the consolidated balance sheets.

Year ended
      Dec. 31, 2004
    
    Registered
    
    Supplemental
    
    OtherAccrued
      current liabilities
    
    $
    2.2
    
    $
    0.7
    
    $
    1.1Other
      long-term liabilities
    
    
    22.2
    
    
    25.4
    
    
    10.6Accrued
      benefit liability
    
    $
    24.4
    
    $
    26.1
    
    $
    11.7
Year ended
      Dec. 31, 2003Accrued
      current liabilities
    
    $
    2.7
    
    $
    0.6
    
    $
    1.2Other
      long-term liabilities
    
    
    19.9
    
    
    24.3
    
    
    9.9Accrued
      benefit liability
    
    $
    22.6
    
    $
    24.9
    
    $
    11.1
D.
      ContributionsExpected cash
      flows are as follows:Registered
    
    Supplemental
    
    Other
    
    Total**Employer
      contributions**2005
      (expected)
    
    $
    2.2
    
    $
    0.6
    
    $
    0.1
    
    $
    2.9**Expected
      benefit payments**2005
    
    
    23.2
    
    
    1.7
    
    
    1.2
    
    
    26.12006
    
    
    24
    
    
    1.8
    
    
    1.3
    
    
    27.12007
    
    
    24.3
    
    
    2
    
    
    1.5
    
    
    27.82008
    
    
    25
    
    
    2
    
    
    1.6
    
    
    28.62009
    
    
    25.8
    
    
    2.1
    
    
    1.7
    
    
    29.62010 –
      2014
    
    
    137.6
    
    
    12.2
    
    
    9.6
    
    
    159.4
**E.
      Plan Assets**Registered
    
    Supplemental
    
    OtherFair value of
      plan assets at Dec. 31, 2002
    
    $
    353.3
    
    $
    0.4
    
    $
    –Contributions
    
    
    0.5
    
    
    0.5
    
    $
    0.1Transfers to
      defined contribution option
    
    
    (9.7
    )
    
    –
    
    
    –Benefits
      paid
    
    
    (26.2
    )
    
    –
    
    
    (0.1
    )Effect of
      translation on U.S. plans
    
    
    (1.9
    )
    
    –
    
    
    –Actual return
      on plan assets 1
    
    
    35.9
    
    
    –
    
    
    –Fair value of
      plan assets at Dec. 31, 2003
    
    $
    351.9
    
    $
    0.9
    
    $
    –Contributions
    
    
    2.6
    
    
    0.5
    
    
    0.1Transfers to
      defined contribution option
    
    
    (9.0
    )
    
    –
    
    
    –Benefits
      paid
    
    
    (25.3
    )
    
    –
    
    
    (0.1
    )Effect of
      translation on U.S. plans
    
    
    (1.6
    )
    
    –
    
    
    –Actual return
      on plan assets 1
    
    
    33.4
    
    
    –
    
    
    –**Fair
      value of plan assets at Dec. 31, 2004**
    
    **$**
    **352.0**
    
    **$**
    **1.4**
    
    $
    **–***1 Net of
      expenses.*


The
corporation’s investment policy is to achieve a consistently high investment
return over time while maintaining an acceptable level of risk to satisfy the
benefit obligations of the pension plans. The goal is to maintain a long-term
rate of return on the fund that exceeds inflation by four per cent. The pension
fund may be invested in publicly traded common or preferred equity shares,
rights or warrants; convertible debentures or preferred securities; bonds,
debentures, mortgages, notes or other debt instruments of government agencies or
corporations; private company securities; guaranteed investment contracts; term
deposits; cash or money market securities; and mutual or pooled funds eligible
for pension fund investment. The target allocation percentages are 60 per cent
equity and 40 per cent fixed income. Cash and money market instruments may be
held from time to time as short-term investment decisions or as defensive
reserves within the portfolios of each asset class. The fund may invest in
derivatives for the purpose of hedging the portfolio or altering the desired mix
of the fund. Derivative transactions that leverage the fund in any way are not
permitted without the specific approval of the Pension Committee.


C
o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s8
9

---

The
allocation of plan assets by major asset category at Dec. 31, 2004 and 2003 is
as follows:

Year ended
      Dec. 31, 2004
    
    Registered
    
    SupplementalEquity
      securities
    
    
    55.9
    %
    
    –Debt
      securities
    
    
    42.5
    %
    
    –Cash
      equivalents
    
    
    1.6
    %
    
    100.0
    %Total
    
    
    100.0
    %
    
    100.0
    %Year ended
      Dec. 31, 2003
    
    
    Registered
    
    
    SupplementalEquity
      securities
    
    
    55.0
    %
    
    –Debt
      securities
    
    
    44.2
    %
    
    –Cash
      equivalents
    
    
    0.8
    %
    
    100.0
    %Total
    
    
    100.0
    %
    
    100.0
    %


Plan
assets include common shares of the corporation having a fair value of $0.7
million at Dec. 31, 2004 (2003 – $0.7 million). The corporation charged the
registered plan $0.1 million for administrative services provided for the year
ended Dec. 31, 2004 (2003 – $0.1 million).

F.
      Reconciliation of Accrued Benefit ObligationsRegistered
    
    Supplemental
    
    OtherAccrued
      benefit obligation as at Dec. 31, 2002
    
    $
    349.8
    
    $
    35.5
    
    $
    18.2Current
      service cost
    
    
    3.8
    
    
    1.4
    
    
    0.6Interest
      cost
    
    
    21.0
    
    
    2.2
    
    
    1.1Expected
      benefits paid
    
    
    (25.0
    )
    
    (1.3
    )
    
    (1.0
    )Past service
      charge
    
    
    0.6
    
    
    (0.6
    )
    
    –Plan
      amendments
    
    
    0.1
    
    
    –
    
    
    –Effect of
      translation on U.S. plans
    
    
    (5.2
    )
    
    –
    
    
    (1.4
    )Actuarial
      loss (gain)
    
    
    21.5
    
    
    (0.7
    )
    
    0.5Accrued
      benefit obligation as at Dec. 31, 2003
    
    $
    366.6
    
    $
    36.5
    
    $
    18.0Current
      service cost
    
    
    4.2
    
    
    1.1
    
    
    0.6Interest
      cost
    
    
    20.5
    
    
    2.1
    
    
    1.0Expected
      benefits paid
    
    
    (23.7
    )
    
    (1.6
    )
    
    (1.2
    )Past service
      charge
    
    
    –
    
    
    –
    
    
    3.8Effect of
      translation on U.S. plans
    
    
    (3.0
    )
    
    –
    
    
    (0.7
    )Actuarial
      loss (gain)
    
    
    14.4
    
    
    (1.5
    )
    
    0.2Accrued
      benefit obligation as at Dec. 31, 2004
    
    $
    379.0
    
    $
    36.6
    
    $
    21.7G.
      Assumptions


The
significant actuarial assumptions adopted in measuring the corporation’s accrued
benefit obligations were as follows:

Year ended
      Dec. 31, 2004
    
    Registered
    
    Supplemental
    
    OtherAccrued
      benefit obligation at Dec. 31Discount
      rate
    
    
    5.5
    %
    
    5.5
    %
    
    5.6
    %Rate of
      compensation increase
    
    
    3.5
    %
    
    3.5
    %
    
    –Benefit
      cost for year ended Dec. 31Discount
      rate
    
    
    5.8
    %
    
    5.8
    %
    
    5.9
    %Rate of
      compensation increase
    
    
    3.5
    %
    
    3.5
    %
    
    –Expected rate
      of return on plan assets
    
    
    7.1
    %
    
    –
    
    
    –Assumed
      health care cost trend rate at Dec. 31Health care
      cost escalation
    
    
    –
    
    
    –
    
    
    10.0
      -12.5%1
    )Dental care
      cost escalation
    
    
    –
    
    
    –
    
    
    4.0
    %Provincial
      health care premium escalation
    
    
    –
    
    
    –
    
    
    2.5
    %


9
0Tr a n s A l t a C
o r p o r a t i o n A R / 0 4

---

Year ended
      Dec. 31, 2003
    
    Registered
    
    Supplemental
    
    OtherAccrued
      benefit obligation at Dec. 31Discount
      rate
    
    
    5.8
    %
    
    5.8
    %
    
    6.1
    %Rate of
      compensation increase
    
    
    3.5
    %
    
    3.5
    %
    
    –Benefit
      cost for year ended Dec. 31Discount
      rate
    
    
    6.3
    %
    
    6.3
    %
    
    6.4
    %Rate of
      compensation increase
    
    
    3.6
    %
    
    3.5
    %
    
    –Expected rate
      of return on plan assets
    
    
    7.1
    %
    
    –
    
    
    –Assumed
      health care cost trend rate at Dec. 31Health care
      cost escalation
    
    
    –
    
    
    –
    
    
    6.6-7.0
    %2Dental care
      cost escalation
    
    
    –
    
    
    –
    
    
    3.5
    %Provincial
      health care premium escalation
    
    
    –
    
    
    –
    
    
    2.5
    %


1
    For the
      next 10 years and five per cent thereafter for Canadian plans. For U.S.
      plans, decreasing to five per cent for 2012 and remaining at that level
      thereafter.2
    For five
      years and 5 per cent thereafter for Canadian plans. For U.S. plans,
      decreasing gradually to 4.5 per cent for 2016 and remaining at that level
      thereafter.


The
expected long-term rate of return on plan assets is based on past performance
and economic forecasts for the types of investments held by the plan. The
estimated rate of return is lower than the historical returns of the appropriate
indices.

Sensitivity to
changes in assumed health care cost trend rates are as follows:

One
      percentage
    
    One
      percentagepoint
      increase
    
    point
      decreaseEffect on
      total service and interest costs
    
    $
    0.1
    
    $
    (0.1
    )Effect on
      post-retirement benefit obligation
    
    $
    1.2
    
    $
    (1.0
    )


19.
    FINANCIAL
      RISK MANAGEMENTA.
    Foreign
      Exchange Rate Risk ManagementI.
    Hedges
      of Foreign Operations


The
corporation has exposure to changes in the carrying values of its
self-sustaining foreign operations as a result of changes in foreign exchange
rates. The corporation uses cross-currency interest rate swaps at fixed and
floating rate terms, forward sales contracts and direct foreign currency debt to
hedge these exposures. The principal component of the cross-currency interest
rate swaps and direct foreign currency debt hedge a portion of the carrying
value of foreign operations. Translation gains and losses related to these
components are deferred and included in CTA in shareholders’ equity on a net of
tax basis.

Realized
gains and losses arising from the hedging of net investments and inter-company
transactions are reflected as an investing activity in the statement of cash
flows. Upon the settlement of certain financial instruments designated as net
investment hedges, a foreign exchange gain of $47.8 million was realized in 2004
(2003 – $194.1 million, 2002 – $4.2 million). This is recorded in the
corporation’s cumulative translation account in total equity. During 2004, the
corporation reclassified prior year cash flows to be consistent with the current
presentation.

Details of
the notional amounts of cross-currency interest rate swaps are as follows:

Year ended
      Dec. 31
    
    2004
    
    2003Amount
    
    Fair
      Value
    
    Maturities
    
    Amount
    
    Fair
      Value
    
    MaturitiesAustralian
      dollars
    
    
    AUD$34.0
    
    $
    (3.4
    )
    
    2005
    
    
    AUD$221.0
    
    $
    (13.1
    )
    
    2005-2010U.S.
      dollars
    
    
    US$706.9
    
    $
    128.7
    
    
    2005-2012
    
    
    US$429.0
    
    $
    60.1
    
    
    2004-2012


In
addition, the corporation has designated U.S. dollar denominated long-term debt
(Note 11)in the amount of US$727.9 million (2003 – US$743.9 million) as
a hedge of its net investment in U.S. and Mexico operations with $147.6 million
of related foreign currency losses (2003 – $103.1 million loss) deferred and
included in CTA.

The
corporation has also hedged a portion of its net investment in self-sustaining
subsidiaries with foreign currency forward sales contracts as shown below:

Year ended
      Dec. 31
    
    2004
    
    2003Amount
    
    Fair Value
    
    Maturities
    
    Amount
    
    Fair
      value
    
    MaturitiesNew Zealand
      dollars
    
    
    NZ$513.3
    
    $
    (142.5
    )
    
    2005
    
    
    NZ$448.5
    
    $
    (98.2
    )
    
    2004U.S.
      dollars
    
    
    US$499.5
    
    $
    82.1
    
    
    2005
    
    
    US$510.3
    
    $
    4.0
    
    
    2004Australian
      dollars
    
    
    AUD$8.6
    
    $
    –
    
    
    2005
    
    
    AUD$34.3
    
    $
    (2.4
    )
    
    2004Mexican
      pesos
    
    
    MXN
      871.6
    
    $
    10.8
    
    
    2009
    
    
    –
    
    
    –
    
    
    –


C
o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s9
1

---

In
addition, the corporation has hedged foreign currency denominated intercompany
loans to a self-sustaining foreign subsidiary using forward contracts with a
notional amount of US$209.0 million (2003 – $206.7 million) and $78.3 million
(2003 – $163.1 million) and a net fair value liability of $78.2 million (2003 –
$52.4 million).

At Dec.
31, 2004, a $231.5 million asset (2003 – $74.9 million) and a $83.9 million
liability (2003 – $87.7 million) related to the cross-currency interest rate
swaps and forward sales contracts was recorded in other assets (Note 9)and deferred credits and other long-term liabilities (Note 12)respectively.

II.
Hedges of Future Foreign Currency Obligations

The
corporation has hedged future foreign currency obligations through forward
purchase contracts as follows:

Year
      ended Dec. 31
    
    
    
    **2004**
    
    2003Currency
    
    Currency
    
    Amount
    
    Amount
    
    Fair
      Value asset
    
    
    
    Amount
    
    Amount
    
    Fair
      value assetsold
    
    purchased
    
    sold
    
    purchased
    
    (liability)
    
    Maturities
    
    sold
    
    purchased
    
    (liability)
    
    MaturitiesCanadian
      dollars
    
    
    U.S.
      dollars
    
    **$**************
    **************43.00**
    
    **$**************
    **************US29.5**
    
    **$******
    ********(6.80
    ********)
    
    **2005**
    
    $
    60.40
    
    $
    US44.1
    
    $
    (1.60
    )
    
    2004-2005U.S.
      dollars
    
    
    Canadian
      dollars
    
    **$**************
    **************US24.5**
    
    **$**************
    **************37.30**
    
    **$**************
    **************7.10**
    
    
    **2005**
    
    
    –
    
    
    –
    
    
    –
    
    
    –Mexican
      pesos
    
    
    U.S.
      dollars
    
    
    **MXN
      51.6**
    
    **$**************
    **************US4.6**
    
    **$**************
    **************0.10**
    
    
    **2005**
    
    
    –
    
    
    –
    
    
    –
    
    
    –Canadian
      dollars
    
    
    New
      Zealand dollars
    
    **$**************
    **************17.80**
    
    **$******
    ******NZ20.0**
    
    **$******
    ********(0.50
    ********)
    
    **2005**
    
    
    –
    
    
    –
    
    
    –
    
    
    –U.S.
      dollars
    
    
    New
      Zealand dollars
    
    **$**************
    **************US207.1**
    
    **$**
    **NZ456.7**
    
    **$**************
    **************141.10**
    
    
    **2005**
    
    $
    US184.8
    
    $
    NZ425.0
    
    $
    98.70
    
    
    2005




At Dec.
31, 2004, a $8.7 million asset (2003 – $94.7 million) and a $52.2 million
liability (2003 – $24.4 million) related to these hedges was recorded in other
assets (Note 9)and deferred credits and other long-term liabilities
(Note 12),respectively.
 **B. Interest
Rate Risk Management**
****
***I.
Existing Debt***

The
corporation has converted fixed interest rate debt at fixed rates ranging from
5.75 per cent to 6.9 per cent to floating rates through receive fixed interest
rate swaps (Note 11)as shown below:
Year ended
      Dec. 31**2004**
    
    2003Notional
    
    Fair
      value
    
    
    
    Notional
    
    Fair
      valueamount
    
    of
      swaps
    
    Maturities
    
    amount
    
    of
      swaps
    
    MaturitiesFixed rate
      debt
    
    **$**
    **375.0**
    
    **$**
    **39.9**
    
    
    **2006-2011**
    
    $
    375.0
    
    $
    36.8
    
    
    2006-2011**$**
    **US300.0**
    
    **$**
    **1.6**
    
    
    **2013**
    
    $
    US200.0
    
    $
    1.1
    
    
    2013


The
corporation has converted floating interest rate debt to fixed rate debt at a
fixed rate of 7.4 per cent through receive floating rate swaps (Note 11)as shown below:


Year ended
Dec. 31

**2004**
    
    
    
    
    
    2003Notional
    
    Fair
      value
    
    
    
    Notional
    
    Fair
      valueamount
    
    of
      swaps
    
    Maturity
    
    amount
    
    of
      swaps
    
    MaturityFloating rate
      debt
    
    **$**
    **US87.9**
    
    **$**
    **(21.1**
    **)**
    
    **2016**
    
    $
    US91.8
    
    $
    (26.8
    )
    
    2016








The fair
value of the corporation’s fixed interest long-term debt changes as interest
rates change, with details as follows:

Year ended
Dec. 31

**2004**
    
    2003Carrying
      amount
    
    Fair value
    
    Carrying
      amount
    
    Fair valueLong-term
      debt, including current portion
    
    **$**
    **3,232.9**
    
    **$**
    **3,416.6**
    
    $
    3,621.1
    
    $
    3,823.3






**C. Energy
Commodities Price Risk Management**
 ****
 ***I.
Trading Activities***


The
corporation markets energy derivatives, including physical and financial swaps,
forwards and options, to optimize returns from assets, to earn trading revenues
and to gain market information.

9
2Tr a n s A l t a C
o r p o r a t i o n A R / 0 4

---

At Dec.
31, 2004 and 2003, details of the corporation’s fixed price trading positions
were as follows:

Electricity
    
    Natural
      gasUnits
      (000s)
    
    (MWh)
    
    (GJ)Fixed price
      payor, notional amounts, Dec. 31, 2004
    
    
    **14,138.00**
    
    
    **35,221.70**Fixed price
      payor, notional amounts, Dec. 31, 2003
    
    
    13,872.60
    
    
    45,638.60Fixed price
      receiver, notional amounts, Dec. 31, 2004
    
    
    **15,854.20**
    
    
    **29,721.20**Fixed price
      receiver, notional amounts, Dec. 31, 2003
    
    
    13,061.80
    
    
    67,738.30Maximum term
      in months, Dec. 31, 2004
    
    
    **48**
    
    
    **34**Maximum term
      in months, Dec. 31, 2003
    
    
    33
    
    
    24


The gross
      physical and financial volumes of settled sales of proprietary trading
      transactions are as follows:**Electricity
      (GWh)****Year
      ended Dec. 31**
    
    2004
    
    2003
    
    2002Physical
    
    
    61,165
    
    
    55,506
    
    
    61,089Financial
    
    
    23,239
    
    
    34,327
    
    
    31,78584,404
    
    
    89,833
    
    
    92,874
Gas (million
      GJ)Year ended
      Dec. 31
    
    2004
    
    2003
    
    2002Physical
    
    
    122.4
    
    
    100.1
    
    
    101.5Financial
    
    
    308.0
    
    
    170.1
    
    
    60.5430.4
    
    
    270.2
    
    
    162.0
The carrying
      and fair value of energy commodity trading assets and liabilities included
      on the balance sheet are as follows:Year ended
      Dec. 31
    
    
    
    2004
    
    
    2003Price risk
      management assetsCurrent
    
    
    $
    61.4
    
    $
    68.4Long-term
    
    
    
    32.5
    
    
    31.6Price risk
      management liabilitiesCurrent
    
    
    
    (49.9)
    
    
    (64.3)Long-term
    
    
    
    (28.5)
    
    
    (29.9)Net price
      risk management assets outstanding
    
    
    $
    15.5
    
    $
    5.8


The change
in fair value of contracts outstanding at Dec. 31, 2004 and 2003, as well as the
changes in fair value of the net price risk management assets for 2004, is
attributed to the following:

Change in
      fair value of net assets
    
    Fair
      valueNet price
      risk management assets outstanding at Dec. 31, 2003
    
    $
    5.8New contracts
      entered into during the period
    
    
    14.9Changes in
      values attributable to market price and other market changes
    
    
    (5.6
    )Contracts
      realized, amortized or settled during the period
    
    
    (4.3
    )Changes in
      values attributable to discontinued hedge treatment of certain
      contracts
    
    
    4.7Net price
      risk management assets outstanding at Dec. 31, 2004
    
    $
    15.5II.
      Hedging Activities


The
corporation uses energy derivatives, including physical and financial swaps,
forwards and options, to manage its exposure to changes in electricity and
natural gas prices. At Dec. 31, 2004, details of the corporation’s hedging
position were as follows:

Fixed price
      payor notional amount
    
    Fixed price
      receiver notional amount
    
    Maximum term
      in monthsCommodity
      hedges (000s)
    
    
    **11,015.21
      GJ**
    ****
    ****
    **10,908.4
      MWh**
    ****
    ****
    **45**Diesel swap
      (millions of litres)
    
    
    **12.9**
    ****
    ****
    **–**
    ****
    ****
    **12**
 The fair
value of these hedges is a $12.6 million liability (2003 – $2.7 million).


In
addition, the corporation has entered into a number of long-term gas purchase
and transportation agreements in the normal course of business to hedge its
long-term electricity sales contracts. The maximum term of these contracts is
four years.

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D.
Credit Risk Management

The
corporation actively manages its exposure to credit risk by assessing the
ability of counterparties to fulfill their obligations under the related
contracts prior to entering into such contracts, and continually monitors these
exposures. For Energy Marketing, the corporation sets strict credit limits for
each counterparty and halts trading activities with the counterparty if the
limits are exceeded. The corporation makes detailed assessments of the credit
quality of all counterparties and, where appropriate, obtains corporate
guarantees and/or letters of credit to support the ultimate collection of these
receivables. TransAlta is exposed to minimal credit risk for Alberta Generation
Power Purchase Arrangements (PPA) as all receivables are guaranteed by letters
of credit.

The
maximum credit exposure to any one customer, excluding the California market
receivables discussed above and including the fair value of open trading
positions, is $67.7 million.

20. JOINT
      VENTURESJoint
      ventures at Dec. 31, 2004 included the following:Joint
      venture
    Ownership
      interest
    DescriptionSheerness
      joint venture
    25%
    Coal-fired
      plant in Alberta, of which TA Cogen has a 50 per cent interest, and is
      operated by Canadian UtilitiesMeridian
      joint venture
    25%
    Cogeneration
      plant in Alberta, of which TA Cogen has a 50 per cent interest, and is
      operated by Husky EnergyFort
      Saskatchewan joint venture
    30%
    Cogeneration
      plant in Alberta, of which TA Cogen has a 50 per cent interest, and is
      operated by Husky EnergyMcBride Lake
      joint venture
    50%
    Wind
      generation facilities in Alberta, operated by TransAltaGoldfields
      Power joint venture
    50%
    Gas-fired
      plant in Australia, operated by TransAltaCE Generation
      LLC
    50%
    Geothermal
      and gas plants in the US, operated by CE Gen affiliatesGenesee
      3
    50%
    Coal-fired
      plant in Alberta, operated by EPCOR Utilities
Inc.


Summarized
information on the results of operations, financial position and cash flows
relating to the corporation’s pro-rata interests in its jointly controlled
corporations was as follows:



2004
    
    2003
    
    2002Results of
      operationsRevenues
    
    $
    505.2
    
    $
    539.0
    
    $
    195.3Expenses
    
    
    (424.3
    )
    
    (429.3
    )
    
    (123.7
    )Non-controlling
      interests
    
    
    (37.1
    )
    
    (25.9
    )
    
    (3.0
    )Proportionate
      share of net earnings
    
    $
    43.8
    
    $
    83.8
    
    $
    68.6Cash
      flowsCash flow
      from operations
    
    $
    153.2
    
    $
    498.7
    
    $
    7.2Cash flow
      used in investing activities
    
    
    (21.6
    )
    
    (1,603.4
    )
    
    (33.2
    )Cash flow
      used in financing activities
    
    
    (129.1
    )
    
    1,131.5
    
    
    –Proportionate
      share of decrease in cash and cash equivalents
    
    $
    2.5
    
    $
    26.8
    
    $
    (26.0
    )Financial
      positionCurrent
      assets
    
    $
    112.7
    
    $
    125.9
    
    $
    37.0Long-term
      assets
    
    
    2,033.7
    
    
    2,214.4
    
    
    587.8Current
      liabilities
    
    
    (110.9
    )
    
    (135.1
    )
    
    (11.9
    )Long-term
      liabilities
    
    
    (635.6
    )
    
    (806.2
    )
    
    (5.5
    )Non-controlling
      interests
    
    
    (416.3
    )
    
    (164.5
    )
    
    (27.4
    )Proportionate
      share of net assets
    
    $
    983.6
    
    $
    1,234.5
    
    $
    580.0


9 4Tr
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21.
RELATED PARTY TRANSACTIONS

On Dec. 1,
2004, TransAlta completed the sale of its 50 per cent interest in the 220-MW
Meridian Cogeneration Facility located in Lloydminster, Saskatchewan to TA Cogen
for its fair value of $110.0 million. TA Cogen (owned 50.01 per cent by
TransAlta and 49.99 per cent by TransAlta Power) financed the acquisition
through the use of $50.0 million of cash on hand and by the issuance of $30.0
million of units to each of TransAlta Power and TEC. TA Cogen also issued an
advance to TEC for $30.0 million. The advance outstanding at Dec. 31, 2004 was
$28.0 million and is included in accounts receivable. TransAlta recorded a gain
of $11.5 million after-tax or $0.06 per common share ($17.7 million pre-tax).

On July
31, 2003, TransAlta completed the sale of its 50 per cent interest in the
two-unit, 756-MW coal-fired Sheerness Generating Station to TA Cogen for $630.0
million. The exchange amount was at fair value and was determined based on an
estimate of the future net cash flows of the plant and approved by the
independent directors of TA Cogen. There are no ongoing contractual commitments
or arrangements resulting from this sale apart from the provision of operational
and management services under normal commercial terms for the Sheerness
Generating Station.

In
connection with the sale of the Sheerness Generating Station, the obligation for
TransAlta to purchase all of TransAlta Power’s interest in TA Cogen on Dec. 31,
2018 that arose on the sale of power generation assets to TA Cogen in 1998 has
been eliminated; therefore the deferred gain of $119.8 million related to this
sale was recognized in earnings in 2003. In addition, the management agreements
between TransAlta, TransAlta Power and TA Cogen were amended to remove the
mechanism for the deferral of management fees and remove the obligation for
TransAlta Power and TA Cogen to pay management fees to TransAlta in the future.
As consideration for the amendments, TransAlta received $1.0 million from
TransAlta Power and $5.0 million from TA Cogen.

In
February 2003, TransAlta entered into an agreement with CE Gen whereby TransAlta
buys available power from certain CE Gen subsidiaries under normal commercial
terms. In addition, CE Gen has entered into contracts with related parties to
provide administrative and maintenance services.

For the
period November 2002 to November 2007, TA Cogen entered into a transportation
swap transaction with a wholly-owned subsidiary of TransAlta, TEC (Note 12).TEC operates and maintains TA Cogen’s three combined-cycle power plants in
Ontario and a plant in Fort Saskatchewan, Alberta. TEC also provides management
services to the Sheerness Generating Station in Alberta, which is operated by
Canadian Utilities. The business purpose of the transportation swap was to
provide TA Cogen with the delivery of fixed price gas without being exposed to
escalating costs of pipeline transportation for two of its plants over the
period of the swap. This stabilizes cash distributions in TA Cogen and thereby
preserves the value of the limited partnership as a financing vehicle of
TransAlta. The notional gas volume in the transaction was the total delivered
fuel for both facilities. Exchange amounts are based on the market value of the
contract. TransAlta entered into an offsetting contract with an external third
party, therefore TransAlta has no risk other than counterparty risk.

TA Cogen
entered into a fixed-for-floating gas swap transaction with TEC for a 61-month
period starting Dec. 1, 2000. The swap transaction provides TA Cogen with fixed
price gas for both the Mississauga and Ottawa plants over the period. The
floating prices associated with the Mississauga and Ottawa cogeneration plants’
long-term fuel supply agreements were transferred to TEC’s account. The notional
gas volume in the transaction was the total delivered fuel for both facilities.
As consideration and in negotiation, TA Cogen transferred the right to
incremental revenues associated with curtailed electrical production and
subsequent higher revenue gas sales. At Dec. 31, 2004, the portion of the
contract related to the non-controlling interest had a fair value liability of
$4.9 million (2003 – $7.9 million).

22.
COMMITMENTS

A
significant portion of the corporation’s electricity and thermal sales revenues
are subject to PPAs and long-term contracts. Commencing Jan. 1, 2001, Alberta
Generation assets became subject to long-term PPAs for a period approximating
the remaining life of each plant or unit. These PPAs set a production
requirement and availability target to be supplied by each plant or unit and the
price at which each megawatt-hour will be supplied to the customer. For Mexico,
the plants’ energy production is subject to 25-year contracts with the Comisión
Federal de Electricidad. These contracts set availability targets and the price
at which the plant will be paid per kilowatt of available capacity, as well as
plant efficiency targets for recovery of fuel costs based on market prices. At
Sarnia, there are 20-year contracts with a customer group with three, five-year
options for extensions to the contracts. The contracts allow for up to 40 per
cent of the plant’s maximum capacity. These contracts set payments for peak
megawatts, total megawatt hours and steam consumed, while TransAlta assumes the
availability and heat rate risk. The remaining capacity is available for export
to the merchant market, based on market conditions. Energy production at the
remaining Ontario plants is subject to contracts expiring in nine to 14 years.
These contracts set availability targets and the price at which the plant will
be paid per MWhs produced, as well as risk sharing of fuel costs based on market
prices.

C
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Thermal
energy contracts for these Ontario plants expire the same time as the energy
production contracts and are with a different customer base. These contracts set
payments for volumes consumed, while TA Cogen assumes the heat rate risk. At
Centralia, a significant portion of production is subject to short- to
medium-term energy sales contracts. In addition, a portion of the corporation’s
energy sales from its gas plants are subject to medium- to long-term energy
sales contracts.

The
corporation has entered into a number of long-term gas purchase agreements,
transportation and transmission agreements, royalty and right-of-way agreements
in the normal course of operations. In 2002, the corporation cancelled orders on
several turbines, and incurred a pre-tax impairment charge of $42.5 million
(Note 7).Approximate future payments under the fixed price purchase
contracts, operating lease and mining agreements are as follows:

Fixed
      pricegas
      purchase
    
    Operating
    
    Miningcontracts
    
    leases
    
    agreements
    
    Total2005
    
    $
    51.4
    
    $
    14.8
    
    $
    81.9
    
    $
    148.12006
    
    $
    53.1
    
    $
    13.2
    
    $
    36.7
    
    $
    103.02007
    
    $
    54.8
    
    $
    11.6
    
    $
    36.8
    
    $
    103.22008
    
    $
    56.8
    
    $
    10.6
    
    $
    33.3
    
    $
    100.72009
    
    $
    32.4
    
    $
    10.2
    
    $
    18.6
    
    $
    61.22010 and
      thereafter
    
    $
    87.0
    
    $
    100.0
    
    $
    300.3
    
    $
    487.3Total
    
    $
    335.5
    
    $
    160.4
    
    $
    507.6
    
    $
    1,003.5**23.
      OTHER CONTINGENCIES**
 In March 2003, FERC
completed its investigation of natural gas and power markets and indicated that
the total industry refunds for price overcharges will be higher than originally
anticipated.


In June
2003, FERC issued two show cause orders, the Partnership Gaming Order and the
Gaming Practices Order, in which TransAlta’s U.S. subsidiaries were named. These
orders required TransAlta to justify certain trading activities in California
between Oct. 1, 2000 and June 20, 2001. In response to FERC’s show cause orders,
TransAlta confirmed that it did not engage in gaming behavior. Based on the
information provided by TransAlta, FERC Trial Staff filed a Motion to Dismiss
with respect to TransAlta in the two show cause proceedings. On Jan. 22, 2004,
FERC granted the FERC Trial Staff’s motion to dismiss TransAlta from both the
Partnership Gaming Order and the Gaming Practices Order. FERC found that
TransAlta did not engage in prohibited gaming practices.

On May 30,
2002, the California Attorney General’s Office filed civil complaints in the
state court of California against eight wholesale power companies, including
TransAlta. The complaint alleges violations of California’s unfair business
practices law in connection with rates charged for wholesale electricity sales.
The state court denied the Attorney General’s complaint and granted an order to
dismiss the claims against TransAlta. The Attorney General dropped its appeal of
this decision on Nov. 2, 2004; as such, the decision is final as of such date.

On Dec.
16, 2002, the Canadian government ratified the Kyoto Protocol, which came into
effect on Feb. 16, 2005. The Kyoto Protocol is not expected to have an impact on
TransAlta’s U.S., Mexican or Australian operations. TransAlta is not able to
estimate the full impact the Protocol will have on its Canadian operations, as
the Canadian government has not yet established an implementation plan. However,
the PPAs for TransAlta’s coal-fired plants in Alberta contain ‘Change of Law’
provisions that should provide an opportunity to recover compliance costs from
the PPA customers.

The
corporation is involved in various other claims and legal actions arising from
the normal course of business. The corporation does not expect that the outcome
of these proceedings having regard to insurance available to it, and the amounts
reserved in respect of such claims, will have a materially adverse effect on the
corporation as a whole.

9
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24.
COMPARATIVE FIGURES

Certain of
the comparative figures have been reclassified to conform with the current
year’s presentation. Such reclassification did not impact previously reported
net income or retained earnings.

2 5.
SUBSEQUENT EVENTS

On Feb.
15, 2005, the corporation redeemed all of its 7.50 per cent Preferred
Securities, which had an aggregate principal amount of $175.0 million and all of
its 8.15 per cent Preferred Securities, which had an aggregate principal amount
of $125.0 million. As a result, $300.0 million of Preferred Securities are
included in the current portion of long-term debt at Dec. 31, 2004.

2 6.
UNITED STATESGENERALLY ACCEPTED ACCOUNTINGPRINCIPLES

These
consolidated financial statements have been prepared in accordance with Canadian
GAAP, which, in most respects, conform to U.S. GAAP. Significant differences
between Canadian and U.S. GAAP are as follows:

A.
      Earnings and Earnings Per Share (EPS)ReconcilingYear ended
      Dec. 31
    
    items
    
    2004
    
    2003
    
    2002Earnings from
      continuing operations – Canadian GAAP
    
    
    
    
    $
    160.6
    
    $
    234.2
    
    $
    66.8Effect of
      asset retirement obligations adoption – Canadian GAAP
    
    
    X
    
    
    –
    
    
    –
    
    
    (9.7
    )Derivatives
      and hedging activities, net of tax
    
    
    I
    
    
    (3.8
    )
    
    (4.5
    )
    
    (3.8
    )Start-up
      costs, net of tax
    
    
    II
    
    
    (0.1
    )
    
    (6.7
    )
    
    (4.5
    )Amortization
      of debt extinguishment, net of tax
    
    
    III
    
    
    –
    
    
    –
    
    
    0.8Recognition
      of debt extinguishment, net of tax
    
    
    III
    
    
    –
    
    
    11.1
    
    
    –Amortization
      of pension transition adjustment
    
    
    V
    
    
    (4.5
    )
    
    (4.6
    )
    
    (5.8
    )Earnings
      from continuing operations – U.S. GAAP
    
    
    
    
    
    152.2
    
    
    229.5
    
    
    43.8Earnings from
      discontinued operations – Canadian and U.S. GAAP
    
    
    
    
    
    –
    
    
    –
    
    
    12.8Net gain on
      disposal of discontinued operations – Canadian and U.S.
    GAAP
    
    
    
    
    
    9.6
    
    
    –
    
    
    120.0Net
      earnings before change in accounting principle – U.S. GAAP
    
    
    
    
    
    161.8
    
    
    229.5
    
    
    176.6Cumulative
      effect of change in accounting principle, net of tax
    
    
    X
    
    
    –
    
    
    52.5
    
    
    –Net
      earnings – U.S. GAAP
    
    
    
    
    $
    161.8
    
    $
    282.0
    
    $
    176.6Foreign
      currency cumulative translation adjustment
    
    
    I,
    VII
    
    
    3.7
    
    
    8.2
    
    
    (16.8
    )Net gain
      (loss) on derivative instruments
    
    
    I,
    VII
    
    
    10.4
    
    
    8.8
    
    
    (51.5
    )Registered
      pension alternate minimum liability
    
    
    V,
    VII
    
    
    (0.6
    )
    
    0.6
    
    
    (1.7
    )Comprehensive
      income – U.S. GAAP
    
    
    
    
    $
    175.3
    
    $
    299.6
    
    $
    106.6Basic EPS
      – U.S. GAAPEarnings from
      continuing operations
    
    
    
    
    $
    0.79
    
    $
    1.24
    
    $
    0.26Earnings from
      discontinued operations
    
    
    
    
    
    –
    
    
    –
    
    
    0.08Net gain on
      disposal of discontinued operations
    
    
    
    
    
    0.05
    
    
    –
    
    
    0.71Cumulative
      effect of change in accounting principle
    
    
    
    
    
    –
    
    
    0.28
    
    
    –Net
      earnings
    
    
    
    
    $
    0.84
    
    $
    1.52
    
    $
    1.05Diluted
      EPS – U.S. GAAPEarnings from
      continuing operations
    
    
    
    
    $
    0.79
    
    $
    1.24
    
    $
    0.26Earnings from
      discontinued operations
    
    
    
    
    
    –
    
    
    –
    
    
    0.08Net gain on
      disposal of discontinued operations
    
    
    
    
    
    0.05
    
    
    –
    
    
    0.71Cumulative
      effect of change in accounting principle
    
    
    
    
    
    –
    
    
    0.28
    
    
    –Net
      earnings
    
    
    
    
    $
    0.84
    
    $
    1.52
    
    $
    1.05


C
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7

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B. Balance
      Sheet InformationYear ended
      Dec. 31
    
    
    
    
    
    2004
    
    
    
    2003Reconciling
    
    Canadian
    
    
    
    Canadianitems
    
    GAAP
    
    U.S.
      GAAP
    
    GAAP
    
    U.S.
      GAAPAssetsCash
    
    
    IX,
    XII
    
    $
    137.1
    
    $
    101.2
    
    $
    155.0
    
    $
    155.0Current
      derivative assets
    
    
    I
    
    
    –
    
    
    47.8
    
    
    –
    
    
    6.9Accounts
      receivable
    
    
    VIII,
      XII
    
    
    429.1
    
    
    396.4
    
    
    420.1
    
    
    419.2Prepaid
      expenses
    
    
    XII
    
    
    54.7
    
    
    52.3
    
    
    53.8
    
    
    53.8Income taxes
      receivable
    
    
    I
    
    
    60.1
    
    
    75.1
    
    
    108.9
    
    
    126.3Investments
    
    
    XII
    
    
    3.0
    
    
    371.7
    
    
    5.0
    
    
    189.4Property,
      plant and equipment, net
    
    
    II,
    XII
    
    
    6,244.4
    
    
    5,699.5
    
    
    6,385.5
    
    
    6,382.6Long-term
      derivative asset
    
    
    I
    
    
    –
    
    
    187.7
    
    
    –
    
    
    102.8Other assets
      (including current portion)
    
    
    I, II,
      XII
    
    
    373.9
    
    
    166.2
    
    
    330.2
    
    
    205.8LiabilitiesAccounts
      payable and accrued liabilities
    
    
    V,
    XII
    
    
    432.3
    
    
    338.5
    
    
    501.2
    
    
    471.1Income taxes
      payable
    
    
    II,
    XII
    
    
    6.9
    
    
    0.7
    
    
    –
    
    
    –Current
      derivative liabilities
    
    
    I
    
    
    –
    
    
    32.2
    
    
    –
    
    
    40.3Current
      portion of long-term debt
    
    
    IX,
    XII
    
    
    587.7
    
    
    580.1
    
    
    183.8
    
    
    183.8Long-term
      debt
    
    
    I,
    XII
    
    
    2,470.2
    
    
    2,365.0
    
    
    2,962.3
    
    
    3,185.9Deferred
      credits and other liabilities (including current portion)
    
    
    I, XI,
      XII
    
    
    524.7
    
    
    511.8
    
    
    511.7
    
    
    517.8Firm
      commitment
    
    
    I
    
    
    –
    
    
    0.4
    
    
    –
    
    
    –Long-term
      derivative liabilities
    
    
    I
    
    
    –
    
    
    48.2
    
    
    –
    
    
    12.2Future or
      deferred income tax liabilities
    
    
    I, II, IV,
      V
    
    
    703.9
    
    
    694.8
    
    
    686.1
    
    
    671.2Non-controlling
      interest
    
    
    I
    
    
    616.4
    
    
    615.4
    
    
    477.9
    
    
    475.6EquityCommon
      shares
    
    
    VIII
    
    
    1,611.9
    
    
    1,611.9
    
    
    1,555.7
    
    
    1,554.8Retained
      earnings
    
    
    I, II,
      V
    
    
    910.3
    
    
    904.0
    
    
    933.9
    
    
    936.0Cumulative
      translation adjustment
    
    
    I
    
    
    (49.5
    )
    
    –
    
    
    (39.1
    )
    
    –Accumulated
      other comprehensive income
    
    
    I,
V
    
    
    –
    
    
    (92.6
    )
    
    –
    
    
    (106.1
    )C.
      Reconciling ItemsI.
      Derivatives and Hedging Activities


Under U.S.
GAAP, trading and non-trading activities are accounted for in accordance with
Statement 133, which requires that derivative instruments be recorded in the
consolidated balance sheets at fair value as either assets or liabilities, and
that changes in fair value be recognized currently in earnings, unless specific
hedge accounting criteria are met. If the derivative is designated as a fair
value hedge, the changes in the fair value of the derivative and of the hedged
item attributable to the hedged risk are recognized currently in earnings. If
the derivative is designated as a cash flow hedge, the changes in the fair value
of the derivative are recorded in other comprehensive income, and the gains and
losses related to these derivatives are recognized in earnings in the same
period as the settlement of the underlying hedged transaction. Any
ineffectiveness relating to these hedges is recognized currently in earnings.
The assets and liabilities related to derivative instruments for which hedge
accounting criteria are met are reflected as derivative hedging instruments in
the consolidated balance sheets. Many of the corporation’s electricity sales and
fuel supply agreements that otherwise would be required to follow derivative
accounting qualify as normal purchases and normal sales under Statement 133 and
are therefore exempt from fair value accounting treatment. This exemption is
available for the electricity industry as electricity cannot be stored in
significant quantities and generators may be required to maintain sufficient
capacity to meet customer demands. This exemption is also available for some
physically settled commodity contracts if certain criteria are met.
Non-derivatives used in trading activities are accounted for using the accrual
method under U.S. GAAP.

i.
    Fair Value Hedging StrategyThe corporation
      enters into forward exchange contracts to hedge certain firm commitments
      denominated in foreign currencies to protect against adverse changes in
      exchange rates and uses interest rate swaps to manage interest rate
      exposure. The swaps modify exposure to interest rate risk by converting a
      portion of the corporation’s fixed-rate debt to a floating rate.The
      corporation’s fair value hedges resulted in no net impact in the years
      ended Dec. 31, 2004, 2003 and 2002 related to the ineffective portion of
      its hedging instruments (inclusive of the time value of money) as well as
      the portion not designated as a hedge.


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|ii. | Cash
      Flow Hedging StrategyIn the year ended Dec. 31, 2004, the
      corporation’s cash flow hedges resulted in an after-tax loss of $nil (2003
      – $1.9 million, 2002 – $nil) related to the ineffective portion of its
      hedging instruments, and an after-tax gain of $nil for year ended Dec. 31,
      2004 (2003 – $2.0 million, 2002 – $nil) related to the portion not
      designated as a hedge.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In November 2003,
forward starting swaps with a notional amount of US$200.0 million and treasury
and spread locks with a notional amount of $100.0 million were settled and debt
was issued, resulting in an after-tax loss of $25.3 million. The loss is being
reclassified from accumulated other comprehensive income (AOCI) into income as
interest expense is recognized on the debt.

Over the next 12
months, the corporation estimates that $3.3 million of after-tax losses that
arose from cash flow hedges will be reclassified from AOCI to net earnings. The
corporation also estimates that $3.7 million of after-tax losses on cash flow
hedging instruments that arose on adoption of Statement 133 will be reclassified
from AOCI to earnings. These estimates assume constant gas and power prices,
interest rates and exchange rates over time; however, the actual amounts that
will be reclassified will vary based on changes in these factors. Therefore,
management is unable to predict what the actual reclassification from AOCI to
earnings (positive or negative) will be for the next 12 months.



|iii. | Net
      Investment HedgesThe company uses cross-currency interest rate
      swaps, forward sales contracts and direct foreign currency debt to hedge
      its exposure to changes in the carrying value of its investments in its
      foreign subsidiaries in the U.S., Australia and Mexico. Realized and
      unrealized gains and losses from these hedges are included in Other
      Comprehensive Income (OCI), with the related amounts due to or from
      counterparties included in long-term derivative assets and liabilities and
      long-term debt.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In the year ended
Dec. 31, 2004, the corporation recognized an after-tax gain of $3.7 million
(2003 – $8.2 million gain, 2002 – $16.8 million loss) on its net investment
hedges, included in OCI.

In the year ended
Dec. 31, 2004, the corporation recognized after-tax gains of $nil (2003 – $0.2
million, 2002 – $nil), related to ineffectiveness of net investment hedges.



|iv. | Trading
      ActivitiesThe corporation markets energy derivatives to optimize
      returns from assets, to earn trading revenues and to gain market
      information. Derivatives, as defined under Statement 133, are recorded on
      the consolidated balance sheets at fair value under both Canadian and U.S.
      GAAP. Non-derivative contracts entered into subsequent to the rescission
      of EITF 98-10 are accounted for using the accrual
method
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

v.
    Other Hedging ActivitiesIn the year ended
      Dec. 31, 2004, the corporation recognized pre-tax losses of $1.1 million
      (2003 – $0.7 million, 2002 – $1.1 million gains) related to hedging
      activities that do not qualify for hedge accounting under Statement
      133.


II.
Start-up Costs

Under U.S.
GAAP, certain start-up costs, including revenues and expenses in the
pre-operating period, are expensed rather than capitalized to deferred charges
and property, plant and equipment as under Canadian GAAP, which also results in
decreased depreciation and amortization expense under U.S. GAAP.

III.
Debt Extinguishment

Under U.S.
GAAP, the premium on redemption of long-term debt related to the 1998 limited
partnership transaction was recorded when incurred, whereas for Canadian GAAP,
the loss was being amortized to earnings over the period of the limited
partnership (20 years). As the buyback option was terminated in connection with
the sale of the Sheerness plant, the deferred amount was recognized in earnings
in 2003.

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IV.
Income Taxes

Future
income taxes under Canadian GAAP are referred to as deferred income taxes under
U.S. GAAP.

Deferred
income taxes under U.S. GAAP would be as follows:

Year ended
      Dec. 31
    
    2004
    
    2003Future income
      tax liabilities (net) under Canadian GAAP
    
    $
    (561.5
    )
    $
    (571.0
    )Derivatives
    
    
    23.2
    
    
    31.3Start-up
      costs
    
    
    (2.3
    )
    
    (2.3
    )Employee
      future benefits
    
    
    (11.8
    )
    
    (14.1
    )$
    (552.4
    )
    $
    (556.1
    )Comprised of
      the following:Year ended
      Dec. 31
    
    
    2004
    
    
    2003Current
      deferred income tax assets
    
    $
    21.5
    
    $
    29.4Long-term
      deferred income tax assets
    
    
    132.0
    
    
    90.3Current
      deferred income tax liabilities
    
    
    (11.1
    )
    
    (4.6
    )Long-term
      deferred income tax liabilities
    
    
    (694.8
    )
    
    (671.2
    )$
    (552.4
    )
    $
    (556.1
    )V.
      Employee Future Benefits


U.S. GAAP
requires that the cost of employee pension benefits be determined using the
accrual method with application from 1989. It was not feasible to apply this
standard using this effective date. The transition asset as at Jan. 1, 1998 was
determined in accordance with elected practice prescribed by the Securities and
Exchange Commission (SEC) and is amortized over 10 years.

As a
result of the corporation’s plan asset return experience for its U.S. registered
pension plan, at Dec. 31, 2004, the corporation was required under U.S. GAAP to
recognize an additional minimum liability. The liability was recorded as a
reduction in common equity through a charge to OCI, and did not affect net
income for 2004. The charge to OCI will be restored through common equity in
future periods to the extent the fair value of trust assets exceeds the
accumulated benefit obligation.

VI.
Joint Ventures

In
accordance with Canadian GAAP, joint ventures are required to be proportionately
consolidated regardless of the legal form of the entity. Under U.S. GAAP,
incorporated joint ventures are required to be accounted for by the equity
method. However, in accordance with practices prescribed by the SEC, the
corporation, as a Foreign Private Issuer, has elected for the purpose of this
reconciliation to account for incorporated joint ventures by the proportionate
consolidation method.

VII.
      Other Comprehensive Income (Loss)The changes
      in the components of OCI were as follows:Year ended
      Dec. 31
    
    2004
    
    2003
    
    2002Net gain on
      derivative instruments:Unrealized
      gain, net of taxes of $4.3 million
    
    $
    7.0
    
    $
    5.4
    
    $
    (55.5
    )Reclassification
      adjustment for gains included in net income, net of taxes of $2.2
      million
    
    
    3.4
    
    
    3.4
    
    
    4.0Net gain on
      derivative instruments
    
    
    10.4
    
    
    8.8
    
    
    (51.5
    )Translation
      adjustments
    
    
    3.7
    
    
    8.2
    
    
    (16.8
    )Registered
      pension alternate minimum liability
    
    
    (0.6
    )
    
    0.6
    
    
    (1.7
    )Other
      comprehensive income (loss)
    
    $
    13.5
    
    $
    17.6
    
    $
    (70.0
    )The
      components of AOCI were:2004
    
    
    2003
    
    
    2002Net loss on
      derivative instruments
    
    $
    (60.8
    )
    $
    (71.2
    )
    $
    (80.0
    )Translation
      adjustments
    
    
    (30.1
    )
    
    (33.8
    )
    
    (42.0
    )Registered
      pension alternate minimum liabilities
    
    
    (1.7
    )
    
    (1.1
    )
    
    (1.7
    )Accumulated
      other comprehensive loss
    
    $
    (92.6
    )
    $
    (106.1
    )
    $
    (123.7
    )


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VIII. Share
Capital

Under U.S.
GAAP, amounts receivable for share capital should be recorded as a deduction
from shareholders’ equity. Under Canadian GAAP, effective Jan. 1, 2004,
TransAlta has prospectively presented employee share purchase plan loans as a
deduction from shareholders’ equity, thereby eliminating the difference between
U.S. and Canadian GAAP as of Jan. 1, 2004. Under the corporation’s employee
share purchase plan, accounts receivable at Dec. 31, 2003 were $0.9 million.

IX.
Right of Offset Agreement

The
corporation had a New Zealand bank deposit that had been offset with a New
Zealand bank facility under a right of offset agreement. The arrangement did not
qualify for offsetting under U.S. GAAP. During the second quarter of 2004, the
corporation refinanced certain foreign operations and the bank deposit was used
to settle the bank facility in full.

X.
Asset Retirement Obligations

FASB
issued Statement 143, Asset Retirement Obligations,which requires asset
retirement obligations to be measured at fair value and recognized when the
obligation is incurred. A corresponding amount is capitalized as part of the
asset’s carrying amount and depreciated over the asset’s useful life. TransAlta
adopted the provisions of Statement 143 effective Jan. 1, 2003.

In
accordance with Canadian GAAP, the asset retirement obligations standard was
adopted retroactively with restatement of prior periods. Under U.S. GAAP, the
impact of adopting Statement 143 was recognized as a cumulative effect of a
change in accounting principle as of Jan. 1, 2003, the beginning of the fiscal
year in which the Statement was first applied. The change resulted in an
after-tax increase in net earnings of $52.5 million ($82.7 million pre-tax).

XI.
Guarantees

TransAlta
accounts for guarantees and related contracts, for which it is the guarantor,
under FASB Interpretation No. 45 (FIN 45), Guarantor’s Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness to Others.In accordance with FIN 45, upon issuance or
modification of a guarantee on or after Jan. 1, 2003, the corporation recognizes
a liability at the time of issuance or material modification for the estimated
fair value of the obligation it assumes under the guarantee. TransAlta reduces
the obligation over the term of the guarantee or related contract in a
systematic and rational manner as risk is reduced under the obligation.

XII.
Variable Interest Entities

In January
2003, FASB issued FIN 46, Consolidation of Variable Interest Entities, an
Interpretation of Accounting Research Bulletin No. 51.

FIN 46
requires certain variable interest entities to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest, or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. In December 2003, FASB issued
FIN 46R, which served to clarify guidance in FIN 46. During the fourth quarter
of 2003, the corporation adopted the provisions of FIN 46R with respect to
special purpose entities. The adoption did not have a significant impact on the
corporation’s financial position, results of operations or cash flows. During
the first quarter of 2004, the corporation adopted the provisions of FIN 46R
related to non-special purpose entities. The corporation has considered the
provisions of FIN 46R for all subsidiaries and their related power purchase,
power sale or tolling agreements. Factors considered in the analysis include the
duration of the agreements, how capacity and energy payments are determined,
source of payment terms for fuel, as well as responsibility and payment for
operating and maintenance expenses. The corporation has two wholly-owned
subsidiaries in Mexico, which were created to hold the corporation’s 100 per
cent interest in the Campeche and Chihuahua power plants. These subsidiaries
were formed in 2000 and 2001, respectively, and are considered variable interest
entities under FIN 46R. As a result of the foregoing considerations, the
corporation has determined that the nature of the fuel purchase and power sale
contracts relating to the wholly-owned Mexican operations insulate the
corporation from significant variability in the cash flows relating to the
assets. Therefore, TransAlta is not the primary beneficiary and does not
consolidate the entities. Accordingly, the subsidiaries owning the Campeche and
Chihuahua plants are presented as equity investments rather than consolidated
subsidiaries on the consolidated financial statements. One hundred per cent of
the results from operations of the two plants are presented as equity income on
the consolidated income statements. There was no impact to net earnings as a
result of adoption of this interpretation. TransAlta wholly owns and operates
the 252-MW Campeche and 259-MW Chihuahua plants which were commissioned in 2003.
The plants’ electrical output is sold under 25-year contracts to Mexico’s
government-owned utility, the Comisión Federal de Electricidad. At Dec. 31,
2004, the corporation’s maximum exposure to loss is its $404.0 million
investment in the two plants.

XIII. Changes
in Accounting Standards

On May 19,
2004, FASB issued FASB Staff Position (FSP) 106-2, Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003(the Act) that provides guidance on the accounting
for the effects of the Act for employers that sponsor post-retirement health
care plans that provide drug benefits. The Act introduces a prescription drug
benefit under Medicare as well as a federal subsidy to sponsors of retiree
health care benefit plans that provide a benefit that is at least actuarially
equivalent to Medicare. TransAlta’s prescription drug benefit plan in the U.S.
is not material to the corporation’s post-retirement benefit plan and therefore
the impact of the FSP is not material to the consolidated financial statements.

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