**Exhibit 13.3**

 

 

 

**TransAlta Consolidated Financial Statements**

 

*December 31, 2009*

 

----

 

***MANAGEMENT’S REPORT***

 

 

To the Shareholders of TransAltaCorporation

 

The Consolidated Financial Statements and other financialinformation included in this annual report have been prepared by management. Itis management’s responsibility to ensure that sound judgment, appropriateaccounting principles and methods, and reasonable estimates have been used toprepare this information. They also ensure that all information presented isconsistent.

 

Management is also responsible for establishing andmaintaining internal controls and procedures over the financial reportingprocess. The internal control system includes an internal audit function and anestablished business conduct policy that applies to all employees. In addition,the Corporation has a code of conduct that applies to all employees and issigned annually. The code of conduct can be viewed on TransAlta’s website(www.transalta.com). Management believes the system of internal controls,review procedures, and established policies provide reasonable assurance as tothe reliability and relevance of financial reports. Management also believesthat TransAlta’s operations are conducted in conformity with the law and with ahigh standard of business conduct.

 

The Board of Directors is responsible for ensuring thatmanagement fulfills its responsibilities for financial reporting and internalcontrol. The Board carries out its responsibility principally through its Auditand Risk Committee (“the Committee”). The Committee, which consists solely ofindependent directors, reviews the financial statements and annual report andrecommends them to the Board for approval. The Committee meets with management,internal auditors, and external auditors to discuss internal controls, auditingmatters, and financial reporting issues. Internal and external auditors havefull and unrestricted access to the Committee. The Committee also recommendsthe firm of external auditors to be appointed by the shareholders.

 

 
| ****                                     | ****                    |
|------------------------------------------|-------------------------|
| **STEPHEN G.  SNYDER**                   | **BRIAN  BURDEN**       |
| President & Chief Executive  Officer | Chief Financial Officer |
| February 23, 2010                        |                    |

 

 

Consolidated Financial Statements  |  1

 

----

 

***MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING***

 

 

To the Shareholders of TransAltaCorporation

 

The following report is provided by management in respect ofTransAlta Corporation’s internal control over financial reporting (as definedin Rules 13a–15f and 15d–15f under the *United States SecuritiesExchange Act* of 1934).

 

TransAlta’s management is responsible for establishing andmaintaining adequate internal control over financial reporting for TransAlta.

 

Management has used the Committee of Sponsoring Organizationsof the Treadway Commission (“COSO”) framework to evaluate the effectiveness ofTransAlta Corporation’s internal control over financial reporting. Managementbelieves that the COSO framework is a suitable framework for its evaluation ofTransAlta Corporation’s internal control over financial reporting because it isfree from bias, permits reasonably consistent qualitative and quantitativemeasurements of TransAlta Corporation’s internal controls, is sufficientlycomplete so that those relevant factors that would alter a conclusion about theeffectiveness of TransAlta Corporation’s internal controls are not omitted, andis relevant to an evaluation of internal control over financial reporting.

 

Internal control over financial reporting cannot provide absoluteassurance of achieving financial reporting objectives because of its inherentlimitations. Internal control over financial reporting is a process thatinvolves human diligence and compliance and is subject to lapses in judgmentand breakdowns resulting from human failures. Internal control over financialreporting also can be circumvented by collusion or improper overrides. Becauseof such limitations, there is a risk that material misstatements may not beprevented or detected on a timely basis by internal control over financialreporting. However, these inherent limitations are known features of thefinancial reporting process, and it is possible to design safeguards into theprocess to reduce, though not eliminate, this risk.

 

TransAlta Corporation’s consolidated financial statementsinclude the accounts of the Sheerness, CE Generation, Wailuku, and Genesee 3joint ventures via proportionate consolidation in accordance with CanadianGAAP. Management does not have the contractual ability to assess the internalcontrols of these joint ventures. Once the financial information is obtainedfrom the joint ventures it falls within the scope of TransAlta Corporation’sinternal controls framework. Management’s conclusion regarding theeffectiveness of internal controls does not extend to the internal controls atthe transactional level of the joint ventures. The 2009 consolidated financialstatements of TransAlta Corporation included $1,576 million and $849 million oftotal and net assets, respectively, as of Dec. 31, 2009, and $437 millionand $79 million of revenues and net earnings, respectively, for the year thenended related to these joint ventures.

 

TransAlta Corporation’s consolidated financial statementsinclude the accounts of Canadian Hydro Developers, Inc. from the date ofacquisition. Management’s evaluation of the internal control over financialreporting did not include an evaluation of the internal controls of CanadianHydro Developers, Inc. Management’s conclusion regarding the effectivenessof the internal control over financial reporting does not extend to theinternal controls of Canadian Hydro Developers, Inc. The 2009 consolidatedfinancial statements of TransAlta Corporation included $1,534 million and $484million of total and net assets, respectively, as of Dec. 31, 2009, and$29 million of revenues and nil of net earnings, respectively, for the yearthen ended related to Canadian Hydro Developers, Inc.

 

Management has assessed the effectiveness of TransAltaCorporation’s internal control over financial reporting, as at Dec. 31,2009, and has concluded that such internal control over financial reporting iseffective.

 

Ernst & Young LLP, who has audited the consolidatedfinancial statements of TransAlta Corporation for the year ended Dec. 31,2009, has also issued a report on internal control over financial reportingunder Auditing Standard No. 5 of the Public Company Accounting OversightBoard (United States). This report is located on the following page ofthis Annual Report.

 

 
| ****                                     | ****                    |
|------------------------------------------|-------------------------|
| **STEPHEN G.  SNYDER**                   | **BRIAN  BURDEN**       |
| President & Chief Executive  Officer | Chief Financial Officer |
| February 23, 2010                        |                    |

 

 

2 |  TransAltaCorporation

 

----

 

***INDEPENDENT AUDITORS’ REPORT ONINTERNAL CONTROLS UNDER STANDARDS***

***OF THE PUBLIC COMPANY ACCOUNTINGOVERSIGHT BOARD (UNITED STATES)***

 

 

To the Shareholders of TransAltaCorporation

 

We have audited TransAlta Corporation’s internal controlover financial reporting as of December 31, 2009, based on criteriaestablished in Internal Control-Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission (the COSO criteria). TheCorporation’s management is responsible for maintaining effective internalcontrol over financial reporting, and for its assessment of the effectivenessof internal control over financial reporting included in the accompanyingManagement’s Annual Report on Internal Control over Financial Reporting. Ourresponsibility is to express an opinion on the Corporation’s internal controlover financial reporting based on our audit.

 

We conducted our audit in accordance with the standards ofthe Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether effective internal control over financial reporting was maintained inall material respects. Our audit included obtaining an understanding ofinternal control over financial reporting, assessing the risk that a materialweakness exists, testing and evaluating the design and operating effectivenessof internal control based on the assessed risk, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinion.

 

A corporation’s internal control over financial reporting isa process designed to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. Acorporation’s internal control over financial reporting includes those policiesand procedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the corporation; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the corporation are beingmade only in accordance with authorizations of management and directors of thecorporation; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use or disposition of thecorporation’s assets that could have a material effect on the financialstatements.

 

Because of its inherent limitations, internal control overfinancial reporting may not prevent or detect misstatements. Also, projectionsof any evaluation of effectiveness to future periods are subject to the riskthat controls may become inadequate because of changes in conditions or thatthe degree of compliance with the policies or procedures may deteriorate.

 

As indicated in the accompanying Management’s Annual Reporton Internal Control Over Financial Reporting, management’s assessment of andconclusion on the effectiveness of internal control over financial reportingdid not include the internal controls of the CE Generation, Sheerness, Wailuku,and Genesee 3 joint ventures, which are included in the 2009 consolidatedfinancial statements of the Corporation and constituted $1,576 million and $849million of total and net assets, respectively, as of December 31, 2009,and $437 million and $79 million of revenues and net earnings, respectively,for the year then ended. Management’s assessment of and conclusion on theeffectiveness of internal control over financial reporting also did not includethe internal controls of Canadian Hydro Developers, Inc. which is includedin the 2009 consolidated financial statements of the Corporation andconstituted $1,534 million and $484 million of total and net assets,respectively, as of December 31, 2009, and $29 million of revenues and nilof net earnings, respectively, for the year then ended. Our audit of internalcontrol over financial reporting of the Corporation did not include anevaluation of the internal control over financial reporting of the CEGeneration, Sheerness, Wailuku, Genesee 3 joint ventures, and Canadian HydroDevelopers, Inc.

 

In our opinion, TransAlta Corporation maintained, in allmaterial respects, effective internal control over financial reporting as ofDecember 31, 2009, based on the COSO criteria.

 

We have also audited, in accordance with Canadian generallyaccepted auditing standards and the standards of the Public Company AccountingOversight Board (United States), the consolidated financial position ofTransAlta Corporation as at December 31, 2009 and 2008 and theconsolidated results of its operations and its cash flows for each of the yearsin the three-year period ended December 31, 2009, and our report datedFebruary 23, 2010, expressed an unqualified opinion thereon.

 

 

**E****rnst & Young LLP**

Chartered Accountants 

 

Calgary, Canada 

February 23, 2010

 

 

Consolidated Financial Statements  |  3

 

----

 

***INDEPENDENT AUDITORS’ REPORT ON FINANCIAL STATEMENTS***

 

 

To the Shareholders of TransAltaCorporation

 

We have audited the consolidated balance sheets of TransAltaCorporation as at December 31, 2009 and 2008 and the consolidatedstatements of earnings and retained earnings, comprehensive income and cashflows for each of the years in the three-year period ended December 31,2009. These financial statements are the responsibility of the Corporation’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our audits in accordance with Canadiangenerally accepted auditing standards and the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform an audit to obtain reasonable assurance whether the financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe our audits provide a reasonablebasis for our opinion.

 

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the consolidatedfinancial position of the Corporation as at December 31, 2009 and 2008 andthe consolidated results of its operations and its cash flows for each of theyears in the three-year period ended December 31, 2009 in conformity withCanadian generally accepted accounting principles. 

 

As discussed in Note 2(C) to the consolidated financialstatements, in 2007 the Corporation changed its method of accounting forcomprehensive income, financial instruments, and hedges.

 

We also have audited, in accordance with the standards ofthe Public Company Accounting Oversight Board (United States), theCorporation’s internal control over financial reporting as of December 31,2009, based on criteria established in Internal Control-Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commissionand our report dated February 23, 2010 expressed an unqualified opinionthereon.

 

 

**Ernst &Young LLP**

Chartered Accountants 

 

Calgary, Canada 

February 23, 2010

 

 

4  |  TransAlta Corporation

 

----

*** ***

***CONSOLIDATED STATEMENTS OFEARNINGS AND RETAINED EARNINGS***

 
| Year  ended Dec. 31*(in millions of Canadian dollars except where noted)* | ** ** | **2009**   | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| **Revenues**                                                                   | ** ** | **2,770**  |       | 3,110    |       | 2,775    |       |
| Fuel  and purchased power                                                      | ** ** | **(1,228** | **)**      | (1,493   | )          | (1,231   | )          |
|                                                                           | ** ** | **1,542**  |       | 1,617    |       | 1,544    |       |
| Operations,  maintenance, and administration                                   | ** ** | **667**    |       | 637      |       | 577      |       |
| Depreciation  and amortization                                                 | ** ** | **475**    |       | 428      |       | 406      |       |
| Taxes,  other than income taxes                                                | ** ** | **22**     |       | 19       |       | 20       |       |
|                                                                           | ** ** | **1,164**  |       | 1,084    |       | 1,003    |       |
|                                                                           | ** ** | **378**    |       | 533      |       | 541      |       |
| Foreign  exchange gain (loss)*(Note 7)*                                        | ** ** | **8**      |       | (12      | )          | 3        |       |
| Writedown  of mining development costs *(Note 3)*                              | ** ** | **(16**    | **)**      | –   |       | –   |       |
| Net  interest expense *(Notes 7 and 17)*                                       | ** ** | **(144**   | **)**      | (110     | )          | (133     | )          |
| Equity  loss***(Note 24)*                                                      | ** ** | **–** |       | (97      | )          | (50      | )          |
| Other  income***(Note 4)*                                                      | ** ** | **8**      |       | 5        |       | 16       |       |
| **Earnings before non-controlling interests and income  taxes**                | ** ** | **234**    |       | 319      |       | 377      |       |
| Non-controlling  interests *(Note 5)*                                          | ** ** | **38**     |       | 61       |       | 48       |       |
| **Earnings before income taxes**                                               | ** ** | **196**    |       | 258      |       | 329      |       |
| Income  tax expense *(Note 6)*                                                 | ** ** | **15**     |       | 23       |       | 20       |       |
| **Net earnings**                                                               | ** ** | **181**    |       | 235      |       | 309      |       |
| **Retained earnings**                                                          |       |       |       |     |       |     |       |
| **Opening balance**                                                            | ** ** | **688**    |       | 763      |       | 710      |       |
| Common share dividends                                                         | ** ** | **(235**   | **)**      | (215     | )          | (202     | )          |
| Shares cancelled under NCIB*(Notes 20 and 21)*                                 | ** ** | **–** |       | (95      | )          | (54      | )          |
| **Closing balance**                                                            | ** ** | **634**    |       | 688      |       | 763      |       |
| **Weighted average number of common shares outstanding  in the year**          | ** ** | **201**    |       | 199      |       | 202      |       |
| ** **                                                                     | ** ** | ** ** |       |     |       |     |       |
| **Net earnings per share, basic and diluted***(Note 20)*                       | ** ** | **0.90**   |       | 1.18     |       | 1.53     |       |

*See accompanying notes.*

 

 

Consolidated Financial Statements  |  5

 

----

 

***CONSOLIDATEDBALANCE SHEETS***

 
| Dec. 31  *(in millions of Canadian dollars)*                             | **2009**   |   | **2008**            |   |
|-------------------------------------------------------------------------------|------------|--------|---------------------|--------|
|                                                                          |       |   | *(Restated, Note 2* | *)*    |
| Cash  and cash equivalents *(Notes 7 and  24)*                                | **82**     |   | 50                  |   |
| Accounts  receivable *(Notes 7, 8, 24, and 28)*                               | **421**    |   | 505                 |   |
| Collateral  paid *(Note 7)*                                                   | **27**     |   | 37                  |   |
| Prepaid  expenses *(Note 24)*                                                 | **18**     |   | 6                   |   |
| Risk  management assets *(Notes 7, 9,  and 10)*                               | **144**    |   | 200                 |   |
| Future  income tax assets *(Note 6)*                                          | **17**     |   | 3                   |   |
| Income  taxes receivable                                                      | **39**     |   | 61                  |   |
| Inventory  *(Note 11)*                                                        | **90**     |   | 51                  |   |
|                                                                          | **838**    |   | 913                 |   |
| **Long-term receivable***(Note 12)*                                           | **49**     |   | 14                  |   |
| **Property, plant, and equipment***(Notes 13 and 24)*                         |       |   |                |   |
| Cost                                                                          | **11,721** |   | 9,932               |   |
| Accumulated  depreciation                                                     | **(4,143** | **)**  | (3,898              | )      |
|                                                                          | **7,578**  |   | 6,034               |   |
| **Goodwill***(Notes  14, 24, and 29)*                                         | **434**    |   | 142                 |   |
| **Intangible assets***(Notes 15 and 24)*                                      | **333**    |   | 213                 |   |
| **Future income tax assets***(Note 6)*                                        | **204**    |   | 248                 |   |
| **Risk management assets***(Notes 7, 9, and 10)*                              | **224**    |   | 221                 |   |
| **Other assets***(Notes  16 and 24)*                                          | **102**    |   | 39                  |   |
| **Total assets**                                                              | **9,762**  |   | 7,824               |   |
| Accounts  payable and accrued liabilities *(Notes  7 and 24)*                 | **521**    |   | 658                 |   |
| Collateral  received *(Note 7)*                                               | **86**     |   | 24                  |   |
| Risk  management liabilities*(Notes 7, 9,  and 10)*                           | **45**     |   | 148                 |   |
| Income  taxes payable                                                         | **10**     |   | 15                  |   |
| Future  income tax liabilities *(Note 6)*                                     | **57**     |   | 14                  |   |
| Dividends  payable                                                            | **61**     |   | 52                  |   |
| Current  portion of long-term debt–recourse *(Notes  7 and 17)*          | **7**      |   | 211                 |   |
| Current  portion of long-term debt–non-recourse *(Notes  7, 17, and 24)* | **24**     |   | 33                  |   |
| Current  portion of asset retirement obligation *(Note  18)*                  | **32**     |   | 45                  |   |
|                                                                          | **843**    |   | 1,200               |   |
| **Long-term debt–recourse***(Notes 7 and 17)*                            | **3,857**  |   | 2,332               |   |
| **Long-term debt–non-recourse***(Notes 7, 17, and 24)*                   | **554**    |   | 232                 |   |
| **Asset retirement obligation***(Notes 18 and 24)*                            | **250**    |   | 252                 |   |
| **Deferred credits and other long-term liabilities***(Note 19)*               | **136**    |   | 131                 |   |
| **Future income tax liabilities***(Notes 6 and 24)*                           | **637**    |   | 596                 |   |
| **Risk management liabilities***(Notes 7, 9,10, and 24)*                      | **78**     |   | 102                 |   |
| **Non-controlling interests***(Note 5)*                                       | **478**    |   | 469                 |   |
| **Common shareholders’ equity**                                          |       |   |                |   |
| Common  shares *(Notes 20 and 21)*                                            | **2,169**  |   | 1,761               |   |
| Retained  earnings *(Note 21)*                                                | **634**    |   | 688                 |   |
| Accumulated  other comprehensive income *(Note 21)*                           | **126**    |   | 61                  |   |
| **Total shareholders’ equity**                                           | **2,929**  |   | 2,510               |   |
| **Total liabilities and shareholders’ equity**                           | **9,762**  |   | 7,824               |   |
| Contingencies  *(Notes 26 and 28)*                                            |       |   |                |   |
| Commitments  *(Notes 7 and 27)*                                               |       |   |                |   |
| Subsequent  events *(Note 33)*                                                |       |   |                |   |

 
| On behalf of the Board: |                               |                               |
|-------------------------|-------------------------------|-------------------------------|
|                    | Donna Soble Kaufman  Director | William D. Anderson

Director |

*See accompanying notes.*

 

 

6  |  TransAltaCorporation

----

 

***CONSOLIDATED STATEMENTS OFCOMPREHENSIVE INCOME***

 
| Year  ended Dec. 31 *(in millions of  Canadian dollars)*                                                                           | ** ** | **2009**   | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| **Net earnings**                                                                                                                   | ** ** | **181**    |       | 235      |       | 309      |       |
| **Other comprehensive income (loss)**                                                                                              |       |       |       |     |       |     |       |
| (Losses)  gains on translating net assets of self-sustaining foreign operations                                                    | ** ** | **(209**   | **)**      | 342      |       | (196     | )          |
| Gains  (losses) on financial instruments designated as hedges of self-sustaining foreign  operations, net of tax(1)                |       | **140**    |       | (295     | )          | 215      |       |
| Gains  (losses) on derivatives designated as cash flow hedges, net of tax(2)                                                       | ** ** | **280**    |       | 198      |       | (41      | )          |
| Loss  on sale of Mexico equity investment reclassified to the Consolidated Statements  of Earnings, net of tax(3) *(Note 24)* |       | **–** |       | (8)      |       | –   |       |
| Reclassification  of derivatives designated as cash flow hedges to the Consolidated Balance  Sheets, net of tax(4)                 |       | **(11**    | **)**      | 8        |       | 1        |       |
| Reclassification  of derivatives designated as cash flow hedges to net earnings, net of tax(5)                                     |       | **(135**   | **)**      | 61       |       | 18       |       |
| **Other comprehensive income (loss)**                                                                                              | ** ** | **65**     |       | 306      |       | (3       | )          |
| **Comprehensive income**                                                                                                           | ** ** | **246**    |       | 541      |       | 306      |       |

*1  Net of income tax expense of 26 million forthe year ended Dec. 31, 2009 (2008 – 61 million recovery, 2007 – 25 millionexpense).*

*2  Net of income tax expense of 120 million forthe year ended Dec. 31, 2009 (2008 – 129 million expense, 2007 – 16 millionrecovery).*

*3  Net of income tax expense of 9 million for theyear ended Dec. 31, 2008 (2007 – nil).*

*4  Net of income tax recovery of 4 million forthe year ended Dec. 31, 2009 (2008 – nil, 2007 – nil).*

*5  Net of income tax recovery of 69 million forthe year ended Dec. 31, 2009 (2008 – 30 million expense, 2007 – 7 millionexpense).*

*See accompanying notes.*

 

 

ConsolidatedFinancial Statements  |  7

----

 

***CONSOLIDATEDSTATEMENTS OF CASH FLOWS***

 
| Year  ended Dec. 31 *(in millions of Canadian dollars)*                           | ** ** | **2009**   | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| **Operating activities**                                                          |       |       |       |     |       |     |       |
| Net  earnings                                                                     | ** ** | **181**    |       | 235      |       | 309      |       |
| Depreciation  and amortization *(Note 29)*                                        | ** ** | **493**    |       | 451      |       | 415      |       |
| Gain  on sale of equipment*(Note 4)*                                              | ** ** | **–** |       | (5       | )          | (16      | )          |
| Non-controlling  interests*(Note 5)*                                              | ** ** | **38**     |       | 61       |       | 48       |       |
| Asset  retirement obligation accretion*(Note 18)*                                 | ** ** | **24**     |       | 22       |       | 24       |       |
| Asset  retirement costs settled*(Note 18)*                                        | ** ** | **(35**    | **)**      | (37      | )          | (38      | )          |
| Future  income taxes*(Note 6)*                                                    | ** ** | **21**     |       | 1        |       | (34      | )          |
| Unrealized  loss from risk management activities                                  | ** ** | **2**      |       | 12       |       | 26       |       |
| Unrealized  foreign exchange gain                                                 | ** ** | **(11**    | **)**      | (5       | )          | (3       | )          |
| Writedown  of mining development costs*(Note 3)*                                  | ** ** | **16**     |       | –   |       | –   |       |
| Equity  loss*(Note 24)*                                                           | ** ** | **–** |       | 97       |       | 50       |       |
| Other  non-cash items                                                             | ** ** | **–** |       | (4       | )          | –   |       |
|                                                                              | ** ** | **729**    |       | 828      |       | 781      |       |
| Change  in non-cash operating working capital balances *(Note 22)*                | ** ** | **(149**   | **)**      | 210      |       | 66       |       |
| Cash  flow from operating activities                                              | ** ** | **580**    |       | 1,038    |       | 847      |       |
| **Investing activities**                                                          |       |       |       |     |       |     |       |
| Acquisition  of Canadian Hydro Developers, Inc., net of cash acquired *(Note 24)* | ** ** | **(766**   | **)**      | –   |       | –   |       |
| Additions  to property, plant, and equipment                                      | ** ** | **(904**   | **)**      | (1,006   | )          | (599     | )          |
| Proceeds  on sale of property, plant, and equipment                               | ** ** | **7**      |       | 30       |       | 47       |       |
| Proceeds  on sale of minority interest in Kent Hills *(Note 4)*                   | ** ** | **29**     |       | –   |       | –   |       |
| Equity  investment                                                                | ** ** | **–** |       | –   |       | (20      | )          |
| Restricted  cash                                                                  | ** ** | **–** |       | 248      |       | 57       |       |
| Long-term  receivable*(Note  12)*                                                 | ** ** | **(41**    | **)**      | (8       | )          | –   |       |
| Realized  (losses) gains on financial instruments                                 | ** ** | **(16**    | **)**      | 52       |       | 107      |       |
| Loan  to equity investment                                                        | ** ** | **–** |       | (245     | )          | –   |       |
| Proceeds  on sale of equity investment *(Note 24)*                                | ** ** | **–** |       | 332      |       | –   |       |
| Net  increase in collateral received from counterparties                          | ** ** | **87**     |       | –   |       | –   |       |
| Net  decrease in collateral paid to counterparties                                | ** ** | **7**      |       | –   |       | –   |       |
| Settlement  of adjustments on sale of Mexican equity investment                   | ** ** | **(7**     | **)**      | –   |       | –   |       |
| Other                                                                             | ** ** | **6**      |       | 16       |       | (2       | )          |
| Cash  flow used in investing activities                                           | ** ** | **(1,598** | **)**      | (581     | )          | (410     | )          |
| **Financing activities**                                                          |       |       |       |     |       |     |       |
| Net  increase (decrease) in credit facilities *(Note 17)*                         | ** ** | **620**    |       | (243     | )          | 289      |       |
| Repayment  of long-term debt *(Note 17)*                                          | ** ** | **(796**   | **)**      | (308     | )          | (252     | )          |
| Issuance  of long-term debt *(Note 17)*                                           | ** ** | **1,119**  |       | 502      |       | 30       |       |
| Dividends  paid on common shares                                                  | ** ** | **(226**   | **)**      | (212     | )          | (205     | )          |
| Redemption  of preferred securities                                               | ** ** | **–** |       | –   |       | (175     | )          |
| Funds  paid to repurchase common shares under NCIB *(Note 21)*                    | ** ** | **–** |       | (130     | )          | (75      | )          |
| Net  proceeds on issuance of common shares *(Note 20)*                            | ** ** | **398**    |       | 15       |       | 20       |       |
| Decrease  in advances to TransAlta Power                                          | ** ** | **–** |       | –   |       | 6        |       |
| Realized  gains on financial instruments                                          | ** ** | **–** |       | 12       |       | –   |       |
| Distributions  paid to subsidiaries' non-controlling interests *(Note 5)*         | ** ** | **(58**    | **)**      | (98      | )          | (87      | )          |
| Other                                                                             | ** ** | **(4**     | **)**      | (5       | )          | 5        |       |
| Cash  flow from (used in) financing activities                                    | ** ** | **1,053**  |       | (467     | )          | (444     | )          |
| **Cash flow from (used in) operating, investing, and  financing activities**      | ** ** | **35**     |       | (10      | )          | (7       | )          |
| **Effect of translation on foreign currency cash**                                | ** ** | **(3**     | **)**      | 9        |       | (8       | )          |
| **Increase (decrease) in cash and cash equivalents**                              | ** ** | **32**     |       | (1       | )          | (15      | )          |
| **Cash and cash equivalents, beginning of year**                                  | ** ** | **50**     |       | 51       |       | 66       |       |
| **Cash and cash equivalents, end of year**                                        | ** ** | **82**     |       | 50       |       | 51       |       |
| Cash  taxes paid                                                                  | ** ** | **43**     |       | 47       |       | 75       |       |
| Cash  interest paid                                                               | ** ** | **149**    |       | 106      |       | 142      |       |
| *See accompanying notes.*                                                         |       |       |       |     |       |     |       |

 

 

8  |  TransAlta Corporation

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***NOTES TO CONSOLIDATED FINANCIALSTATEMENTS***

*(Tabular amounts in millions of Canadian dollars, except as otherwisenoted)*

 

***1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES***

 

**A.    Descriptionof the Business**

 

TransAlta Corporation (“TransAlta” or “the Corporation”), wasincorporated under the Canada *Business Corporations Act*in March 1985. The Corporation became a public company in December 1992after TransAlta Utilities Corporation (“TAU”) became a subsidiary. The Corporationhas two reportable segments that are supported by a corporate group that providesfinance, treasury, tax, legal, environmental health and safety, sustainable development,corporate communications, government relations, information technology, human resources,internal audit, and other administrative support.

 

The two reportable segments of the Corporation are as follows:

 

**I.      Generation**

The Generation segment owns coal, gas, wind, geothermal, biomass,and hydro plants in Canada, the United States (“U.S.”), and Australia. It generatesits revenues from the sale of electricity, steam, gas, and ancillary services.

 

**II.     CommercialOperations & Development (“COD”)**

The COD segment derives revenues from the wholesale trading ofelectricity and other energy-related commodities and derivatives not supported byTransAlta-owned generation assets. COD also utilizes contracts of various durationsfor the forward sales of electricity and purchases of natural gas and transmissioncapacity to effectively manage available generating capacity and fuel and transmissionneeds on behalf of Generation.

 

**B.    Consolidation**

 

These consolidated financial statements have been prepared bymanagement in accordance with Canadian Generally Accepted Accounting Principles(“Canadian GAAP”).

 

The consolidated financial statements include the accounts ofTransAlta, all subsidiaries, and the proportionate share of the accounts of jointventures and jointly controlled corporations.

 

**C.    Useof Estimates**

 

The preparation of consolidated financial statements in accordancewith Canadian GAAP requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosures of contingent assetsand liabilities at the date of the consolidated financial statements and the reportedamounts of revenues and expenses during the period. These estimates are subjectto uncertainty. Actual results could differ from those estimates due to factorssuch as fluctuations in interest rates, currency exchange rates, inflation levelsand commodity prices, changes in economic conditions and legislative and regulatorychanges *(Notes 7, 9, 10, 13, 14, 15, 17, 18, 26, 30, and31).*

 

**D.    RevenueRecognition**

 

The majority of the Corporation’s revenues are derived from thesale of physical power and from energy marketing and trading activities. Revenuesunder long-term electricity and thermal sales contracts generally include one ormore of the following components: fixed capacity payments for being available, energypayments for generation of electricity, availability payments or penalties for exceedingor not meeting availability targets, excess energy payments for power generationabove 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 eachmegawatt hour (“MWh”) produced at market prices, and are recognized upon delivery.

 

Trading activities use derivatives such as physical and financialswaps, forward sales contracts and futures contracts and options, which are usedto earn trading revenues and to gain market information. These derivatives are accountedfor using fair value accounting and are presented on a net basis in the ConsolidatedStatements of Earnings. The initial recognition of fair value and subsequent changesin fair value affect reported net earnings in the period the change occurs. Thefair values of those instruments that remain open at the balance sheet date representunrealized gains or losses and are presented on the Consolidated Balance Sheetsas risk management assets or liabilities.

 

The majority of derivatives traded by the Corporation are nottraded on an active exchange or extend beyond the time period for which exchange-basedquotes are available. The fair values of these derivatives have been determinedusing valuation techniques or models.

 

**E.     ForeignCurrency Translation**

 

The Corporation’s functional currency is Canadian dollars whileself-sustaining foreign operations’ functional currencies are U.S. and Australiandollars.

 

The Corporation’s self-sustaining foreign operations are translatedusing the current rate method. Translation gains and losses resulting from translatingthese foreign operations are included in Other Comprehensive Income (“OCI”) withthe cumulative gain or loss reported in Accumulated Other Comprehensive Income(“AOCI”). Foreign currency denominated monetary and non-monetary assets and liabilitiesof self-sustaining foreign operations are translated at exchange rates in effecton the balance sheet date.

 

Transactions denominated in a currency other than the functionalcurrency are translated at the exchange rate on the transaction date. The resultingexchange gains and losses on these items are included in net earnings.

 

 

Notes toConsolidated Financial Statements  |  9

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**F.    ****FinancialInstruments and Hedges**

 

**I.      FinancialInstruments**

Financial assets and financial liabilities, including derivatives,and certain non-financial derivatives are recognized on the Consolidated BalanceSheets from the point when the Corporation becomes a party to the contract. Financialliabilities are removed from the consolidated financial statements when the liabilityis extinguished either through settlement of or release from the obligation of theunderlying liability. All financial instruments are measured at fair value uponinitial recognition except for certain non-financial derivative contracts that meetthe Corporation’s expected purchase, sale or usage requirements, commonly termednormal purchase / normal sale (“NPNS”) contracts. Measurement in subsequent periodsdepends on whether the financial instrument has been classified as held for trading,available-for-sale, held-to-maturity, loans and receivables, or other financialliabilities. Classification of the financial instrument is determined at inceptiondepending on the underlying exposure that is being hedged.

 

Financial assets and financial liabilities classified as heldfor trading are measured at fair value with changes in those fair values recognizedin net earnings. Financial assets classified as either held-to-maturity or loansand receivables, and other financial liabilities are measured at amortized costusing the effective interest method of amortization. Investments in equity instrumentsclassified as available-for-sale that do not have a quoted market price in an activemarket are measured at cost.

 

Derivative instruments are recorded on the Consolidated BalanceSheets at fair value, including those derivatives that are embedded in financialor non-financial contracts that are not closely related to the host contracts. TransAltarecognizes as separate assets and liabilities only those derivatives embedded inhybrid instruments issued, acquired, or substantively modified after Jan. 1,2003. Changes in the fair values of derivative instruments are recognized in netearnings with the exception of the effective portion of (i) derivatives designatedas cash flow hedges or (ii) hedges of foreign currency exposure of a net investmentin a self-sustaining foreign operation, which are recognized in OCI. Derivativesused in trading activities are described in more detail in Note 1(D).

 

Certain financial instruments can be designated as held for trading(the fair value option) on initial recognition even if the financial instrumentwas not acquired or incurred principally for the purpose of selling or repurchasingit in the near term. An instrument that is classified as held for trading by wayof this fair value option must have reliable fair values and satisfy one of thefollowing criteria (i) when doing so eliminates or significantly reduces ameasurement or recognition inconsistency that would otherwise arise from measuringassets or liabilities, or recognizing gains and losses on them on a different basisor (ii) it belongs to a group of financial assets, financial liabilities orboth that are managed and evaluated on a fair value basis in accordance with TransAlta’srisk management strategy, and are reported to senior management personnel on thatbasis.

 

Transaction costs are expensed as incurred for financial instrumentsclassified or designated as held for trading. For other financial instruments, transactioncosts are capitalized on initial recognition. The Corporation uses the effectiveinterest method of amortization for any transaction costs or fees, premiums or discountsearned or incurred for financial instruments measured at amortized cost. Financialguarantees that meet the definition of a derivative are measured at fair value andare subsequently re-measured at fair value at each balance sheet date.

 

**II.     Hedges**

Where hedge accounting can be applied and the Corporation choosesto seek hedge accounting treatment, a hedge relationship is designated as a fairvalue hedge, a cash flow hedge, or a hedge of foreign currency exposure of a netinvestment in a self-sustaining foreign operation. In order to manage the ratioof floating rate versus fixed rate debt, the Corporation uses interest rate swapsas fair value or cash flow hedges. To hedge exposures to anticipated changes ininterest rates for forecasted issuances of debt the Corporation uses interest rateswaps as cash flow hedges. For cash flow hedges, the Corporation primarily usesphysical and financial swaps, forward contracts, futures contracts, and optionsto hedge its exposure to fluctuations in electricity and natural gas prices. TheCorporation also uses foreign currency forward contracts as cash flow hedges tohedge the foreign exchange exposures resulting from anticipated transactions andfirm commitments denominated in foreign currencies. To hedge exposure to changesin the carrying value of net investments in foreign operations that are a resultof changes in foreign exchange rates, the Corporation primarily uses cross-currencyinterest rate swaps, foreign currency forward contracts, and foreign denominateddebt.

 

To be accounted for as a hedge, a derivative must be designatedand documented as a hedge, and must be highly effective at inception and on an ongoingbasis. The documentation prepared for the derivative at inception defines all relationshipsbetween hedging instruments and hedged items, as well as the Corporation’s riskmanagement objective and strategy for undertaking various hedge transactions. Theprocess of hedge accounting includes linking derivatives to specific assets andliabilities on the Consolidated Balance Sheets or to specific firm commitments oranticipated transactions.

 

The Corporation also formally assesses, both at the hedge’s inceptionand on an ongoing basis, whether the derivatives used are highly effective in offsettingchanges in fair values or cash flows of hedged items. To be classified as effective,it is reasonable to expect that the Corporation will fulfill its contractual obligationswithout having to purchase commodities in the market and cash flow exposure doesnot exist. If the above hedge criteria are not met, the derivative is accountedfor on the Consolidated Balance Sheets at fair value, with subsequent changes infair value recorded in net earnings in the period of change. For those instrumentsthat the Corporation does not seek or are ineligible for hedge accounting, changesin fair value are recorded in net earnings.

 

 

10  |  TransAlta Corporation

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a.     Fair Value Hedges

In a fair value hedging relationship, the carrying value of thehedged item is adjusted for changes in fair value attributable to the hedged riskand is recognized in net earnings. Changes in the fair value of the hedged item,to the extent that the hedging relationship is effective, are offset by changesin the fair value of the hedging derivative, which is also recorded in net earnings.Hedge effectiveness of fair value hedges is achieved if changes in the fair valueof the derivative substantially offset changes in the fair value of the item hedged.When hedge accounting is discontinued, the carrying value of the hedged item isno longer adjusted and the cumulative fair value adjustments to the carrying valueof the hedged item are amortized to net earnings over the remaining term of theoriginal hedging relationship.

 

The Corporation primarily uses interest rate swaps as fair valuehedges to manage the ratio of floating rate versus fixed rate debt. Interest rateswaps require the periodic exchange of payments without the exchange of the notionalprincipal amount on which the payments are based. If hedge criteria are met, interestexpense on the debt is adjusted to include the payments made or received under theinterest rate swaps.

 

b.     Cash Flow Hedges

In a cash flow hedging relationship, the effective portion ofthe change in the fair value of the hedging derivative is recognized in OCI whileany ineffective portion is recognized in net earnings. Hedge effectiveness of cashflow hedges is achieved if the derivatives’ cash flows substantially offset thecash flows of the hedged item and the timing of the cash flows is similar. Whenhedge accounting is discontinued, the amounts previously recognized in AOCI arereclassified to net earnings during the periods when the variability in the cashflows of the hedged item affects net earnings. Gains and losses on derivatives arereclassified from OCI immediately to net earnings when it is probable that the forecastedtransaction will not occur within the specified time period.

 

The Corporation primarily uses physical and financial swaps,forward sales contracts, futures contracts, and options as cash flow hedges to hedgethe Corporation’s exposure to fluctuations in electricity and natural gas prices.If hedging criteria are met, as described above, gains and losses on these derivativesare recognized in net earnings in the same period and financial statement captionas the hedged exposure. Up to the date of settlement, the fair values of the hedgesare recorded in risk management assets or liabilities with changes in value beingreported in OCI.

 

The Corporation also uses foreign currency forward contractsas cash flow hedges to hedge the foreign exchange exposures resulting from anticipatedtransactions and firm commitments denominated in foreign currencies. If the hedgingcriteria are met, changes in value are reported in OCI with the fair value beingreported in risk management assets or liabilities, as appropriate. Upon settlementof the derivative, any gain or loss on the forward contracts is included in thecost of the asset acquired or liability incurred.

 

The Corporation uses forward starting interest rate swaps ascash flow hedges to hedge exposures to anticipated changes in interest rates forforecasted issuances of debt. If the hedging criteria are met, changes in valueare reported in OCI with the fair value being reported in risk management assetsor liabilities, as appropriate.

 

c.     Foreign Currency Exposure of a Net Investment in a Self-SustainingForeign Operation Hedges

In hedging a foreign currency exposure of a net investment ina self-sustaining foreign operation, the effective portion of foreign exchange gainsand losses on the hedging instruments is recognized in OCI and the ineffective portionis recognized in net earnings. The amounts previously recognized in AOCI are recognizedin net earnings when there is a reduction in the hedged net investment as a resultof a dilution or sale of the net investment.

 

The Corporation primarily uses cross-currency interest rate swaps,foreign currency forward contracts, and foreign denominated debt to hedge exposureto changes in the carrying values of the Corporation’s net investments in self-sustainingforeign operations as a result of changes in foreign exchange rates. Gains and losseson these instruments that qualify for hedge accounting are reported in OCI withfair values recorded in risk management assets or liabilities.

 

**G.    Cashand Cash Equivalents**

 

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

 

**H.    CollateralPaid and Received**

 

The terms and conditions of certain contracts may require thecounterparties to provide collateral when the fair value of the obligation pursuantto these contracts is in excess of any credit limits granted. Downgrades in creditworthinessby certain credit rating agencies may decrease the credit limits granted and accordinglyincrease the amount of collateral that may have to be provided.

 

**I.      Inventory**

 

The majority of fuel and purchased power recorded on the ConsolidatedStatements of Earnings reflects the cost of inventory consumed in the generationof electricity. All inventory is carried at the lower of cost and net realizablevalue and cost is determined using the weighted average cost method.

 

The cost of internally produced coal inventory is determinedusing absorption costing which is defined as the sum of all applicable expendituresand charges directly incurred in bringing inventory to its existing condition andlocation. Available coal inventory tends to increase during the second and thirdquarters as a result of favourable weather conditions and lower production as maintenanceis performed. Due to the limited amount of processing steps incurred in mining coaland preparing it for consumption and the relatively low value on a per-unit basis,management does not distinguish between work in process and coal available for consumption.

 

The cost of natural gas inventory includes all applicable expendituresand charges incurred in bringing inventory to its existing condition and location.

 

 

Notes toConsolidated Financial Statements  |  11

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**J.     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, oracquisition. Original cost includes items such as materials, labour, interest, andother appropriately allocated costs. As costs are expended for new construction,these costs are capitalized as PP&E on the Consolidated Balance Sheets and aresubject to depreciation upon commencement of commercial operations. The cost ofroutine maintenance and repairs, such as inspections and corrosion removal, andthe replacement of minor parts, are charged to expense as incurred. Certain expendituresrelating to the replacement of components incurred during major maintenance arecapitalized and amortized over the estimated benefit period of such expenditures.A component is a tangible portion of the asset that can be separately identifiedas an asset and depreciated over its own expected useful life, and is expected toprovide a benefit of greater than one year.

 

The estimate of the useful life of PP&E is based on currentfacts and past experience, and takes into consideration existing long-term salesagreements and contracts, current and forecasted demand, and the potential for technologicalobsolescence. The useful life is used to estimate the rate at which the PP&Eis depreciated or amortized. These estimates are subject to revision in future periodsbased on new or additional information. Depreciation and amortization are calculatedusing straight-line and unit-of-production methods. Coal rights are amortized ona unit-of-production basis, based on the estimated mine reserves.

 

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

 

On an annual basis, and when indicators of impairment exist,TransAlta determines whether the net carrying amount of PP&E is recoverablefrom future undiscounted cash flows. Factors that could indicate an impairment exists,include significant underperformance relative to historical or projected futureoperating results, significant changes in the manner or use of the assets, significantnegative industry or economic trends, or a change in the strategy for the Corporation’soverall 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 leadingto an indication that an asset may be impaired. This can be further complicatedwhere TransAlta is not the operator of the facility. Events can occur in these situationsthat may not be known until a date subsequent to their occurrence.

 

The Corporation’s businesses, the market and business environmentare routinely monitored, and judgments and assessments are made to determine whetheran 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 thetotal of the undiscounted future cash flows, excluding financing charges with theexception of plants that have specifically dedicated debt, is less than the carryingamount of the PP&E, an asset impairment must be recognized in the consolidatedfinancial statements. The amount of the impairment charge to be recognized is calculatedby 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 transactionbetween willing parties, and is normally estimated by calculating the present valueof expected future cash flows related to the asset.

 

**K.    Goodwill**

 

Goodwill is the cost of an acquisition less the fair value ofthe related identifiable net assets of an acquired business. Goodwill is not subjectto amortization, but instead is tested for impairment at least annually, or morefrequently if an analysis of events and circumstances indicate that a possible impairmentmay exist. These events could include a significant change in financial positionof the reporting segment to which the goodwill relates or significant negative industryor economic trends. To test for impairment, the fair value of the reporting segmentsto which the goodwill relates is compared to the carrying values of the reportingsegments. The Corporation determined that the fair value of each reporting segmentexceeded its carrying values as at Dec. 31, 2009 and 2008.

 

**L.     IntangibleAssets**

 

Intangible assets consist of power sale contracts, with rateshigher than market rates at the date of acquisition, primarily acquired in the purchaseof Canadian Hydro Developers, Inc. (“Canadian Hydro”) *(Note 24)*and CE Generation LLC (“CE Gen”), a jointly controlled enterprise *(Note 32)*. Sale contracts are valued at cost and are amortizedon a straight-line basis over the remaining applicable contract period, which rangesfrom one to 25 years.

 

**M.    ProjectDevelopment Costs**

 

Deferred project development costs include external, direct,and incremental costs that are necessary for completing an acquisition or constructionproject. These costs are included in operating expenses until construction of aplant or acquisition of an investment is likely to occur, there is reason to believethat future costs are recoverable, and that efforts will result in future valueto 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 reportingperiod, and unrecoverable amounts of capitalized costs for projects no longer probableof occurring are charged to expense.

 

 

12  |  TransAlta Corporation

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**N.    IncomeTaxes**

 

The Corporation follows Canadian GAAP for non-regulated entitiesfor all electricity generation operations and as a result, future income taxes havebeen recorded for all operations.

 

The Corporation uses the liability method of accounting for incometaxes for its operations. Under the liability method, income taxes are recognizedfor the differences between financial statement carrying values and the respectiveincome tax basis of assets and liabilities (temporary differences), and the carryforwardof unused tax losses. Future income tax assets and liabilities are measured usingincome tax rates expected to apply in the years in which temporary differences areexpected to be recovered or settled. The effect on future income tax assets andliabilities of a change in tax rates is included in net earnings in the period thechange is substantively enacted. Future income tax assets are evaluated annuallyand if realization is not considered ‘more likely than not’, a valuation allowanceis provided.

 

TransAlta’s income tax positions are based on research and interpretationsof the income tax laws and rulings in each of the jurisdictions in which the Corporationoperates. The Corporation’s operations are complex, and the computation and provisionfor income taxes involves tax interpretations, regulations, and legislation thatare continually changing and as such, further appeals and audits by taxation authoritiesmay result. 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 informationcurrently available.

 

**O.    EmployeeFuture Benefits**

 

The Corporation accrues its obligations under employee benefitplans and the related costs, net of plan assets. The cost of pensions and otherpost-employment and post-retirement benefits earned by employees is actuariallydetermined using the projected benefit method pro-rated on services and management’sbest estimate of expected plan investment performance, salary escalation, retirementages of employees, and expected health care costs. The defined benefit pension plansare based on an employee’s final average earnings and years of service. The expectedreturn on plan assets is based on expected future capital market returns. The discountrate used to calculate the interest cost on the accrued benefit obligation is determinedby reference to market interest rates at the balance sheet date on high-qualitydebt instruments with cash flows that match the timing and amount of expected benefitpayments. As the members of the Canadian Registered Plan are now almost all inactive,the past service costs from plan amendments and the excess of the net cumulativeunamortized actuarial gain or loss over 10 per cent of the greater of the accruedbenefit obligation and the market value of plan assets are amortized over the EstimatedAverage Remaining Life (“EARL”). When the restructuring of a benefit plan givesrise to both a curtailment and settlement of obligations, the curtailment is accountedfor prior to the settlement. Transition obligations and assets arising from theprospective adoption of new accounting standards are amortized over EARL. This methodhas not been applied to the Centralia plan as it did not qualify because the majorityof its members are still active. The U.S. plan is amortized using Estimated AverageRemaining Service Life (“EARSL”).

 

In 2007, the past service costs and actuarial gains and losseson defined benefit plans had been amortized using EARSL *(Note 2)*.

 

**P.     Long-TermDebt**

 

Transaction costs are recorded against the carrying value oflong-term debt. The Corporation uses the effective interest method to amortize issuancecosts and fees associated with long-term debt. A portion of the debt has been hedgedusing fixed to floating interest rate swaps and therefore the Corporation has includedthe fair value of these swaps with the value of the debt.

 

**Q.    AssetRetirement Obligation (“ARO”)**

 

The Corporation recognizes ARO in the period in which they areincurred if a reasonable estimate of a fair value can be determined. The associatedasset retirement costs are capitalized as part of the carrying amount of the long-livedasset. The ARO liability is accrued over the estimated time period until settlementof the obligation and the asset is depreciated over the estimated useful life ofthe asset. Reclamation costs for mining assets are recognized on a unit-of-productionbasis.

 

TransAlta has recorded an ARO for all generating facilities forwhich it is legally required to remove the facilities at the end of their usefullives and restore the plant and mine sites to their original condition. For somehydro facilities, the Corporation is required to remove the generating equipment,but is not legally required to remove the structures. TransAlta has recognized legalobligations arising from government legislation, written agreements between entities,and case law. The asset retirement liabilities are recognized when the ARO is incurred.Asset retirement liabilities for coal mines are incurred over time, as new areasare mined, and a portion of the liability is settled over time as areas are reclaimedprior to final pit reclamation.

 

For active mines, accretion expense is included in fuel and purchasedpower.

 

**R.    Stock-BasedCompensation Plans**

 

The Corporation has two types of stock-based compensation plansas described in Note 30. Under the fair value method for stock options, compensationexpense is measured at the grant date at fair value and recognized over the serviceperiod.

 

Stock grants under the Performance Share Ownership Plan (“PSOP”)are accrued in operations, maintenance, and administration (“OM&A”) expenseas earned to the balance sheet date, based upon the percentile ranking of the totalshareholder return of the Corporation’s common shares in comparison to the totalshareholder returns of companies comprising the comparator group. Compensation expenseunder the phantom stock option plan is recognized in OM&A for the amount bywhich the quoted market price of TransAlta’s shares exceed the option price, andadjusted 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 considerationpaid over the carrying amount of the stock option or stock cancelled is chargedto retained earnings.

 

 

Notes to ConsolidatedFinancial Statements  |  13

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**S.     Accountingfor Emission Credits and Allowances**

 

Purchased emission allowances are recorded on the ConsolidatedBalance Sheets at historical cost and are carried at the lower of weighted averagecost and net realizable value. Allowances granted to TransAlta or internally generatedare recorded at nil. TransAlta records an emission liability on the ConsolidatedBalance Sheets using the best estimate of the amount required to settle the Corporation’sobligation in excess of government-established caps and targets. To the extent compliancecosts are recoverable under the terms of contracts with third parties, these amountsare recognized as revenue in the period of recovery.

 

Proprietary trading of emissions allowances that meet the definitionof a derivative are accounted for using the fair value method of accounting. Allowancesthat do not satisfy the criteria of a derivative are accounted for using the accrualmethod.

 

**T.     PlannedMaintenance**

 

Planned maintenance is performed at regular intervals and theexpenditures include both expense and capital portions. The planned major maintenanceincludes repairs and maintenance of existing components and the replacement of existingcomponents. Repairs and maintenance of existing components are expensed in the periodincurred. Costs of replacing existing components are capitalized in the period ofmaintenance activities and amortized on a straight-line basis over the life of theasset. Any remaining net book value of the component being replaced is expensedthrough depreciation. A component is a tangible portion of the asset that can beseparately identified as an asset and depreciated over its own expected useful life,and is expected to provide a benefit of greater than one year.

 

**U.    BusinessCombinations**

 

Acquisitions are recorded using the purchase method of accounting,in accordance with Handbook Section 1581, *Business Combinations*,with the results of operations included in these consolidated financial statementsfrom the date of acquisition *(Note 24)*. The purchaseprice has been allocated to assets acquired and liabilities assumed at the dateof acquisition. The amounts assigned to the net assets acquired have given riseto future income tax liabilities that have been recorded as part of the purchaseprice allocation. The excess of the purchase price over the fair values assignedto the identifiable net assets acquired has been recorded as goodwill.

 

 

***2.   ACCOUNTING CHANGES***

 

**A.    CurrentYear Reclassifications**

 

Certain of the comparative figures have been reclassified toconform with the current year’s presentation. Such reclassification did not impactpreviously reported net earnings or retained earnings.

 

**I.      Classificationof Pension Assets**

During 2009, pension assets were classified on the ConsolidatedBalance Sheets as other assets. In 2008, $9 million was reclassified from deferredcredits and other long-term liabilities to other assets in order to present comparablefigures.

 

**II.     Classificationof Collateral**

During 2009, collateral paid to counterparties was reclassifiedon the Consolidated Balance Sheets from accounts receivable to collateral paid inorder to be presented separately. In 2008, $37 million was also reclassified fromaccounts receivable in order to present comparable figures.

 

During 2009, collateral received from counterparties was reclassifiedon the Consolidated Balance Sheets from accounts payable to collateral receivedin order to be presented separately. In 2008, $24 million was also reclassifiedfrom accounts payable in order to present comparable figures.

 

**III.    Classificationof Mining Development Costs**

During 2009, mining development costs were classified on theConsolidated Balance Sheets as PP&E. In 2008, $13 million was reclassified fromother assets to PP&E in order to present comparable figures.

 

**IV.    Classificationof Debt**

The Corporation’s credit facilities extend for more than oneyear, and as a result the outstanding balance of the Corporation’s credit facilitieshas been reclassified from short-term debt to recourse long-term debt on the ConsolidatedBalance Sheets. In 2008, $443 million was reclassified in order to present comparablefigures.

 

**B.   ****CurrentYear Accounting Changes**

** **

**I.      FinancialInstruments – Disclosures**

On Oct. 1, 2009, the Corporation adopted amendments to Section 3862,*Financial Instruments – Disclosures,* to convergewith *Improving Disclosures about Financial Instruments (Amendmentsto IFRS 7)*. The amendments expand the disclosures required in respectof recognized fair value measurements and clarify existing principles for disclosuresabout the liquidity risk associated with financial instruments. The implementationof this standard did not have an impact upon the consolidated financial statementsas the disclosure requirements are already provided as part of the Corporation’sexisting financial instrument disclosures.

 

 

14  |  TransAlta Corporation

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**II.     FinancialInstruments – Recognition and Measurement**

On July 29, 2009, the Corporation retrospectively adopted,to Jan. 1, 2009, *Impairment of Financial Assets,*amending Section 3855, *Financial Instruments – Recognitionand Measurement.* The amendments changed the categories into which debtinstruments could be classified and the impairment requirements for certain financialassets. Consequential amendments to Section 3025, *Impaired Loans*,were made to incorporate these changes. The implementation of this standard didnot have an impact upon the consolidated financial statements.

 

On July 1, 2009, the Corporation adopted *Embedded Derivatives on Reclassification of Financial Assets,*amendingSection 3855, *Financial Instruments – Recognitionand Measurement*. The amendment indicates that contracts with embeddedderivatives cannot be reclassified out of the held for trading category if the embeddedderivative cannot be fair valued. The implementation of this standard did not havean impact upon the consolidated financial statements.

 

**III.    CreditRisk**

On Jan. 1, 2009, the Corporation adopted the Emerging IssuesCommittee (“EIC”) Abstract 173, *Credit Risk and the Fair Valueof Financial Assets and Financial Liabilities*. Under EIC – 173, an entity’sown credit risk and the credit risk of the counterparty should be taken into accountin determining the fair value of financial assets and liabilities, including derivativeinstruments. Disclosure required as a result of adopting this standard can be foundin Note 9.

 

**IV.    Deferralof Costs and Internally Developed Intangibles**

On Jan. 1, 2009, the Corporation adopted Handbook Section 3064,*Goodwill and Intangible Assets,* replacingSection 3062, *Goodwill and Other IntangibleAssets,* and Section 3450, *Research and Development Costs*.Section 3064 further defines that an internally developed intangible assetmust demonstrate technical feasibility, an intention for use or sale, the generationof future economic benefits, and adequate access to resources to complete the developmentof the intangible asset in order to be able to capitalize associated costs. Theimplementation of this standard did not have an impact upon the consolidated financialstatements.

 

**V.     MiningExploration Costs**

On Jan. 1, 2009, the Corporation adopted EIC – 174, *Mining Exploration Costs*. EIC – 174 provides guidance on thecapitalization of mining exploration costs, particularly when mining reserves havenot been proven. The EIC also defines when an impairment test should be performedon previously capitalized costs. The implementation of this standard did not havean impact upon the consolidated financial statements.

 

**C.   ****Prior YearAccounting Changes**

** **

**I.      EmployeeFuture Benefits**

During 2008, TransAlta assessed the accounting treatment forthe amortization of the past service costs and actuarial gains and losses on definedbenefit plans. In prior years, the past service costs and actuarial gains and losseson defined benefit plans had been amortized using EARSL, which was determined bythe actuary to be seven years. As a result of the assessment, TransAlta amortizedthe past service costs and actuarial gains and losses on defined benefit plans underCanadian GAAP using EARL for plans whose members are almost all retired, which isdetermined by the actuary to be 17 years. As the members of the Canadian RegisteredPlan are now almost all inactive, starting in 2008 the past service costs from planamendments and the excess of the net cumulative unamortized actuarial gain or lossover 10 per cent of the greater of the accrued benefit obligation and the marketvalue of plan assets will be amortized over EARL.

 

**II.     FinancialInstruments**

On Jan. 1, 2007, TransAlta adopted four new accounting standardsthat were issued by the CICA: Section 1530, *ComprehensiveIncome,*Section 3855, *Financial Instruments – Recognitionand Measurement,* Section 3861, *Financial Instruments– Disclosure and Presentation,*and Section 3865, *Hedges*. TransAlta adopted these standards retroactively withan adjustment of opening AOCI solely related to accumulated unrealized foreign currencylosses on the translation of self-sustaining foreign operations.

 

Section 3861 outlines disclosure requirements that are designedto enhance financial statement users’ understanding of the significance of financialinstruments to an entity’s financial position, performance, and cash flows. Thepresentation requirements outlined in this section have been adopted in the Corporation’sfinancial instruments presentation and related disclosure.

 

**III.    ComprehensiveIncome**

Section 1530 introduces comprehensive income, which consistsof net earnings and OCI. OCI represents changes in shareholders’ equity during aperiod arising from transactions and changes in prices, markets, interest rates,and exchange rates and includes unrealized gains and losses on financial assetsclassified as available-for-sale, unrealized foreign currency translation gainsor losses arising from self-sustaining foreign operations, net of hedging activities,and changes in the fair value of the effective portion of cash flow hedging instruments.TransAlta has included in the consolidated financial statements the ConsolidatedStatements of Comprehensive Income. The cumulative changes in OCI are included inAOCI, which is presented as a new category of shareholders’ equity on the ConsolidatedBalance Sheets.

 

 

Notes to ConsolidatedFinancial Statements  |  15

----

 

**IV.    FinancialInstruments – Recognition and Measurement**

Section 3855 establishes standards for recognizing and measuringfinancial assets, financial liabilities, and non-financial derivatives. It requiresthat financial assets and financial liabilities, including derivatives, be recognizedon the Consolidated Balance Sheets when the Corporation becomes a party to the contractualprovisions of the financial instrument or non-financial derivative contract. Underthis standard, all financial instruments are required to be measured at fair valueupon initial recognition except for certain related party transactions. Measurementin subsequent periods depends on whether the financial instrument has been classifiedas held for trading, available-for-sale, held-to-maturity, loans and receivables,or other financial liabilities. Transaction costs are expensed as incurred for financialinstruments classified or designated as held for trading. For other financial instruments,transaction costs are capitalized on initial recognition and amortized using theeffective interest method. Financial liabilities are removed from the consolidatedfinancial statements when the liability is extinguished either through settlementof or release from the obligation of the underlying liability.

 

Financial assets and financial liabilities held for trading aremeasured at fair value with changes in those fair values recognized in net earnings.Financial assets held-to-maturity, loans and receivables, and other financial liabilitiesare measured at amortized cost using the effective interest method of amortization.Investments in equity instruments classified as available-for-sale that do not havea quoted market price in an active market are measured at cost.

 

Derivative instruments are recorded on the Consolidated BalanceSheets at fair value, including those derivatives that are embedded in financialor non-financial contracts that are not closely related to the host contracts. Changesin the fair values of derivative instruments are recognized in net earnings withthe exception of the effective portion of (i) derivatives designated as effectivecash flow hedges or (ii) hedges of foreign currency exposure of a net investmentin a self-sustaining foreign operation, which are recognized in OCI.

 

Section 3855 also provides an entity the option to designatea financial instrument as held for trading (the fair value option) on its initialrecognition or upon adoption of the standard, even if the financial instrument,other than loans and receivables, was not acquired or incurred principally for thepurpose of selling or repurchasing it in the near term. An instrument that is classifiedas held for trading by way of this fair value option must have reliable fair valuesand satisfy one of the following criteria (i) when doing so eliminates or significantlyreduces a measurement or recognition inconsistency that would otherwise arise frommeasuring assets or liabilities, or recognizing gains and losses on them on a differentbasis or (ii) it belongs to a group of financial assets, financial liabilitiesor both which are managed and evaluated on a fair value basis in accordance withTransAlta’s risk management strategy, and are reported to senior management personnelon that basis.

 

Other significant accounting implications arising upon the adoptionof Section 3855 include the use of the effective interest method of amortizationfor any transaction costs or fees, premiums or discounts earned or incurred forfinancial instruments measured at amortized cost, and the recognition of the inceptionfair value of the obligation undertaken in issuing a guarantee that meets the definitionof a guarantee pursuant to Accounting Guideline 14, *Disclosure ofGuarantees* (“AcG-14”). No subsequent re-measurement at fair value isrequired unless the financial guarantee qualifies as a derivative. If the financialguarantee meets the definition of a derivative it is remeasured at fair value ateach balance sheet date and reported as a derivative in other assets or other liabilities,as appropriate.

 

In addition, Section 3855 requires that an entity must selectan accounting policy of either expensing debt issue costs as incurred or applyingthem against the carrying value of the related asset or liability. TransAlta iscurrently applying all eligible debt transaction costs against the carrying valueof the debt.

 

As part of the implementation of Handbook Section 3855,TransAlta selected Jan. 1, 2003 as the transition date with respect to theassessment of embedded derivatives. TransAlta recognizes as separate assets andliabilities only those derivatives embedded in hybrid instruments issued, acquiredor substantively modified on or after the selected transition date.

 

**V.     Hedges**

Section 3865 specifies the criteria that must be satisfiedin order for hedge accounting to be applied and the accounting for each of the permittedhedging strategies: fair value hedges, cash flow hedges, and hedges of foreign currencyexposures of net investments in self-sustaining foreign operations. Hedge accountingis discontinued prospectively when the derivative no longer qualifies as an effectivehedge, or the derivative is terminated or sold, or upon the sale or early terminationof the hedged item.

 

In a fair value hedging relationship, the carrying value of thehedged item is adjusted for changes in fair value attributable to the hedged riskand recognized in net earnings. Changes in the fair value of the hedged item, tothe extent that the hedging relationship is effective, are offset by changes inthe fair value of the hedging derivative, which is also recorded in net earnings.When hedge accounting is discontinued, the carrying value of the hedged item isno longer adjusted and the cumulative fair value adjustments to the carrying valueof the hedged item are amortized to net earnings over the remaining term of theoriginal hedging relationship.

 

In a cash flow hedging relationship, the effective portion ofthe change in the fair value of the hedging derivative is recognized in OCI whileany ineffective portion is recognized in net earnings. When hedge accounting isdiscontinued, the amounts previously recognized in AOCI are reclassified to netearnings during the periods when the variability in the cash flows of the hedgeditem affects net earnings. Gains and losses on derivatives are reclassified immediatelyto net earnings when the hedged item is sold or early terminated, or it is probablethat the anticipated transaction will not occur.

 

In hedging a foreign currency exposure of a net investment ina self-sustaining foreign operation, the effective portion of foreign exchange gainsand losses on the hedging instruments is recognized in OCI and the ineffective portionis recognized in net earnings. The amounts previously recognized in AOCI are recognizedin net earnings when there is a reduction in the hedged net investment as a resultof a dilution or sale of the net investment or reduction in equity of the foreignoperation as a result of dividends or distributions.

 

 

16  |  TransAlta Corporation

----

 

Prior to the adoption of Section 3865, gains and losseson physical and financial swaps, forward sales contracts, futures contracts andoptions used to hedge the Corporation’s exposure to fluctuations in electricityand natural gas prices related to output from the plants and designated as hedgeswere recognized in net earnings in the same period and financial statement captionas the hedged exposure (settlement accounting). The derivatives were not recordedon the Consolidated Balance Sheets. Foreign currency forward contracts used to hedgethe foreign exchange exposures resulting from anticipated contracts and firm commitmentsdenominated in foreign currencies where hedge criteria were met were not recognizedon the Consolidated Balance Sheets. Interest rate swaps used to manage the impactof fluctuating interest rates on existing debt were not recognized on the ConsolidatedBalance Sheets if they met hedge criteria.

 

**VI.    Impactupon adoption of Sections 1530, 3855 and 3865**

For hedging relationships existing prior to adopting Section 3865that continue to qualify for hedge accounting under the new standard, the transitionaccounting is as follows: (i) fair value hedges – any gain or loss on the hedginginstrument was recognized in opening retained earnings and the carrying amount ofthe hedged item was adjusted by the cumulative change in fair value attributableto the designated hedged risk and was also included in opening retained earningsand (ii) cash flow hedges and hedges of net investments in self-sustainingforeign operations – the effective cumulative portion of any gain or loss on thehedging instrument was recognized in AOCI and the cumulative ineffective portionwas included in opening retained earnings.

 

**D.   ****FutureAccounting Changes**

** **

**I.      BusinessCombinations and Non-Controlling Interests**

In January 2009, the Accounting Standards Board of Canada(“AcSB”) issued Section 1582, *Business Combinations,*Section 1601, *Consolidated Financial Statements,*and Section 1602, *Non-controlling Interests*which will be adopted concurrently. Section 1582 and Section 1602 proposesignificant changes with respect to accounting for business combinations and tothe accounting and presentation of non-controlling interests, respectively. Section 1601is a replacement of Section 1600, *Consolidated Financial Statements,*and its implementation is not expected to have an impact upon the consolidated financialposition or results of operations. The Corporation is currently assessing theimpact of adopting the above standards on the consolidated financial statements.

 

**II.     InternationalFinancial Reporting Standards (“IFRS”) Convergence**

In 2005, the AcSB announced that accounting standards in Canadaare to converge with IFRS. On May 8, 2009, the AcSB re-confirmed that IFRSwill be required for interim and annual financial statements commencing on Jan. 1,2011, with appropriate comparative IFRS financial information for 2010. While IFRSuses a conceptual framework similar to Canadian GAAP, there are significant differencesin accounting policies that will be addressed as part of the convergence project.In respect of PP&E, additional disclosures reconciling the changes in individualclasses of PP&E and accumulated amortization will be required, and costs relatedto major inspection activities will be recognized as part of the carrying valueof PP&E and depreciated over the period until the next major inspection. Foremployee future benefits, an entity may recognize as at Jan. 1, 2010, all experienceand transitional gains and losses related to employee future benefits to retainedearnings with subsequent experience gains and losses being recorded in other comprehensiveincome. Long-term contracts deemed to be finance leases results in the associatedPP&E being removed from the Consolidated Balance Sheets and replaced with along-term receivable representing the present value of lease payments to be receivedover the life of the contract. Payments received under the contract are recordedin revenue and interest income, dependent upon the interest rate and duration ofthe contract.

 

The project is on track and is currently in the solution developmentand implementation phase. Cross-functional, issue-specific teams have been establishedto analyze the impacts of adopting IFRS, and focus on developing and implementingspecific solutions for convergence.

 

A steering committee, comprised of senior representatives acrossthe Corporation, has been established to monitor the progress and critical decisionsin the transition to IFRS, and continues to meet regularly. Quarterly updates areprovided to the Audit and Risk Committee. The Corporation is continuing to assessthe impact of adopting these standards on the consolidated financial statements.

 

 

***3.   WRITEDOWN OF MINING DEVELOPMENT COSTS***

In 2006, TransAlta ceased mining activities at the Centraliamine but continued to develop the option to mine the Westfield site, a coal reservelocated adjacent to Centralia Thermal. With the successful modifications of theboilers at Centralia Thermal and longer-term contracts in place to supply coal,in 2009 the project to develop the Westfields site, has now been placed on holdindefinitely and the costs that have been capitalized were expensed.

 

 

***4.   OTHER INCOME***

During 2009, the Corporation sold a 17 per cent interest in itsKent Hills project to Natural Forces Technologies Inc. (“Natural Forces”) for proceedsof $29 million, and recorded a pre-tax gain of $1 million. During 2009, the Corporationsettled an outstanding commercial issue related to the sale of its Mexican equityinvestment for a pre-tax gain of $7 million.

 

During 2008 and 2007, mining equipment with a net book valueof $2 million and $31 million related to the cessation of mining activities at theCentralia coal mine was sold for proceeds of $7 million and $47 million, respectively.

 

 

Notes toConsolidated Financial Statements  |  17

----

** **

***5.****      ****NON-CONTROLLINGINTERESTS***

** **

**A.**        **Consolidated Statements of Earnings**

 
| **Year ended Dec. 31**                                                | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Stanley Power’s interest in  TransAlta Cogeneration L. P. *(Note 32)* | ** ** | **23**   |       | 32       |       | 29       |       |
| 25 per cent interest in Saranac  Partnership not owned by CE Gen           | ** ** | **14**   |       | 29       |       | 19       |       |
| Natural Forces’ interest in Kent  Hills *(Note 4)*                    | ** ** | **1**    |       | –   |       | –   |       |
| **Total**                                                                  | ** ** | **38**   |       | 61       |       | 48       |       |

 

**B.**        **ConsolidatedBalance Sheets**

 
| **As at Dec. 31**                                           | ** ** | **2009** | ** ** | **2008** | ** ** |
|------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Stanley Power’s interest in  TransAlta Cogeneration L. P.   | ** ** | **434**  |       | 449      |       |
| 25 per cent interest in Saranac Partnership  not owned by CE Gen | ** ** | **16**   |       | 20       |       |
| Natural Forces’ interest in Kent  Hills                     | ** ** | **28**   |       | –   |       |
| **Total**                                                        | ** ** | **478**  |       | 469      |       |

 

The change in non-controlling interests is outlined below:

 
| Balance, Dec. 31, 2008                                     |   | 469 |   |
|-----------------------------------------------------------------|--------|-----|--------|
| Distributions paid                                              |   | (58 | )      |
| Non-controlling interests portion  of net earnings              |   | 38  |   |
| Proceeds on sale of minority  interest in Kent Hills *(Note 4)* |   | 29  |   |
| **As at  Dec. 31, 2009**                                   |   | 478 |   |

 

**C.**        **ConsolidatedStatements of Cash Flows**

 

The allocation of the distributions paid by subsidiaries tonon-controlling interests is as follows:

 
| **Year ended Dec. 31**                | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Stanley Power                              | ** ** | **38**   |       | 59       |       | 65       |       |
| Minority interests of Saranac  Partnership | ** ** | **18**   |       | 39       |       | 22       |       |
| Natural Forces                             | ** ** | **2**    |       | –   |       | –   |       |
| **Total**                                  | ** ** | **58**   |       | 98       |       | 87       |       |

 

 

***6.****      ****INCOMETAXES***

** **

**A.**        **ConsolidatedStatements of Earnings**

** **

**I.**         **RateReconciliations**

 
| **Year ended Dec. 31**                                    | ** ** | **2009**   | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| **Earnings before  income taxes**                              | ** ** | **196**    |       | 258      |       | 329      |       |
| Equity loss                                                    | ** ** | **–** |       | (97      | )          | (50      | )          |
| **Earnings before  income taxes and equity loss**              | ** ** | **196**    |       | 355      |       | 379      |       |
| Statutory Canadian federal and  provincial income tax rate (%) | ** ** | **29**     |       | 30       |       | 32       |       |
| Expected income tax expense                                    | ** ** | **57**     |       | 105      |       | 121      |       |
| Increase (decrease) in income taxes  resulting from:           |       |       |       |     |       |     |       |
| Lower effective foreign tax rates                              | ** ** | **(29**    | **)**      | (24      | )          | (36      | )          |
| Resolution of uncertain tax  positions                         | ** ** | **–** |       | (15      | )          | (18      | )          |
| Tax recovery on sale of Mexican  equity investment *(Note 24)* | ** ** | **–** |       | (35      | )          | –   |       |
| Capital taxes                                                  | ** ** | **1**      |       | 1        |       | 2        |       |
| Effect of tax rate changes                                     | ** ** | **(6**     | **)**      | –   |       | (48      | )          |
| Statutory and other rate  differences                          | ** ** | **(4**     | **)**      | (7       | )          | (1       | )          |
| Other                                                          | ** ** | **(4**     | **)**      | (2       | )          | –   |       |
| **Income tax expense**                                         | ** ** | **15**     |       | 23       |       | 20       |       |
| **Effective tax rate  (%**)                                    | ** ** | **8**      |       | 6        |       | 5        |       |

 

**II.**        **Components of Income Tax Expense**

 
| **Year ended Dec. 31**                                                                 | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current tax (recovery) expense                                                              | ** ** | **(6**   | **)**      | 22       |       | 54       |       |
| Future income tax expense related  to the origination and reversal of temporary differences | ** ** | **27**   |       | 1        |       | 14       |       |
| Future income tax (recovery)  expense resulting from changes in tax rates or laws           | ** ** | **(6**   | **)**      | –   |       | (48      | )          |
| **Income tax expense**                                                                      | ** ** | **15**   |       | 23       |       | 20       |       |

 

 
| 18  |  TransAlta  Corporation

  |
|-----------------------------------------------------------|

 

----

 

**B.**        **ConsolidatedBalance Sheets**

 

Significantcomponents of the Corporation’s future income tax assets (liabilities) are asfollows:

 
| **As at Dec. 31**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Net operating and capital loss  carryforwards    | ** ** | **297**  |       | 231      |       |
| Future site restoration costs                    | ** ** | **75**   |       | 71       |       |
| Property, plant, and equipment                   | ** ** | **(839** | **)**      | (736     | )          |
| Risk management assets and liabilities           | ** ** | **(82**  | **)**      | (52      | )          |
| Employee future benefits and  compensation plans | ** ** | **19**   |       | 24       |       |
| Allowance for doubtful accounts                  | ** ** | **19**   |       | 22       |       |
| Other deductible temporary  differences          | ** ** | **38**   |       | 81       |       |
| **Net future income  tax liability**             | ** ** | **(473** | **)**      | (359     | )          |

 

 

***7.****     **FINANCIAL INSTRUMENTS***

** **

**A.**        **Analysisof Financial Assets and Liabilities by Measurement Basis**

 

Financial assets and financialliabilities are measured on an ongoing basis at cost, fair value, or amortizedcost *(Note 1 (F))*. The following tableanalyses the carrying amounts of the financial assets and liabilities bycategory:

 
| **Carrying value of financial  instruments as at Dec. 31, 2009** | ** ** | ** **      | ** ** | ** **      | ** ** | ** **      | ** ** | ** **      | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|------------|------------|
| ** **                                                            | ** ** | ** **      | ** ** | **Derivatives** | ** ** | ** **      | ** ** | ** **      | ** ** | ** ** | ** ** |
| ** **                                                            | ** ** | **Derivatives** | ** ** | **classified**  | ** ** | ** **      | ** ** | **Other**       | ** ** | ** ** | ** ** |
| ** **                                                            | ** ** | **used for**    | ** ** | **as held**     | ** ** | **Loans and**   | ** ** | **financial**   | ** ** | ** ** | ** ** |
| ** **                                                            | ** ** | **hedging**     | ** ** | **for trading** | ** ** | **receivables** | ** ** | **liabilities** | ** ** | **Total**  | ** ** |
| **Financial assets**                                                  |       |            |       |            |       |            |       |            |       |       |       |
| Cash and cash equivalents                                             | ** ** | **–**      | ** ** | **–**      | ** ** | **82**          | ** ** | **–**      | ** ** | **82**     | ** ** |
| Accounts receivable                                                   | ** ** | **–**      | ** ** | **–**      | ** ** | **421**         | ** ** | **–**      | ** ** | **421**    | ** ** |
| Collateral paid                                                       | ** ** | **–**      | ** ** | **–**      | ** ** | **27**          | ** ** | **–**      | ** ** | **27**     | ** ** |
| Risk management assets                                                |       |            |       |            |       |            |       |            |       |       |       |
| Current                                                               | ** ** | **130**         | ** ** | **14**          | ** ** | **–**      | ** ** | **–**      | ** ** | **144**    | ** ** |
| Long-term                                                             | ** ** | **219**         | ** ** | **5**           | ** ** | **–**      | ** ** | **–**      | ** ** | **224**    | ** ** |
| **Financial  liabilities**                                            |       |            | ** ** |            |       | **–**      |       |            |       |       |       |
| Accounts payable and accrued  liabilities                             | ** ** | **–**      | ** ** | **–**      | ** ** | **–**      | ** ** | **521**         | ** ** | **521**    | ** ** |
| Collateral received                                                   | ** ** | **–**      | ** ** | **–**      | ** ** | **–**      | ** ** | **86**          | ** ** | **86**     | ** ** |
| Risk management liabilities                                           |       |            |       |            |       |            |       |            |       |       |       |
| Current                                                               | ** ** | **28**          | ** ** | **17**          | ** ** | **–**      | ** ** | **–**      | ** ** | **45**     | ** ** |
| Long-term                                                             | ** ** | **75**          | ** ** | **3**           | ** ** | **–**      | ** ** | **–**      | ** ** | **78**     | ** ** |
| Long-term debt recourse(1)                                            | ** ** | **–**      | ** ** | **–**      | ** ** | **–**      | ** ** | **3,864**       | ** ** | **3,864**  | ** ** |
| Long-term debt non-recourse(1)                                        | ** ** | **–**      | ** ** | **–**      | ** ** | **–**      | ** ** | **578**         | ** ** | **578**    | ** ** |

 
| **Carrying value of financial  instruments as at Dec. 31, 2008** | ** ** | ** **      | ** ** | ** **      | ** ** | ** **      | ** ** | ** **      | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|------------|------------|
| ** **                                                            | ** ** | ** **      | ** ** | **Derivatives** | ** ** | ** **      | ** ** | ** **      | ** ** | ** ** | ** ** |
| ** **                                                            | ** ** | **Derivatives** | ** ** | **classified**  | ** ** | ** **      | ** ** | **Other**       | ** ** | ** ** | ** ** |
| ** **                                                            | ** ** | **used for**    | ** ** | **as held**     | ** ** | **Loans and**   | ** ** | **financial**   | ** ** | ** ** | ** ** |
| ** **                                                            | ** ** | **hedging**     | ** ** | **for trading** | ** ** | **receivables** | ** ** | **liabilities** | ** ** | **Total**  | ** ** |
| **Financial assets**                                                  |       |            |       |            |       |            |       |            |       |       |       |
| Cash and cash equivalents                                             |       | –          |       | –          |       | 50              |       | –          |       | 50         |       |
| Accounts receivable                                                   |       | –          |       | –          |       | 505             |       | –          |       | 505        |       |
| Collateral paid                                                       |       | –          |       | –          |       | 37              |       | –          |       | 37         |       |
| Risk management assets                                                |       |            |       |            |       |            |       |            |       |       |       |
| Current                                                               |       | 121             |       | 79              |       | –          |       | –          |       | 200        |       |
| Long-term                                                             |       | 220             |       | 1               |       | –          |       | –          |       | 221        |       |
| **Financial  liabilities**                                            |       |            |       |            |       |            |       |            |       |       |       |
| Accounts payable and accrued  liabilities                             |       | –          |       | –          |       | –          |       | 658             |       | 658        |       |
| Collateral received                                                   |       | –          |       | –          |       | –          |       | 24              |       | 24         |       |
| Risk management liabilities                                           |       |            |       |            |       |            |       |            |       |       |       |
| Current                                                               |       | 74              |       | 74              |       | –          |       | –          |       | 148        |       |
| Long-term                                                             |       | 96              |       | 6               |       | –          |       | –          |       | 102        |       |
| Long-term debt recourse(1)                                            |       | –          |       | –          |       | –          |       | 2,543           |       | 2,543      |       |
| Long-term debt non-recourse(1)                                        |       | –          |       | –          |       | –          |       | 265             |       | 265        |       |
| *1  Includes current portion.*                                   |       |            |       |            |       |            |       |            |       |       |       |

 

 
| Notes to  Consolidated Financial Statements  |  19

  |
|--------------------------------------------------------------------------------|

 

----

 

**B.   Fair Value of Financial Instruments**

 

The fair value of a financial instrument is the amount ofconsideration that would be agreed upon in an arm’s-length transaction betweenknowledgeable and willing parties who are under no compulsion to act. Fairvalues can be determined by reference to prices for that instrument in activemarkets to which the Corporation has access. In the absence of an activemarket, the Corporation determines fair values based on valuation models or byreference to other similar products in active markets.

 

Fair values determined using valuation models require theuse of assumptions. In determining those assumptions, the Corporation looksprimarily to external readily observable market inputs. In limitedcircumstances, the Corporation uses input parameters that are not based onobservable market data.

 

**I.    Level Determinations and Classifications**

The LevelI, II and III classifications in the fair value hierarchy utilized by theCorporation are defined as follows:

 

Level I

Fair values are determined using inputs that are quotedprices (unadjusted) in active markets for identical assets or liabilities thatthe Corporation has the ability to access. In determining Level I EnergyTrading fair values, the Corporation uses quoted prices for identically tradedcommodities obtained from active exchanges such as the New York MercantileExchange.

 

Level II

Fair valuesare determined using inputs other than unadjusted quoted prices that areobservable for the asset or liability, either directly or indirectly.

 

Energy Trading fair values falling within the Level IIcategory are determined through the use of quoted prices in active marketsadjusted for factors specific to the asset or liability, such as basis andlocation differentials. The Corporation includes over-the-counter derivativeswith values based upon observable commodity futures curves and derivatives withinput validated by broker quotes or other publicly available market dataproviders in Level II. Level II fair values also include fair values determinedusing valuation techniques, such as option pricing models and regression orextrapolation formulas, where the inputs are readily observable, includingcommodity prices for similar assets or liabilities in active markets, andimplied volatilities for options.

 

In determining Level II fair values of other risk managementassets and liabilities, the Corporation uses observable inputs other thanunadjusted quoted prices that are observable for the asset or liability, suchas interest rate yield curves and currency rates. For certain financialinstruments where insufficient trading volume or lack of recent trades exists,the Corporation relies on similar interest or currency rate inputs and otherthird-party information such as credit spreads.

 

Level III

Fair valuesare determined using inputs for the asset or liability that are not readilyobservable.

 

In limited circumstances, Energy Trading may enter intocommodity transactions involving non-standard features for whichmarket-observable data is not available. In these cases, Level III fair valuesare determined using valuation techniques with inputs that are based onhistorical data such as unit availability, transmission congestion, demandprofiles, and/or volatilities and correlations between products derived fromhistorical prices. Where commodity transactions extend into periods for whichmarket-observable prices are not available, an internally-developed fundamentalprice forecast is used in the valuation.

 

As a result of the acquisition of Canadian Hydro, TransAltaalso has various contracts with terms that extend beyond five years *(Note 24)*. Valuation of these contracts must be extrapolatedas the lengths of these contracts make reasonably alternate fundamental priceforecasts unavailable.

 

The fair value measurement of a financial instrument isincluded in only one of the three levels, the determination of which is basedupon the lowest level input that is significant to the derivation of the fairvalue.

 

The fair values of the Corporation’s financial assets andliabilities are outlined below:

 
| ** **                                                              | ** ** | ** **            | ** ** | ** **   | ** **   | ** **           | ** ** | ** ** | ** ** | **Total**  | ** ** |
|-------------------------------------------------------------------------|------------|-----------------------|------------|--------------|--------------|----------------------|------------|------------|------------|------------|------------|
| ** **                                                              | ** ** | **Fair value****(1)** | ** ** | ** **   | **carrying** | ** **           |
| **As at Dec. 31, 2009**                                            | ** ** | **Level I**           | ** ** | **Level II** | ** **   | **Level III****(3)** | ** ** | **Total**  | ** ** | **value**  | ** ** |
| **Financial assets  and liabilities measured at fair value**            |       |                  |       |         |         |                 |       |       |       |       |       |
| Net risk management assets  (liabilities)(2)                            |       | –                |       | 271          |         | (26                  | )          | 245        |       | 245        |       |
|                                                                    |       |                  |       |         |         |                 |       |       |       |       |       |
| **Financial assets  and liabilities measured at other than fair value** |       |                  |       |         |         |                 |       |       |       |       |       |
| Long-term debt                                                          |       | –                |       | 4,499        |         | –               |       | 4,499      |       | 4,442      |       |
| ** **                                                              | ** ** | ** **            | ** ** | ** **   | ** **   | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                              | ** ** | ** **            | ** ** | ** **   | ** **   | ** **           | ** ** | ** ** | ** ** | **Total**  | ** ** |
| ** **                                                              | ** ** | **Fair value****(1)** | ** ** | ** **   | **carrying** | ** **           |
| **As at Dec. 31, 2008**                             | ** ** | **Level I**           | ** ** | **Level II** | ** **   | **Level III**        | ** ** | **Total**  | ** ** | ** ** | **value**  | ** ** |
| **Financial assets  and liabilities measured at fair value**            |       |                  |       |         |         |                 |       |       |       |       |       |
| Net risk management assets(2)                                           |       | 1                     |       | 170          |         | –               |       | 171        |       | 171        |       |
|                                                                    |       |                  |       |         |         |                 |       |       |       |       |       |
| **Financial assets  and liabilities measured at other than fair value** |       |                  |       |         |         |                 |       |       |       |       |       |
| Long-term debt                                                          |       | –                |       | 2,542        |         | –               |       | 2,542      |       | 2,808      |       |

 

*1** **Excludes financial assets andliabilities where book value approximates fair value due to the liquid natureof the asset or liability (cash and cash equivalents, accounts receivable,collateral paid, accounts payable and accrued liabilities, and collateralreceived).*

*2** **Includes Energy Trading and otherrisk management assets and liabilities on a net basis (Note 9).*

*3** **Resulting primarily from the acquisitionof Canadian Hydro (Note 24).*

 

 
| 20  |  TransAlta  Corporation

  |
|-----------------------------------------------------------|

 

----

 

**II.     Fair ValuesDetermined Using Valuation Models (Levels II & III)**

 

Fair values determined using valuation models require the useof assumptions. Where assumptions and inputs are based on readily observablemarket data, the fair values are categorized as Level II. The key inputs tovaluation models and regression or extrapolation formulas include interest rateyield curves, currency rates, credit spreads, implied volatilities, andcommodity prices for similar assets or liabilities in active markets, asapplicable.

 

Where the fair values have been developed using valuationmodels based on unobservable or internally developed assumptions or inputs(Level III Energy Trading Risk Management fair values), the key inputs includehistorical data such as plant performance, volatilities and correlationsbetween products derived from historical prices, congestion on transmissionpaths, or demand profiles for individual non-standard deals and structuredproducts. In limited circumstances, an internally-developed fundamental priceforecast is used when commodity transactions extend into periods for whichmarket-observable prices are not available.

 

The effect of using reasonably possible alternativeassumptions as inputs to valuation techniques from which the Level III EnergyTrading fair values are determined at Dec. 31, 2009 is estimated to be +/-$24 million (2008–nil). This estimate is based on a +/- one standard deviationmove from the mean where historical data is used in the valuation. Where aninternally-developed fundamental price forecast is used, reasonably alternatefundamental price forecasts sourced from external consultants are included inthe estimate. For contracts with terms that extend beyond five years, valuationmust be extrapolated as the lengths of these contracts make reasonablyalternate fundamental price forecasts unavailable.

 

The total change in fair value estimated using a valuationtechnique with unobservable inputs, for financial assets and liabilitiesmeasured and recorded at fair value, that was recognized in pre-tax netearnings for the year ended Dec. 31, 2009 was a $1 million gain (2008–$16million gain). A reconciliation of the movements in risk management fair valuesby Level, as well as additional Level III gain (loss) information can be foundin Note 9.

 

**C.****    ****Inception Gains and Losses**

 

The majority of derivatives traded by the Corporation arenot traded on an active exchange or extend beyond the time period for whichexchange-based quotes are available. The fair values of these derivatives havebeen determined using valuation techniques or models.

 

In some instances, a difference may arise between the fairvalue of a financial instrument at initial recognition (“the transactionprice”) and the amount calculated through a valuation model. This unrealizedgain or loss at inception is recognized in net earnings only if the fair valueof the instrument is evidenced by a quoted market price in an active market,observable current market transactions that are substantially the same, or avaluation technique that uses observable market inputs. Where these criteriaare not met, the difference is deferred on the Consolidated Balance Sheets inrisk management assets or liabilities, and is recognized in net earnings overthe term of the related contracts. The difference yet to be recognized in netearnings and a reconciliation of changes during the period is as follows:

 
| **As at Dec. 31**                                                    | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Unamortized gain at beginning of  year                                    | ** ** | **2**    |       | 3        |       | 4        |       |
| New transactions                                                          | ** ** | **(1**   | **)**      | 1        |       | 4        |       |
| Recognized in the Consolidated  Statements of Earnings during the period: |       |     |       |     |       |     |       |
| Amortization                                                              | ** ** | **(2**   | **)**      | (2       | )          | (5       | )          |
| **Unamortized (loss)  gain at end of year**                               | ** ** | **(1**   | **)**      | 2        |       | 3        |       |

 

**D.****    ****Nature and Extent of Risks Arising fromFinancial Instruments**

 

The following discussion is limited to the nature and extentof risks arising from financial instruments.

 

**I.     Market Risk**

 

**a.    Commodity Price Risk**

The Corporation has exposure to movements in certaincommodity prices in both its electricity generation and proprietary tradingbusinesses, including the market price of electricity and fuels used to produceelectricity. Most of the Corporation’s electricity generation and related fuelsupply contracts are considered to be contracts for delivery or receipt of anon-financial item in accordance with expected NPNS contracts that are notconsidered to be financial instruments. As such, the discussion related tocommodity price risk is limited to the Corporation’s proprietary tradingbusiness and commodity derivatives used in hedging relationships associatedwith the Corporation’s electricity generating activities.

 

The Corporation has a Commodity Exposure Management Policy(the “Policy”) that governs both the commodity transactions undertaken in itsproprietary trading business and those undertaken to manage commodity priceexposures in its generation business. The Policy defines and specifies thecontrols and management responsibilities associated with commodity activities,as well as the nature and frequency of required reporting of such activities. 

 

***i.*****    *Commodity Price Risk — Proprietary Trading***

 

The Corporation’s COD segmentconducts proprietary trading activities and uses a variety of instruments tomanage risk, earn trading revenue, and gain market information.

 

 
| Notes to  Consolidated Financial Statements  |  21

 

  |
|----------------------------------------------------------------------------------------|

 

----

 

In compliance with the Policy, proprietary tradingactivities are subject to limits and controls, including Value at Risk (“VaR”)limits. The Board of Directors approves the limit for total VaR fromproprietary trading activities. VaR is the most commonly used metric employedto track and manage the market risk associated with trading positions. A VaRmeasure gives, for a specific confidence level, an estimated maximum pre-taxloss that could be incurred over a specified period of time. VaR is used todetermine the potential change in value of the Corporation’s proprietarytrading portfolio, over a three day period within a 95 per cent confidencelevel, resulting from normal market fluctuations. VaR is estimated using thehistorical variance/covariance approach.

 

VaR is a measure that has certain inherent limitations. Theuse of historical information in the estimate assumes that price movements inthe past will be indicative of future market risk. As such, it may only bemeaningful under normal market conditions. Extreme market events are notaddressed by this risk measure. In addition, the use of a three day measurementperiod implies that positions can be unwound or hedged within three days,although this may not be possible if the market becomes illiquid.

 

The Corporation recognizes the limitations of VaR andactively uses other controls, including restrictions on authorized instruments,volumetric and term limits, stress-testing of individual portfolios and of thetotal proprietary trading portfolio, and management reviews when loss limitsare triggered.

 

Changes in market prices associated with proprietary tradingactivities affect net earnings in the period that the price changes occur. VaRat Dec. 31, 2009 associated with the Corporation’s proprietary tradingactivities was $3 million (2008 – $6 million).

 

***ii.******   ******Commodity Price Risk — Generation***

 

The Generation segment utilizes various commodity contractsto manage the commodity price risk associated with its electricity generation,fuel purchases, emissions, and byproducts, as considered appropriate. ACommodity Exposure Management Plan is prepared and approved annually, whichoutlines the intended hedging strategies associated with the Corporation’sgeneration assets and related commodity price risks. Controls also includerestrictions on authorized instruments, management reviews on individualportfolios, and approval of asset transactions that could add potentialvolatility to the Corporation’s reported net earnings.

 

In addition, certain electricity sale contracts do notqualify as NPNS contracts. These contracts are designated as all-in-one hedgesand result in a net asset or liability position on the Consolidated BalanceSheets. Upon physical delivery of the commodity, TransAlta receives a grosssettlement at the contracted price. Upon receipt of payment, the related netrisk management asset or liability is eliminated. If an all-in-one hedgecontract cannot be settled by physical delivery of the underlying commodity, itwill be settled financially.

 

TransAlta has entered into various contracts with otherparties whereby the other parties have agreed to pay a fixed price forelectricity to TransAlta based on the average monthly Alberta Power Poolprices. While the contracts do not create any obligation for the physicaldelivery of electricity to other parties, the Corporation believes it hassufficient electrical generation available to satisfy these contracts.

 

Changes in market prices associated with cash flow hedges donot affect net earnings in the period in which the price change occurs.Instead, changes in fair value are deferred until settlement through OCI, atwhich time the net gain or loss resulting from the combination of the hedginginstrument and hedged item affects net earnings.

 

VaR at Dec. 31, 2009 associated with the Corporation’scommodity derivative instruments used in generation hedging activities was $45million (2008–$86 million).

 

The Corporation’s policy on asset-backed transactions is toseek NPNS contract status or hedge accounting treatment. For positions andeconomic hedges that do not meet hedge accounting requirements or short-termoptimization transactions such as buybacks entered into to offset existinghedge positions, these transactions are marked to the market value with changesin market prices associated with these transactions affecting net earnings inthe period in which the price change occurs. VaR at Dec. 31, 2009associated with the Corporation’s commodity derivative instruments used in thegeneration business, but which are not designated as hedges, was nil (2008 –nil).

 

**b.****   ****Interest Rate Risk**

 

Interest rate risk arises as the fair value or future cashflows of a financial instrument can fluctuate because of changes in marketinterest rates. Changes in interest rates can impact the Corporation’sborrowing costs and the capacity revenues received from Power PurchaseArrangements (“PPAs”). Changes in the cost of capital may also affect thefeasibility of new growth initiatives.

 

The possible effect on net earnings and OCI for the yearsended Dec. 31, 2009, 2008, and 2007, due to changes in market interestrates affecting the Corporation’s floating rate debt, interest-bearing assets,and held for trading and hedging interest rate derivatives outstanding at thebalance sheet date, is outlined below. The sensitivity analysis has beenprepared using management’s assessment that a 50 basis point increase ordecrease is the most reasonably possible change in market interest rates overthe next quarter and is consistent with a +/– one standard deviation move fromthe mean.

 
| **Year ended Dec. 31** | ** ** | **2009**            | ** ** | ** **          | **2008**   | ** **          | ** ** | **2007**            | ** ** | ** **          |
|-----------------------------|------------|---------------------|------------|---------------------|------------|---------------------|------------|---------------------|------------|---------------------|
| ** **                  | ** ** | **Net earnings**    | ** ** | ** **          | ** ** | **Net earnings**    | ** ** | ** **          | ** ** | **Net earnings**    | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **increase****(1)** | ** ** | **OCI loss****(1)** | ** ** | **increase****(1)** | ** ** | **OCI loss****(1)** | ** ** | **increase****(1)** | ** ** | **OCI loss****(1)** | ** ** |
| **50 basis point  change**  | ** ** | **5**               | ** ** | **(10**             | **)**      | 2                   |       | –              |       | 4                   |   | – |   |

 

*1  This calculation assumes adecrease in market interest rates. An increase would have the opposite effect.*

 

 
| 22  |  TransAlta Corporation

 

  |
|------------------------------------------------------------------|

 

----

 

**c.****   ****Currency Rate Risk**

 

The Corporation has exposure to various currencies, such asthe Euro, and the U. S., and Australian dollars, as a result of investments andoperations in foreign jurisdictions, the net earnings from those operations,and the acquisition of equipment and services from foreign suppliers.

 

The foreign currency risk sensitivities outlined below arelimited to the risks that arise on financial instruments denominated incurrencies other than the functional currency.

 

The possible effect on net earnings and OCI for the yearsended Dec, 31, 2009, 2008, and 2007, due to changes in the exchange ratesassociated with financial instruments outstanding at the balance sheet date, isoutlined below. The sensitivity analysis has been prepared using management’sassessment that a five cent increase or decrease in these currencies relative tothe Canadian dollar is a reasonable potential change over the next quarter andis consistent with a +/- one standard deviation move from the mean.

 
| **Year ended Dec. 31** | ** ** | **2009**            | ** ** | ** **             | **2008**   | ** **          | ** ** | **2007**               | ** ** | ** **          |
|-----------------------------|------------|---------------------|------------|------------------------|------------|---------------------|------------|------------------------|------------|---------------------|
| ** **                  | ** ** | **Net earnings**    | ** ** | ** **             | ** ** | **Net earnings**    | ** ** | ** **             | ** ** | **Net earnings**    | ** ** | ** ** | ** ** |
| **Currency**                | ** ** | **decrease****(1)** | ** ** | **OCI gain****(1, 2)** | ** ** | **decrease****(1)** | ** ** | **OCI gain****(1, 2)** | ** ** | **decrease****(1)** | ** ** | **OCI gain****(1, 2)** | ** ** |
| U.S.                        | ** ** | 4                   | ** ** | **2**                  |       | 4                   |       | 2                      |       | –              |   | 4 |   |
| AUD                         | ** ** | **1**               | ** ** | **–**             |       | 2                   |       | –                 |       | 1                   |   | – |   |
| Euro                        | ** ** | –              | ** ** | **–**             |       | –              |       | 3                      |       | 1                   |   | 2 |   |
| **Total**                   | ** ** | 5                   | ** ** | **2**                  |       | 6                   |       | 5                      |       | 2                   |   | 6 |   |

 

*1** **These calculations assume an increase in the value of these currenciesrelative to the Canadian dollar. A decrease would have the opposite effect.*

*2** **The foreign exchange impact related to financial instruments used asthe hedging instruments in the net investment hedges have been excluded.*

 

**II.    Credit Risk**

 

Credit risk is the risk that customers or counterpartieswill cause a financial loss for the Corporation by failing to discharge theirobligations, and the risk to the Corporation associated with changes increditworthiness of entities with which commercial exposures exist. TheCorporation actively manages its exposure to credit risk by assessing theability of counterparties to fulfill their obligations under the relatedcontracts prior to entering into such contracts. The Corporation makes detailedassessments of the credit quality of all counterparties and, where appropriate,obtains corporate guarantees, cash collateral, and/or letters of credit tosupport the ultimate collection of these receivables. For commodity trading andorigination, the Corporation sets strict credit limits for each counterpartyand monitors exposures on a daily basis. TransAlta uses standard agreementsthat allow for the netting of exposures and often include margining provisions.If credit limits are exceeded, TransAlta will request collateral from thecounterparty or halt trading activities with the counterparty. TransAlta isexposed to minimal credit risk for Alberta Generation PPAs as receivables aresubstantially all secured by letters of credit.

 

At Dec. 31, 2009, TransAlta had one counterparty whosenet settlement position accounted for greater than 10 per cent of the totaltrade receivables outstanding at year-end.

 

The Corporation’s maximum exposure to credit risk atDec. 31, 2009, without taking into account collateral held, is representedby the current carrying amounts of accounts receivable and risk managementassets as per the Consolidated Balance Sheets. Letters of credit and cash arethe primary types of collateral held as security related to these amounts. Themaximum credit exposure to any one customer for commodity trading operationsand hedging, excluding the California market receivables and including the fairvalue of open trading positions, net of any collateral held, at Dec. 31,2009 was $63 million (2008 - $105 million).

 

The Corporation uses external credit ratings, as well asinternal ratings in circumstances where external ratings are not available, toestablish credit limits for counterparties. The following table outlines thedistribution, by credit rating, of financial assets as at Dec. 31, 2009:

 
| ** **             | ** ** | **Investment** | ** ** | **Non-investment** | ** ** | ** ** | ** ** |
|------------------------|------------|----------------|------------|--------------------|------------|------------|------------|
| **Per cent (%)**       | ** ** | **grade**      | ** ** | **grade**          | ** ** | **Total**  | ** ** |
| Accounts receivable    |       | 92             |       | 8                  | ** ** | **100**    | ** ** |
| Risk management assets |       | 100            |       | –             | ** ** | **100**    | ** ** |

 

The Corporation utilizes an allowancefor doubtful accounts to record potential credit losses associated with tradereceivables. A reconciliation of the account for the year is presented in Note8.

 

At Dec. 31, 2009, theCorporation did not have any significant past due trade receivables.

 

**III.  Liquidity Risk**

 

Liquidity risk relates to the Corporation’s ability toaccess capital to be used in proprietary trading activities, commodity hedging,capital projects, debt refinancing, and general corporate purposes. Investmentgrade ratings support these activities and provide better access to capitalmarkets through commodity and credit cycles. TransAlta is focused onmaintaining a strong balance sheet and stable investment grade credit ratings.

 

Counterparties enter into certain electricity and naturalgas purchase and sale contracts for the purposes of asset-backed sales andproprietary trading. The terms and conditions of these contracts may requirethe counterparties to provide collateral when the fair value of the obligationpursuant to these contracts is in excess of any credit limits granted.Downgrades in creditworthiness by certain credit rating agencies may decreasethe credit limits granted and accordingly increase the amount of collateralthat may have to be provided.

 

TransAlta manages liquidity risk by monitoring liquidity ontrading positions, preparing and revising longer-term financing plans toreflect changes in business plans and the market availability of capital,reporting liquidity risk exposure for proprietary trading activities on aregular basis to the Exposure Management Committee, senior management, andBoard of Directors, and maintaining investment grade credit ratings.

 

 
| Notes to  Consolidated Financial Statements  |  23

  |
|--------------------------------------------------------------------------------|

 

----

 

A maturity analysis for theCorporation’s financial liabilities is as follows:

 
| ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2015 and**   | ** ** | ** ** | ** ** |
|---------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|----------------|------------|------------|------------|
| ** **                                              | ** ** | **2010**   | ** ** | **2011**   | ** ** | **2012**   | ** ** | **2013**   | ** ** | **2014**   | ** ** | **thereafter** | ** ** | **Total**  | ** ** |
| Accounts payable and accrued  liabilities               |       | 521        |       | —     |       | —     |       | —     |       | —     |       | —         |       | 521        |       |
| Collateral received                                     |       | 86         |       | —     |       | —     |       | —     |       | —     |       | —         |       | 86         |       |
| Debt(1)                                                 |       | 29         |       | 251        |       | 1,090      |       | 659        |       | 231        |       | 2,203          |       | 4,463      |       |
| Energy Trading risk management  (assets) liabilities(2) |       | (112       | )          | (103       | )          | (76        | )          | (12        | )          | 1          |       | 31             |       | (271       | )          |
| Other risk management liabilities  (assets)(2)          |       | 15         |       | (7         | )          | —     |       | —     |       | —     |       | 18             |       | 26         |       |
| Interest on long-term debt                              |       | 224        |       | 203        |       | 183        |       | 170        |       | 142        |       | 600            |       | 1,522      |       |
| **Total**                                               | ** ** | **763**    | ** ** | **344**    | ** ** | **1,197**  | ** ** | **817**    | ** ** | **374**    | ** ** | **2,852**      | ** ** | **6,347**  | ** ** |

 

*1** **Excludes impact of hedge accounting and includes credit facilities thatare currently scheduled to mature in 2012 and 2013.*

*2** **Net risk management assets and liabilities (Note 9).*

 

**E.    Financial InstrumentsProvided as Collateral**

 

At Dec. 31, 2009, $45 million (2008 — $63 million) offinancial assets, consisting of cash and accounts receivable, related to theCorporation’s proportionate share of CE Gen have been pledged as collateral forcertain CE Gen debt. Should any defaults occur the debt-holders would havefirst claim on these assets.

 

At Dec. 31, 2009, the Corporation provided $27 million(2008 — $37 million) in cash as collateral to regulated clearing agents assecurity for commodity trading activities. These funds are held in segregatedaccounts by the clearing agents.

 

**F.    Financial Assets Held asCollateral**

 

At Dec. 31, 2009, the Corporation received $86 million(2008 — $24 million) in cash as collateral associated with counterparty obligations.Under the terms of the contract, the Corporation may be obligated to payinterest on the outstanding balance and to return the principal when thecounterparty has met its contractual obligations, or when the amount of theobligation declines as a result of changes in market value. Interest payable tothe counterparties on the collateral received is calculated in accordance witheach contract.

 

**G.    Gains and Losses onFinancial Instruments**

 

The Corporation’s COD segment utilizes a variety of derivativesin its proprietary trading activities, including certain commodity hedgingactivities that do not qualify for hedge accounting or where a choice was madenot to apply hedge accounting as well as other contracting activities, and therelated assets and liabilities are classified as held for trading. The netrealized and unrealized gains or losses from changes in the fair value ofderivatives are reported as revenue in the period the change occurs. For theyear ended Dec. 31, 2009, the COD segment recognized a net unrealized lossof $6 million (2008 – $2 million net unrealized loss, 2007 – $3 million netunrealized loss).

 

The Corporation’s Generation segment utilizes a variety ofderivatives in its operations, including certain commodity hedges that do notqualify for hedge accounting or where a choice was made not to apply hedgeaccounting as well as other contracting activities, and the related assets andliabilities are classified as held for trading. The net unrealized gains orlosses from changes in the fair value of derivatives are reported as revenue inthe period the change occurs. For the year ended Dec. 31, 2009, theGeneration segment recognized a net unrealized gain of $3 million (2008 – $12million net unrealized loss, 2007 – $30 million net unrealized loss).

 

Net interest expense as reported on the ConsolidatedStatements of Earnings includes interest income and expense, respectively, onthe Corporation’s interest-bearing financial assets, primarily cash, and itsinterest-bearing financial liabilities, primarily long-term debt. Interestexpense is calculated using the effective interest method *(Note 17)*.Interest rate derivatives that are not designated as hedges are classified asheld for trading and are marked-to-market each reporting period with the netgain or loss recorded in net interest expense.

 

Foreign exchange derivatives that are not designated ashedges are also classified as held for trading, with the net foreign exchangegain or loss on Energy Trading derivatives recorded in revenue, and the netgain or loss on other foreign exchange derivatives recorded in foreign exchangegain (loss) on the Consolidated Statements of Earnings.

 

Other derivatives that are not designated as hedges are alsoclassified as held for trading, with the net gain or loss recorded inoperations, maintenance, and administration expense. Other derivatives consistof a total return swap that fixes a portion of the settlement cost of certainemployee compensation and deferred share unit programs. The total return swapis cash settled every quarter.

 

The table below outlines the net realized and unrealizedgains and losses included in net earnings that are associated with derivativesnot designated as hedges:

 
| **Year ended Dec. 31**                  | ** ** | **2009**   | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Foreign exchange derivatives  (losses) gains | ** ** | **(1**     | **)**      | 11       |       | 4        |       |
| Interest rate derivatives losses             | ** ** | **–** |       | –   |       | 2        |       |
| Other derivatives gains                      | ** ** | **–** |       | 1        |       | –   |       |

 

 
| 24 |  TransAlta  Corporation

 

  |
|-------------------------------------------------------------|

----

** **

***8.     ACCOUNTS RECEIVABLE***

 
| **As at Dec. 31**                                            | ** ** | **2009** | ** ** | **2008** | ** ** |
|-------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Gross accounts receivable                                         | ** ** | **470**  |       | 562      |       |
| Allowance for doubtful accounts *(Note 28)*                       | ** ** | **(49**  | **)**      | (57      | )          |
| **Net accounts  receivable**                                      | ** ** | **421**  |       | 505      |       |
|                                                              |       |     |       |     |       |
| The change in allowance for  doubtful accounts is outlined below: |       |     |       |     |       |
|                                                              |       |     |       |     |       |
| Balance, Dec. 31, 2008                                       |       |     |       | 57       |       |
| Change in foreign exchange rates                                  |       |     |       | (8       | )          |
| **Balance,  Dec. 31, 2009**                                  |       |     | ** ** | **49**   | ** ** |

 

 

***9.     RISK MANAGEMENT ASSETS ANDLIABILITIES***

 

Risk management assets and liabilities are comprised of twomajor types: (1) those that are used in the COD and Generation segments inrelation to trading activities and certain contracting activities (“EnergyTrading”) and (2) those used in hedging non-Energy Trading transactions,such as debt, and the net investment in self-sustaining foreign subsidiaries(“other risk management assets and liabilities”).

 

Theoverall balances reported in risk management assets and liabilities are shownbelow:

 
| **As at Dec. 31**                        | ** ** | ** **  | ** ** | **2009**   | ** ** | ** ** | ** ** | ** **  | ** ** | **2008**   | ** ** | ** ** | ** ** |
|-----------------------------------------------|------------|-------------|------------|------------|------------|------------|------------|-------------|------------|------------|------------|------------|------------|
| ** **                                    | ** ** | **Energy**  | ** ** | ** ** | ** ** | ** ** | ** ** | **Energy**  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Balance Sheet–Totals**                 | ** ** | **Trading** | ** ** | **Other**  | ** ** | **Total**  | ** ** | **Trading** | ** ** | **Other**  | ** ** | **Total**  | ** ** |
| **Risk management  assets**                   |       |        |       |       |       |       |       |        |       |       |       |       |       |
| Current                                       | ** ** | **144**     | ** ** | **–** | ** ** | **144**    |       | 176         |       | 24         |       | 200        |       |
| Long-term                                     | ** ** | **207**     | ** ** | **17**     | ** ** | **224**    |       | 187         |       | 34         |       | 221        |       |
| **Risk management  liabilities**              |       |        |       |       |       |       |       |        |       |       |       |       |       |
| Current                                       | ** ** | **30**      | ** ** | **15**     | ** ** | **45**     |       | 142         |       | 6          |       | 148        |       |
| Long-term                                     | ** ** | **50**      | ** ** | **28**     | ** ** | **78**     |       | 57          |       | 45         |       | 102        |       |
| **Net risk  management assets (liabilities)** | ** ** | **271**     | ** ** | **(26**    | **)**      | **245**    |       | 164         |       | 7          |       | 171        |       |

 

**EnergyTrading**

The values of risk management assetsand liabilities for Energy Trading are included on the Consolidated BalanceSheets as follows:

 
| **As at Dec. 31**               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2009**       | ** ** | ** ** | ** ** | **2008**  | ** ** |
|--------------------------------------|------------|------------|------------|------------|------------|------------|------------|----------------|------------|------------|------------|-----------|------------|
| **Balance Sheet–EnergyTrading** | ** ** | ** ** | ** ** | ** ** | ** ** | **Hedges** | ** ** | **Non-hedges** | ** ** | **Total**  | ** ** | **Total** | ** ** |
| **Risk management  assets**          |       |       |       |       |       |       |       |           |       |       |       |      |       |
| Current                              | ** ** |       | ** ** |       | ** ** | **130**    | ** ** | **14**         | ** ** | **144**    |       | 176       | ** ** |
| Long-term                            | ** ** |       | ** ** |       | ** ** | **202**    | ** ** | **5**          | ** ** | **207**    |       | 187       | ** ** |
| **Risk management  liabilities**     |       |       |       |       |       |       |       |           |       |       |       |      |       |
| Current                              | ** ** |       | ** ** |       | ** ** | **15**     | ** ** | **15**         | ** ** | **30**     |       | 142       | ** ** |
| Long-term                            | ** ** |       | ** ** |       | ** ** | **47**     | ** ** | **3**          | ** ** | **50**     |       | 57        | ** ** |
| **Net risk  management assets**      | ** ** |       | ** ** |       | ** ** | **270**    | ** ** | **1**          | ** ** | **271**    |       | 164       | ** ** |

 

The following table illustrates the disclosure on themovements in the fair value of the Corporation’s Energy Trading net riskmanagement assets and liabilities separately by source of valuation during theyear ended Dec. 31, 2009:

 
| ** **                                                                                                                | ** ** | **Hedges**  | ** ** | **Non-hedges** | ** ** | **Total**     | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|----------------|------------|---------------|------------|
| ** **                                                                                                                | ** ** | **Level I** | ** ** | **Level II**   | ** ** | **Level III** | ** ** | **Level I** | ** ** | **Level II** | ** ** | **Level III** | ** ** | **Level I** | ** ** | **Level II** | ** ** | **Level III** | ** ** |
| Net risk management assets at  Dec. 31, 2008                                                                         |       | –      |       | 163            |       | –        |       | 1 |   | – |   | – |   | 1 |   | 163 |   | – |   |
| Changes attributable to:                                                                                                  |       |        |       |           |       |          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Acquisition of Canadian Hydro *(Note 24)*                                                                                 |       | –      |       | –         |       | (31           | )          | – |   | – |   | – |   | – |   | – |   | (31 | ) |
| Commodity price changes                                                                                                   |       | –      |       | 147            |       | –        |       | – |   | (2 | ) | – |   | – |   | 145 |   | – |   |
| New contracts entered                                                                                                     |       | –      |       | 37             |       | (1            | )          | – |   | – |   | 1 |   | – |   | 37 |   | – |   |
| Contracts settled                                                                                                         |       | –      |       | (20            | )          | –        |       | (1 | ) | 2 |   | – |   | (1 | ) | (18 | ) | – |   |
| Change in foreign exchange rates                                                                                          |       | –      |       | (25            | )          | –        |       | – |   | – |   | – |   | – |   | (25 | ) | – |   |
| Transfers in/out of Level III                                                                                             |       | –      |       | (5             | )          | 5             |       | – |   | – |   | – |   | – |   | (5 | ) | 5 |   |
| **Net risk  management assets (liabilities)  at Dec. 31, 2009**                                                      | ** ** | **–**  | ** ** | **297**        | ** ** | **(27**       | **)**      | **–** | ** ** | **–** | ** ** | **1** | ** ** | **–** | ** ** | **297** | ** ** | **(26** | **)** |
| **Additional Level  III gain(loss) information:**                                                                         |       |        |       |           |       |          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Change in fair value included in  OCI                                                                                     |       |        |       |           |       | 4             |       |   |   |   |   | – |   |   |   |   |   | 4 |   |
| Unrealized gain(loss) included in  earnings before income taxes relating to those net assets   held at Dec. 31, 2009 |       |        |       |           |       | –        |       |   |   |   |   | 1 |   |   |   |   |   | 1 |   |

 

 

Notes toConsolidated Financial Statements  |  25

 

----

 

To the extent applicable, changes in net risk managementassets and liabilities for non-hedge positions are reflected within the grossmargin of both the COD and the Generation business segments.

 

The anticipated timing of settlementof the above contracts over each of the next five calendar years and thereafteris as follows:

 
| ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2015 and**   | ** ** | ** ** | ** ** |
|-------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|----------------|------------|------------|------------|
| ** **                          | ** ** | **2010**   | ** ** | **2011**   | ** ** | **2012**   | ** ** | **2013**   | ** ** | **2014**   | ** ** | **thereafter** | ** ** | **Total**  | ** ** |
| **Hedges**                          | Level I    |       | –     |       | –     |       | –     |       | –     |       | –     |           | –     |       | –     |   |
|                                | Level II   |       | 110        |       | 99         |       | 76         |       | 13         |       | (1         | )              | –     |       | 297        |   |
|                                | Level III  |       | 3          |       | 3          |       | (1         | )          | (1         | )          | –     |           | (31        | )          | (27        | ) |
| **Non-hedges**                      | Level I    |       | –     |       | –     |       | –     |       | –     |       | –     |           | –     |       | –     |   |
|                                | Level II   |       | (2         | )          | 1          |       | 1          |       | –     |       | –     |           | –     |       | –     |   |
|                                | Level III  |       | 1          |       | –     |       | –     |       | –     |       | –     |           | –     |       | 1          |   |
| **Total**                           | Level I    |       | –     |       | –     |       | –     |       | –     |       | –     |           | –     |       | –     |   |
|                                | Level II   |       | 108        |       | 100        |       | 77         |       | 13         |       | (1         | )              | –     |       | 297        |   |
|                                | Level III  |       | 4          |       | 3          |       | (1         | )          | (1         | )          | –     |           | (31        | )          | (26        | ) |
| **Total net assets  (liabilities)** | ** ** | **112**    | ** ** | **103**    | ** ** | **76**     | ** ** | **12**     | ** ** | **(1**     | **)**      | **(31**        | **)**      | **271**    |       |

 

The Corporation’s outstanding Energy Trading derivativefinancial instruments at Dec. 31, 2009, were as follows:

 
| ** **                                                          | ** ** | **Electricity** | ** ** | **Natural gas** | ** ** | **Transmission** | ** ** | **Oil**       | ** ** |
|---------------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|------------------|------------|---------------|------------|
| **Units (000s)**                                                    | ** ** | **(MWh)**       | ** ** | **(GJ)**        | ** ** | **(MWh)**        | ** ** | **(gallons)** | ** ** |
| **Derivative  financial instruments designated as hedges**          |       |            |       |            |       |             |       |          |       |
| Notional Amounts                                                    |       |            |       |            |       |             |       |          |       |   |
| Purchases                                                           |       | –          |       | 360             |       | –           |       | 25,074        |       |
| Sales                                                               |       | 175,756         |       | 2,163           |       | –           |       | –        |       |
| **Derivative  financial instruments held for trading (non-hedges)** |       |            |       |            |       |             |       |          |       |
| Notional Amounts                                                    |       |            |       |            |       |             |       |          |       |   |
| Purchases                                                           |       | 14,844          |       | 309,764         |       | 4,852            |       | –        |       |
| Sales                                                               |       | 14,107          |       | 323,793         |       | –           |       | –        |       |

 

**Other Risk Management Assets and Liabilities**

The risk management assets andliabilities related to other non-Energy Trading are as follows:

 
| **As at Dec. 31**                        | ** ** | ** ** | ** ** | **2009**       | ** ** | ** ** | ** ** | **2008**  | ** ** |
|-----------------------------------------------|------------|------------|------------|----------------|------------|------------|------------|-----------|------------|
| **Balance Sheet–Other**                  | ** ** | **Hedges** | ** ** | **Non-hedges** | ** ** | **Total**  | ** ** | **Total** | ** ** |
| **Risk management  assets**                   |       |       |       |           |       |       |       |      |       |
| Current                                       | ** ** | **–** |       | **–**     | ** ** | **–** |       | 24        | ** ** |
| Long-term                                     | ** ** | **17**     |       | **–**     | ** ** | **17**     |       | 34        | ** ** |
| **Risk management  liabilities**              |       |       |       |           |       |       |       |      |       |
| Current                                       | ** ** | **13**     |       | **2**          | ** ** | **15**     |       | 6         | ** ** |
| Long-term                                     | ** ** | **28**     |       | **–**     | ** ** | **28**     |       | 45        | ** ** |
| **Net risk  management (liabilities) assets** | ** ** | **(24**    | **)**      | **(2**         | **)**      | **(26**    | **)**      | 7         |       |

 

The following table illustrates the disclosure on themovements in the fair value of the Corporation’s other net risk managementassets and liabilities separately by source of valuation during the year endedDec. 31, 2009:

 
| ** **                                                      | ** ** | **Hedges** | ** ** | **Non-hedges** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------------|------------|------------|------------|----------------|------------|-----------|------------|
| Net risk management assets  (liabilities) at Dec. 31, 2008 |       | 8          |       | (1             | )          | 7         |       |
| Changes in net asset value attributable  to:                    |       |       |       |           |       |      |       |
| Market price changes                                            |       | (20        | )          | –         |       | (20       | )          |
| New contracts entered                                           |       | (38        | )          | (2             | )          | (40       | )          |
| Contracts settled                                               |       | 26         |       | 1              |       | 27        |       |
| **Net risk  management liabilities at Dec. 31, 2009**      | ** ** | **(24**    | **)**      | **(2**         | **)**      | **(26**   | **)**      |

 

Changes in non-Energy Trading risk management assets and liabilitiesfor hedge positions are reflected within net earnings when such transactionshave settled during the period or ineffectiveness exists in the hedgingrelationship. So long as these hedges remain effective and qualify for hedgeaccounting, the change in value of existing and new contracts will be deferredin OCI until settlement of the instrument or reduction in the net investment inself-sustaining foreign operations.

 

 

26  |  TransAltaCorporation

----

 

The anticipated timing of settlementof the above contracts over each of the next five calendar years and thereafteris as follows:

 
| ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2015 and**   | ** ** | ** ** | ** ** |
|-------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|----------------|------------|------------|------------|
| ** **                          | ** ** | **2010**   | ** ** | **2011**   | ** ** | **2012**   | ** ** | **2013**   | ** ** | **2014**   | ** ** | **thereafter** | ** ** | **Total**  | ** ** |
| Hedges                              |       | (13        | )          | 7          |       | –     |       | –     |       | –     |       | (18            | )          | (24        | )          |
| Non-hedges                          |       | (2         | )          | –     |       | –     |       | –     |       | –     |       | –         |       | (2         | )          |
| **Total net  (liabilities) assets** |       | (15        | )          | 7          |       | –     |       | –     |       | –     |       | (18            | )          | (26        | )          |

 

Additional information related toother risk management assets and liabilities designated as hedges andnon-hedges are outlined below:

 

**A.    Hedges**

 

I.      **Hedgesof Foreign Operations**

U.S. dollar denominated long-term debt with a face value ofU.S.$1,100 million (2008–U.S.$1,100 million) has been designated as a part ofthe hedge of TransAlta’s net investment in self-sustaining foreign operations.

 

The Corporation has also hedged a portion of its netinvestment in self-sustaining foreign operations with cross-currency interestrate swaps and foreign currency forward sales (purchase) contracts as shownbelow:

 

a.       Cross-Currency Interest Rate Swap

Outstanding liability resulting from cross-currency interestrate swap is as follows:

 
| **As at Dec. 31** | ** ** | **2009**     | ** ** | **2008**            | ** ** |
|----------------------------------|------------|--------------|------------|---------------------|------------|
| ** **                       | ** ** | **Notional** | ** ** | **Fair value** | ** ** | ** ** | ** ** | **Notional** | ** ** | **Fair value** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | **amount**   | ** ** | **liability**       | ** ** | **Maturity** | ** ** | **amount** | ** ** | **asset** | ** ** | **Maturity** | ** ** |
|                             | ** ** | **AUD34**    | ** ** | **(2**              | **)**      | **2010** |   | AUD34 |   | 2 |   | 2009 |   |

 

b.       Foreign Currency Contracts

Outstanding foreign currency forward sales (purchase)contracts are as follows:

 
| **As at Dec. 31** | ** ** | **2009**     | ** ** | **2008**       | ** ** |
|------------------------|------------|--------------|------------|----------------|------------|
| ** **             | ** ** | **Notional** | ** ** | **Fair value** | ** ** | ** ** | ** ** | **Notional** | ** ** | **Fair value** | ** ** | ** ** | ** ** |
| ** **             | ** ** | **amount**   | ** ** | **liability**  | ** ** | **Maturity** | ** ** | **amount** | ** ** | **liability** | ** ** | **Maturity** | ** ** |
|                   | ** ** | **AUD120**   | ** ** | **(2**         | **)**      | **2010** |   | AUD108 |   | (1 | ) | 2009 |   |
|                   | ** ** | **U.S.182**  | ** ** | **(1**         | **)**      | **2010** |   | U.S.(107) |   | (1 | ) | 2009 |   |

 

**II.**       **Hedges of Future Foreign Currency Obligations**

 

a.       Foreign Exchange Forward Contract

TransAlta’sfuture foreign currency obligations are primarily related to foreigndenominated capital asset purchases. The Corporation has hedged a portion ofthese obligations through forward purchase contracts as follows:

 
| **As at Dec. 31** | ** ** | **2009**   | ** ** | **2008**      | ** ** |
|------------------------|------------|------------|------------|---------------|------------|
| ** **             | ** ** | **Amount** | ** ** | **Amount**    | ** ** | **Fair value** | ** ** | ** ** | ** ** | **Amount** | ** ** | **Amount** | ** ** | **Fair value** | ** ** | ** ** | ** ** |
| ** **             | ** ** | **sold**   | ** ** | **purchased** | ** ** | **liability** | ** ** | **Maturity** | ** ** | **sold** | ** ** | **purchased** | ** ** | **asset** | ** ** | **Maturity** | ** ** |
|                   | ** ** | **91**     | ** ** | **U.S.78**    | ** ** | **(8** | **)** | **2010** |   | 51 |   | U.S.48 |   | 8 |   | 2009–2010 |   |
|                   | ** ** | **U.S.14** | ** ** | **15**        | ** ** | **–** | ** ** | **2010** |   | – |   | – |   | – |   | – |   |
|                   | ** ** | **AUD4**   | ** ** | **U.S.3**     | ** ** | **–** | ** ** | **2010** |   | – |   | – |   | – |   | – |   |
|                   | ** ** | **–** | ** ** | **–**    | ** ** | **–** | ** ** | **–** |   | 84 |   | EUR57 |   | 13 |   | 2009 |   |

 

b.Cross-Currency Interest Rate Swap

Outstanding liability resulting from cross-currency interestrate swap is as follows:

 
| **As at Dec. 31** | ** ** | ** **    | ** ** | **2009**       | ** ** | ** **   | ** ** | ** **   | ** ** | **2008**       | ** ** | ** **   | ** ** |
|------------------------|------------|---------------|------------|----------------|------------|--------------|------------|--------------|------------|----------------|------------|--------------|------------|
| ** **             | ** ** | **Notional**  | ** ** | **Fair value** | ** ** | ** **   | ** ** | **Notional** | ** ** | **Fair value** | ** ** | ** **   | ** ** |
| ** **             | ** ** | **amount**    | ** ** | **liability**  | ** ** | **Maturity** | ** ** | **amount**   | ** ** | **asset**      | ** ** | **Maturity** | ** ** |
|                   | ** ** | **U.S.(500)** | ** ** | **(16**        | **)**      | **2015**     |       | –       |       | –         |       | –       |       |

 

**III.Interest Rate Risk Management**

The Corporation has converted a portion of its fixedinterest rate debt, with rates ranging from 5.75 per cent to 6.65 per cent, tofloating rate debt through interest rate swaps as shown below:

 
| **As at Dec. 31** | ** ** | ** **       | ** ** | **2009**              | ** ** | ** **   | ** ** | ** **   | ** ** | **2008**       | ** ** | ** **   | ** ** |
|------------------------|------------|------------------|------------|-----------------------|------------|--------------|------------|--------------|------------|----------------|------------|--------------|------------|
| ** **             | ** ** | **Notional****** | ** ** | **Fair value**        | ** ** | ** **   | ** ** | **Notional** | ** ** | **Fair value** | ** ** | ** **   | ** ** |
| ** **             | ** ** | **amount**       | ** ** | **asset (liability)** | ** ** | **Maturity** | ** ** | **amount**   | ** ** | **asset**      | ** ** | **Maturity** | ** ** |
|                   | ** ** | **100**          | ** ** | ** ****7**       |       | **2011**     |       | 100          |       | 12             |       | 2011         | ** ** |
|                   | ** ** | **U.S.50**       | ** ** | ** ****(1**      | **)**      | **2013**     |       | –       |       | –         |       | –       | ** ** |
|                   | ** ** | **U.S.150**      | ** ** | ** ****7**       |       | **2018**     |       | U.S.100      |       | 21             |       | 2018         | ** ** |

 

 

Notes toConsolidated Financial Statements  |  27

----

 

Including the interest rate swaps above, 31 per cent of theCorporation’s debt is subject to floating interest rates as at Dec. 31,2009 (2008–24 per cent).

 

The Corporation also has an outstanding forward startinterest rate swap that converts floating rate debt into fixed rate debt. Thecommencement date for this swap is March 5, 2010, with fixed rates rangingfrom 3.5 per cent to 4.6 per cent, as shown below:

 
| **As at Dec. 31** | ** ** | ** **   | ** ** | **2009**       | ** ** | ** **   | ** ** | ** **   | ** ** | **2008**       | ** ** | ** **   | ** ** |
|------------------------|------------|--------------|------------|----------------|------------|--------------|------------|--------------|------------|----------------|------------|--------------|------------|
| ** **             | ** ** | **Notional** | ** ** | **Fair value** | ** ** | ** **   | ** ** | **Notional** | ** ** | **Fair value** | ** ** | ** **   | ** ** |
| ** **             | ** ** | **amount**   | ** ** | **liability**  | ** ** | **Maturity** | ** ** | **amount**   | ** ** | **liability**  | ** ** | **Maturity** | ** ** |
|                   | ** ** | **U.S.300**  | ** ** | **(8**         | **)**      | **2020**     |       | U.S.300      |       | (46            | )          | 2019         |       |

 

**B.Non-Hedges**

 

**I.Cross-Currency Interest Rate Swaps**

Cross-currency interest rate swaps are periodically enteredinto in order to limit the Corporation’s exposure to fluctuations in foreignexchange and interest rates. The (liability) asset resulting from anoutstanding cross-currency interest rate swap is as follows:

 
| **As at Dec. 31** | ** ** | ** **   | ** ** | **2009**       | ** ** | ** **   | ** ** | ** **   | ** ** | **2008**       | ** ** | ** **   | ** ** |
|------------------------|------------|--------------|------------|----------------|------------|--------------|------------|--------------|------------|----------------|------------|--------------|------------|
| ** **             | ** ** | **Notional** | ** ** | **Fair value** | ** ** | ** **   | ** ** | **Notional** | ** ** | **Fair value** | ** ** | ** **   | ** ** |
| ** **             | ** ** | **amount**   | ** ** | **liability**  | ** ** | **Maturity** | ** ** | **amount**   | ** ** | **asset**      | ** ** | **Maturity** | ** ** |
|                   | ** ** | **AUD13**    | ** ** | **(2**         | **)**      | **2010**     |       | AUD41        |       | 1              |       | 2009         |       |

 

**II.Foreign Currency Contracts**

The Corporation periodically enters into foreign exchangeforwards to hedge future foreign denominated revenues and expenses for whichhedge accounting is not pursued. These items are classified as held fortrading, and changes in the fair values associated with these transactions arerecognized in net earnings.

 

Outstanding notional amounts and fairvalues with these foreign currency forward sales (purchases) are as follows:

 
| **As at Dec. 31** | ** ** | ** **   | ** ** | **2009**       | ** ** | ** **   | ** ** | ** **   | ** ** | **2008**       | ** ** | ** **   | ** ** |
|------------------------|------------|--------------|------------|----------------|------------|--------------|------------|--------------|------------|----------------|------------|--------------|------------|
| ** **             | ** ** | **Notional** | ** ** | **Fair value** | ** ** | ** **   | ** ** | **Notional** | ** ** | **Fair value** | ** ** | ** **   | ** ** |
| ** **             | ** ** | **amount**   | ** ** | **liability**  | ** ** | **Maturity** | ** ** | **amount**   | ** ** | **liability**  | ** ** | **Maturity** | ** ** |
|                   | ** ** | **U.S.13**   | ** ** | **–**     | ** ** | **2010**     |       | U.S.90       |       | (2             | )          | 2009         |       |

 

**III.Total Return Swaps**

The Corporation also has certain compensation and deferredshare unit programs, the values of which depend on the common share price ofthe Corporation. The Corporation has fixed a portion of the settlement cost ofthese programs by entering into a total return swap for which hedge accountinghas not been pursued. The total return swap is cash settled every quarter basedupon the difference between the fixed price and the market price of the Corporation’scommon shares at the end of each quarter *(Note 7).*

 

**C.Contingent Features in Derivative Instruments**

 

Collateral is posted in the normal course of business basedon the Corporation’s senior unsecured credit rating as determined by certainmajor credit rating agencies. Certain of the Corporation’s derivativeinstruments contain financial assurance provisions that require collateral tobe posted only if a material adverse credit-related event occurs. If a materialadverse event resulted in the Corporation’s senior unsecured debt to fall belowinvestment grade, the counterparties to such derivative instruments couldrequest ongoing full collateralization.

 

As at Dec. 31, 2009 the Corporation had postedcollateral of $37 million in the form of letters of credit, on derivativeinstruments in a net liability position. If the credit-risk-contingent featuresincluded in certain derivative agreements were triggered, based upon the valueof derivatives as at Dec. 31, 2009, the Corporation would be required topost an additional $29 million of collateral to its counterparties.

 

 

***10. HEDGING ACTIVITIES***

 

Derivative and non-derivative financial instruments are usedto manage exposures to interest, commodity prices, currency, credit, and othermarket risks. When derivatives are used to manage the Corporation’s ownexposures, the Corporation determines for each derivative whether hedgeaccounting can be applied. Where hedge accounting can be applied and theCorporation chooses to seek hedge accounting treatment, a hedge relationship isdesignated as a fair value hedge, a cash flow hedge, or a hedge of foreigncurrency exposure of a net investment in a self-sustaining foreign operation.The derivative must be highly effective in accomplishing the objective ofoffsetting either changes in the fair value or cash flows attributable to thehedged risk both at inception and over the life of the hedge. If it isdetermined that the derivative is not highly effective as a hedge, hedgeaccounting will be discontinued prospectively.

 

 

28  |  TransAltaCorporation

----

 

**A.Fair Value Hedges**

 

Interest rate swaps are used to hedge exposures to thechanges in a fixed interest rate instrument’s fair value caused by changes ininterest rates.

 

No ineffective portion of fair value hedges was recorded in2009, 2008, or 2007.

 

The following table summarizes the impact and location offair value hedges on the Consolidated Statements of Earnings:

 
| **Year ended Dec. 31**   | ** ** | ** **                              | ** ** | **2009**   | ** ** | **2008** | ** ** | **2007** | ** ** |
|-------------------------------|------------|-----------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| **Instruments in fair value** | ** ** | **Location of gain (loss) on the**      |       |       |       |     |       |     |       |
| **hedging relationships**     | ** ** | **Consolidated Statements of Earnings** |       |       |       |     |       |     |       |
| Interest rate contracts       |       | Net  interest expense                   | ** ** | **20**     |       | (26      | )          | (34      | )          |
| Long-term debt                |       | Net  interest expense                   | ** ** | **(20**    | **)**      | 26       |       | 34       |       |
| **Net earnings  impact**      | ** ** |                                    |       | **–** |       | –   |       | –   |       |

 

**B.Cash Flow Hedges**

 

Forwardsale and purchase contracts, as well as foreign exchange contracts, are used tohedge the variability in future cash flows. All components of each derivative’schange in fair value have been included in the assessment of cash flow hedgeeffectiveness.

 

Forthe year ended Dec. 31, 2009, a pre-tax unrealized gain of $400 million(2008–gain of $327 million, 2007–loss of $57 million) was recorded in OCI forthe effective portion of the cash flow hedges, and a pre-tax total of $204million (2008–$91 million, 2007–$25 million) related to amounts previouslyrelated to OCI was reclassified to net earnings. For the year endedDec. 31, 2009, a realized loss of $2 million (2008–nil, 2007–nil), wasrecognized in net earnings for ineffectiveness.

 

Overthe next 12 months, the Corporation estimates that $77 million (2008–$17million after-tax losses) of after-tax gains will be reclassified from AOCI tonet earnings. These estimates assume constant gas and power prices, interestrates, and exchange rates over time; however, the actual amounts that will bereclassified will vary based on changes in these factors. In addition, it isthe Corporation’s intent to settle a substantial portion of the cash flowhedges by physical delivery of the underlying commodity, resulting in grosssettlement at the contract price. These contracts are designated as all-in-onehedges and are required to be accounted for as cash flow hedges.

 

Thefollowing tables summarize the impact of cash flow hedges on the ConsolidatedStatements of Comprehensive Income, Consolidated Statements of Earnings, andthe Consolidated Balance Sheets:

 
| **Year ended Dec. 31, 2009** | ** ** | ** **                 | ** ** | ** **                       | ** ** | ** **                 | ** ** | ** **           | ** ** | ** **       | ** ** |
|-----------------------------------|------------|----------------------------|------------|----------------------------------|------------|----------------------------|------------|----------------------|------------|------------------|------------|
| ** **                        | ** ** | **Effective portion**      | ** ** | ** **                       | ** ** | **Ineffective portion**    | ** ** |
| **Derivatives in**                | ** ** | **Pre-tax gain**           | ** ** | **Location of gain**             | ** ** | **Pre-tax gain**           | ** ** | **Location of**      | ** ** | **Pre-tax loss** | ** ** |
| **cash flow hedging**             | ** ** | **(loss) recognized**      | ** ** | **(loss) reclassified**          | ** ** | **(loss) reclassified**    | ** ** | **loss recognized**  | ** ** | **recognized**   | ** ** |
| **relationships**                 | ** ** | **in OCI**                 | ** ** | **from OCI**                     | ** ** | **from OCI**               | ** ** | **in earnings**      | ** ** | **in earnings**  | ** ** |
| Interest rate                     | ** ** | **37**                     |       | Net interest expense             |       | **1**                      |       | Net interest expense |       | **2**            |       |
| Foreign exchange                  | ** ** | **(31**                    | **)**      | Foreign exchange                 | ** ** | **–**                 |       |                 |       |             |       |
|                              |       |                       |       | Property, plant,                 |       |                       |       |                 |       |             |       |
|                              |       |                       |       | and equipment                    |       | **(15**                    | **)**      |                 |       |             |       |
| Commodity                         | ** ** | **394**                    |       | Revenue                          |       | **(205**                   | **)**      |                 |       |             |       |
| **OCI impact**                    | ** ** | **400**                    |       | **OCI impact**                   | ** ** | **(219**                   | **)**      | **Earnings impact**  | ** ** | **2**            | ** ** |
| ** **                        | ** ** | ** **                 |       | ** **                       | ** ** | ** **                 | ** ** | ** **           | ** ** | ** **       | ** ** |
| **Year ended Dec. 31, 2008** | ** ** | ** **                 | ** ** | ** **                       | ** ** | ** **                 | ** ** |                 |       |             |       |
| ** **                        | ** ** | **Effective portion**      | ** ** | ** **                       | ** ** |                       |       |                 |       |
| **Derivatives in**                | ** ** | **Pre-tax (loss)**         | ** ** | **Location of gain**             | ** ** | **Pre-tax**                | ** ** |                 |       |             |       |
| **cash flow hedging**             | ** ** | **gain recognized**        | ** ** | **reclassified**                 | ** ** | **gain reclassified**      | ** ** |                 |       |             |       |
| **relationships**                 | ** ** | **in OCI**                 | ** ** | **from OCI**                     | ** ** | **from OCI**               | ** ** |                 |       |             |       |
| Interest rate                     |       | (56                        | )          | Net interest expense             |       | –                     |       |                 |       |             |       |
| Foreign exchange                  |       | 31                         |       | Foreign exchange                 |       | –                     |       |                 |       |             |       |
|                              |       |                       |       | Property, plant,                 |       |                       |       |                 |       |             |       |
|                              |       |                       |       | and equipment                    |       | 8                          |       |                 |       |             |       |
| Commodity                         |       | 352                        |       | Revenue                          |       | 91                         |       |                 |       |             |       |
| OCI impact                        |       | 327                        |       | OCI impact                       |       | 99                         |       |                 |       |             |       |
|                              |       |                       |       |                             |       |                       |       |                 |       |             |       |
| **Year ended Dec. 31, 2007** |       |                       |       |                             |       |                       |       |                 |       |             |       |
| ** **                        | ** ** | **Effective portion** | ** ** | ** **                       | ** ** |                       |       |                 |       |
| **Derivatives in**           | ** ** | **Pre-tax gain**      | ** ** | **Location of (loss)** | ** ** | **Pre-tax (loss)**    | ** ** |                 |       |             |       |
| **cash flow hedging**   | ** ** | **(loss) recognized** | ** ** | **gain reclassified**       | ** ** | **gain reclassified** | ** ** |                 |       |             |       |
| **relationships**                 | ** ** | **in OCI**            | ** ** | **from OCI**                | ** ** | **from OCI**          | ** ** |                 |       |             |       |
| Interest  rate                    |       | 9                          |       | Net interest expense             |       | (5                         | )          |                 |       |             |       |
| Foreign  exchange                 |       | (10                        | )          | Foreign exchange                 |       | –                     |       |                 |       |             |       |
|                              |       |                       |       | Property, plant,                 |       |                       |       |                 |       |             |       |
|                              |       |                       |       | and equipment                    |       | 1                          |       |                 |       |             |       |
| Commodity                         |       | (56                        | )          | Revenue                          |       | 30                         |       |                 |       |             |       |
| OCI  impact                       |       | (57                        | )          | OCI impact                       |       | 26                         |       |                 |       |             |       |

** **

** **

Notes toConsolidated Financial Statements  |  29

----

 

**C.      NetInvestment Hedges**

 

Foreign exchange contracts and foreign currency denominatedliabilities are used to manage the Corporation’s foreign currency exposures tonet investments in self-sustaining foreign operations having a functionalcurrency other than the Canadian dollar. Foreign denominated expenses are alsoused to assist in managing foreign currency exposures on net earnings fromself-sustaining foreign operations.

 

For the year ended Dec. 31, 2009, a net after-tax lossof $69 million (2008–gain of $47 million, 2007–gain of $19 million), relatingto the translation of the Corporation’s net investment in self-sustainingforeign operations, net of hedging, was recognized in OCI.

 

All net investment hedges currently have no ineffectiveportion. The following table summarizes the pre-tax impact of net investmenthedges on the Consolidated Statements of Comprehensive Income:

 
| ** **              | ** ** | **Pre-tax (losses) gains** | ** ** | **Pre-tax losses**     | ** ** | **Pre-tax (losses) gains** | ** ** |
|-------------------------|------------|----------------------------|------------|------------------------|------------|----------------------------|------------|
| **Derivatives  in net** | ** ** | **recognized in OCI**      | ** ** | **recognized in OCI**  | ** ** | **recognized in OCI**      | ** ** |
| **investment hedging**  | ** ** | **for the year ended**     |       | **for the year ended** |       | **for the year ended**     |       |
| **relationships**       | ** ** | **Dec. 31, 2009**     |       | **Dec. 31, 2008** |       | **Dec. 31, 2007**     |       |
| Foreign  exchange       | ** ** | **(64**                    | **)**      | (37                    | )          | (2                         | )          |
| Cross  currency         | ** ** | **(3**                     | **)**      | (62                    | )          | 152                        |       |
| Long-term  debt         | ** ** | **233**                    |       | (257                   | )          | 90                         |       |
| **OCI impact**          | ** ** | **166**                    |       | (356                   | )          | 240                        |       |

 

**Summary**

The following table summarizes the fair values of derivativeinstruments categorized by their hedging relationships, as well as derivativesthat are not designated as hedges:

 
| **As at Dec. 31**           | ** ** | ** **     | ** ** | ** **    | ** ** | **2009**       | ** ** | ** **     | ** ** | ** ** | ** ** | **2008**   | ** ** |
|----------------------------------|------------|----------------|------------|---------------|------------|----------------|------------|----------------|------------|------------|------------|------------|------------|
| ** **                       | ** ** | ** **     | ** ** | ** **    | ** ** | **Net**        | ** ** | **Not**        | ** ** | ** ** | ** ** | ** ** | ** ** |
|                             | ** ** | **Fair Value** | ** ** | **Cash Flow** | ** ** | **Investment** | ** ** | **Designated** |       |       |       |       |       |
|                             | ** ** | **Hedges**     | ** ** | **Hedges**    | ** ** | **Hedges**     | ** ** | **as a Hedge** | ** ** | **Total**  | ** ** | **Total**  | ** ** |
| Financial derivative assets      |       |           |       |          |       |           |       |           |       |       |       |       |       |
| Energy Trading                   | ** ** | **–**     | ** ** | **332**       | ** ** | **–**     | ** ** | **19**         | ** ** | **351**    |       | 363        |       |
| Non-Energy Trading               | ** ** | **14**         | ** ** | **3**         | ** ** | **–**     | ** ** | **–**     | ** ** | **17**     |       | 58         |       |
| **Total**                        | ** ** | **14**         | ** ** | **335**       | ** ** | **–**     | ** ** | **19**         | ** ** | **368**    |       | 421        |       |
| Financial derivative liabilities |       |           |       |          |       |           |       |           |       |       |       |       |       |
| Energy Trading                   | ** ** | **–**     | ** ** | **62**        | ** ** | **–**     | ** ** | **18**         | ** ** | **80**     |       | 199        |       |
| Non-Energy Trading               | ** ** | **1**          | ** ** | **35**        | ** ** | **5**          | ** ** | **2**          | ** ** | **43**     |       | 51         |       |
| **Total**                        | ** ** | **1**          | ** ** | **97**        | ** ** | **5**          | ** ** | **20**         | ** ** | **123**    |       | 250        |       |

 

Additional information on derivative instruments has beenpresented on a net basis in Note 9.

 

 

***11.  INVENTORY***

 

Inventory includes coal, natural gas, and emission creditswhich are valued at the lower of cost and net realizable value.

 
| **As at Dec. 31**     | ** ** | **2009**   | ** ** | **2008** | ** ** |
|----------------------------|------------|------------|------------|----------|------------|
| Coal                       | ** ** | **86**     | ** ** | 45       | ** ** |
| Natural gas                | ** ** | **4**      |       | 5        |       |
| Purchased emission credits | ** ** | **–** |       | 1        |       |
| **Total**                  | ** ** | **90**     |       | 51       |       |

 

The increase in coal inventory in 2009 compared to 2008 isprimarily due to lower production at the Centralia and Alberta Thermal plants.

 

The change in inventory is outlined below:

 
| Balance, Dec. 31, 2008      |       |   |   | 51     |   |
|----------------------------------|------------|--------|--------|--------|--------|
| Net additions                    |       |   |   | 44     |   |
| Change in foreign exchange rates |       |   |   | (5     | )      |
| **Balance,  Dec. 31, 2009** | ** ** |   |   | **90** |   |

 

No inventory is pledged as security for liabilities.

 

For the years ended Dec. 31, 2009 and 2008, noinventory was written down from its carrying value nor were any writedownsrecorded in previous periods reversed back into net earnings.

 

 

30  |  TransAlta Corporation

----

 

***12.  LONG-TERM RECEIVABLE***

 

In 2008, the Corporation received a notice of reassessmentfrom the federal taxation authority in Canada related to the disposal of theTransmission Business in the 2002 taxation year. As a result of thereassessment, the Corporation was required by law to pay approximately $49million in taxes plus interest and penalties notwithstanding the Corporation’sability to challenge this reassessment. The Corporation funded a portion ofthis amount in 2008 by transferring $8 million from its tax prepayment account.Additional cash payments and a loss carryback were applied in 2009 to fund theremaining balance. The Corporation is in the process of challenging thisreassessment. Since it is anticipated that the dispute will not be resolvedwithin one year, these prepayments have been recorded as a long-termreceivable.

 

 

***13.  PROPERTY, PLANT, ANDEQUIPMENT***

 
| **As at Dec. 31**                | ** ** | **2009**        | ** ** | ** ** | ** ** | ** **       | ** ** | **2008**     | ** ** | ** ** | ** ** |
|---------------------------------------|------------|-----------------|------------|------------|------------|------------------|------------|--------------|------------|------------|------------|
| ** **                            | ** ** | ** **      | ** ** | ** ** | ** ** | **Accumulated**  | ** ** | ** **   | ** ** | ** ** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|                                  |       |            |       |       | ** ** | **depreciation** |       |         |       |       | ** ** | **depreciation** |   |   |   |
|                                  | ** ** | **Depreciable** |       |       | ** ** | **and**          | ** ** | **Net book** |       |       | ** ** | **and** | ** ** | **Net book** | ** ** |
|                                  | ** ** | **lives**       | ** ** | **Cost**   | ** ** | **amortization** | ** ** | **value**    | ** ** | **Cost**   | ** ** | **amortization** | ** ** | **value** | ** ** |
| Thermal generation equipment          | ** ** | **3–50**   | ** ** | **4,709**  | ** ** | **2,267**        | ** ** | **2,442**    |       | 4,835      |       | 1,993 |   | 2,842 |   |
| Mining property &  equipment | ** ** | **4–50**   | ** ** | **795**    | ** ** | **415**          | ** ** | **380**      |       | 776        |       | 352 |   | 424 |   |
| Gas generation                        | ** ** | **2–30**   | ** ** | **2,135**  | ** ** | **883**          | ** ** | **1,252**    |       | 2,244      |       | 1,030 |   | 1,214 |   |
| Geothermal generation                 | ** ** | **10–20**  | ** ** | **333**    | ** ** | **101**          | ** ** | **232**      |       | 386        |       | 87 |   | 299 |   |
| Hydro generation                      | ** ** | **3–60**   | ** ** | **611**    | ** ** | **172**          | ** ** | **439**      |       | 399        |       | 226 |   | 173 |   |
| Wind generation                       | ** ** | **30**          | ** ** | **1,556**  | ** ** | **125**          | ** ** | **1,431**    |       | 375        |       | 39 |   | 336 |   |
| Biomass                               | ** ** | **15–30**  | ** ** | **25**     | ** ** | **1**            | ** ** | **24**       |       | –     |       | – |   | – |   |
| Capital spares and other              | ** ** | **2–15**   | ** ** | **270**    | ** ** | **65**           | ** ** | **205**      |       | 228        |       | 68 |   | 160 |   |
| Assets under construction             | ** ** | **–**      | ** ** | **1,038**  | ** ** | **–**       | ** ** | **1,038**    |       | 443        |       | – |   | 443 |   |
| Coal rights(1)                        | ** ** | **–**      | ** ** | **133**    | ** ** | **86**           | ** ** | **47**       |       | 134        |       | 83 |   | 51 |   |
| Land                                  | ** ** | **–**      | ** ** | **68**     | ** ** | **–**       | ** ** | **68**       |       | 63         |       | – |   | 63 |   |
| Transmission systems                  | ** ** | **15–50**  | ** ** | **48**     | ** ** | **28**           | ** ** | **20**       |       | 49         |       | 20 |   | 29 |   |
| **Total**                             |       |            | ** ** | **11,721** | ** ** | **4,143**        | ** ** | **7,578**    |       | 9,932      |       | 3,898 |   | 6,034 |   |

 

*1  Coal rights are amortized on aunit-of-production basis, based on the estimated mine reserve.*

 

The Corporation capitalized $36million of interest to PP&E in 2008 (2008 – $21 million, 2007 – $6million).

 

The change in PP&E is outlinedbelow:

 
|                                      |       |       | ** ** | **Accumulated**  |       |         |       |
|-------------------------------------------|------------|------------|------------|------------------|------------|--------------|------------|
|                                      |       |       | ** ** | **depreciation** |       |         |       |
|                                      |       |       | ** ** | **and**          | ** ** | **Net book** | ** ** |
|                                      | ** ** | **Cost**   | ** ** | **amortization** | ** ** | **value**    | ** ** |
| Balance, Dec. 31, 2008               |       | 9,932      |       | 3,898            |       | 6,034        |       |
| Acquisition of Canadian Hydro *(Note 24)* |       | 1,291      |       | –           |       | 1,291        |       |
| Additions                                 |       | 904        |       | –           |       | 904          |       |
| Disposals                                 |       | (10        | )          | (6               | )          | (4           | )          |
| Depreciation                              |       | –     |       | 463              |       | (463         | )          |
| Change in foreign exchange rates          |       | (273       | )          | (94              | )          | (179         | )          |
| Retirement of assets                      |       | (132       | )          | (118             | )          | (14          | )          |
| Transfers                                 |       | 9          |       | –           |       | 9            |       |
| **Balance,  Dec. 31, 2009**          | ** ** | **11,721** | ** ** | **4,143**        | ** ** | **7,578**    | ** ** |

 

 

***14.  GOODWILL***

 

The change in goodwill is outlined below:

 
| Balance, Dec. 31, 2008               |       | 142     |       |
|-------------------------------------------|------------|---------|------------|
| Acquisition of Canadian Hydro *(Note 24)* |       | 304     |       |
| Change in foreign exchange rates          |       | (12     | )          |
| **Balance,  Dec. 31, 2009**          | ** ** | **434** | ** ** |

 

A portion of goodwill in Generation is related to CE Gen, aself-sustaining foreign operation denominated in U.S. dollars *(Note 29)*. Unrealized foreign exchange gains and lossesrelated to the translation of self-sustaining foreign operations do not affectnet earnings and as such translation gains and losses are reflected in AOCI.

 

 

Notes toConsolidated Financial Statements  |  31

----

 

***15.  INTANGIBLE ASSETS***

 

The change in intangible assets is outlined below:

 
| ** **                                | ** ** | ** ** | ** ** | **Accumulated**  | ** ** | **Net book** | ** ** |
|-------------------------------------------|------------|------------|------------|------------------|------------|--------------|------------|
| ** **                                | ** ** | **Cost**   | ** ** | **amortization** | ** ** | **value**    | ** ** |
| Balance, Dec. 31, 2008               |       | 499        |       | 286              |       | 213          |       |
| Acquisition of Canadian Hydro *(Note 24)* |       | 176        |       | –           |       | 176          |       |
| Change in foreign exchange rates          |       | (68        | )          | (43              | )          | (25          | )          |
| Amortization                              |       | –     |       | 31               |       | (31          | )          |
| **Balance,  Dec. 31, 2009**          | ** ** | **607**    |       | **274**          | ** ** | **333**      |       |

 

A portion of intangible assets are related to CE Gen, aself-sustaining foreign operation denominated in U.S. dollars. Unrealizedforeign exchange gains and losses related to the translation of self-sustainingforeign operations do not affect net earnings and as such translation gains andlosses are reflected in AOCI.

 

 

***16.  OTHER ASSETS***

 
| **As at Dec. 31**                         | ** ** | **2009** | ** ** | **2008** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|
| Deferred license fees                     | ** ** | **22**   |       | 21       |       |
| Accrued pension benefit asset *(Note 31)* | ** ** | **18**   |       | 9        |       |
| Project development costs                 | ** ** | **45**   |       | 4        |       |
| Keephills 3 transmission deposit          | ** ** | **8**    |       | –   |       |
| Other                                     | ** ** | **9**    |       | 5        |       |
| **Total other assets**                    | ** ** | **102**  |       | 39       |       |

 

Deferred license fees consist primarily of a license tolease the land on which certain generating assets are located, and are beingamortized on a straight-line basis over the useful life of the generatingassets to which the license relates.

 

The Keephills 3 transmission deposit is TransAlta’sproportionate share of a provincially required deposit for Keephills 3. Thefull amount of the deposit is anticipated to be reimbursed over the next 10years, as long as certain performance criteria are met.

 

Project development costs include external, direct, andincremental costs incurred during the development phase of future powerprojects.

 

 

***17.  LONG-TERM DEBT AND NETINTEREST EXPENSE***

 

**A.      AmountsOutstanding**

 
| **As at Dec. 31**       |       |         | ** ** | **2009**       |   |                | ** ** |         |       | **2008**       |       |                |                |
|------------------------------|------------|--------------|------------|----------------|--------|---------------------|------------|--------------|------------|----------------|------------|---------------------|---------------------|
|                         | ** ** | **Carrying** |       |           |   |                |       | **Carrying** |       |           |       |                |                |
|                         | ** ** | **value**    |       | **Face value** |   | **Interest****(1)** |       | **value**    | ** ** | **Face value** | ** ** | **Interest****(1)** | ** **          |
| Credit facilities(2)         | ** ** | **1,063**    |       | **1,063**      |   | **1.0%**            |       | 443          |       | 443            |       | 2.8                 | %    |
| Debentures, due 2011 to 2030 | ** ** | **1,055**    |       | **1,076**      |   | **6.7%**            |       | 682          |       | 681            |       | 6.8                 | %                   |
| Senior notes(3)              | ** ** | **1,687**    |       | **1,684**      |   | **5.9%**            |       | 1,352        |       | 1,344          |       | 6.3                 | %                   |
| Non-recourse                 | ** ** | **578**      |       | **581**        |   | **6.3%**            |       | 265          |       | 265            |       | 7.4                 | %                   |
| Other                        | ** ** | **59**       |       | **59**         |   | **6.7%**            |       | 66           |       | 66             |       | 6.7                 | %                   |
|                         | ** ** | **4,442**    |       | **4,463**      |   |                |       | 2,808        |       | 2,799          |       |                |                |
| Less: current portion        | ** ** | **(31**      | **)**      | **(31**        | **)**  |                |       | (244         | )          | (244           | )          |                |                |
| **Total long-term  debt**    | ** ** | **4,411**    |       | **4,432**      |   |                |       | 2,564        |       | 2,555          |       |                |                |

 

*1  Interest is an average rateweighted by principal amounts outstanding before the effect of hedging.*

*2  Composed of Bankers’Acceptances and other commercial borrowings under long-term committed creditfacilities.*

*3  2009–U.S.$1,600 million,2008-U.S.$1,100 million.*

 

A portion of the fixed rate components of debentures andsenior notes have been hedged using fixed to floating interest rate swaps andtherefore the Corporation has included the fair value of these swaps with thevalue of the debt. Non-recourse debt is not hedged and therefore recorded atcost.

 

Credit facilities are drawn on the Corporation’s $1.5billion committed syndicated bank credit facility and on the Corporation’sU.S.$300 million committed facility. The $1.5 billion committed syndicated bankfacility is the primary source for short-term liquidity after the cash flowgenerated from the Corporation’s businesses. The facility is a five-yearrevolver which was last renewed in May 2007 and matures in 2012. TheU.S.$300 million committed facility is a five-year facility that matures in2013. Interest rates on the credit facilities vary depending on the optionselected; Canadian prime, Bankers’ Acceptance, U.S. LIBOR or U.S. base rate, inaccordance with a pricing grid that is standard for such facilities. TheCorporation also has $240 million available in committed bilateral creditfacilities all of which mature in 2011.

 

 

32  |  TransAlta Corporation

----

** **

**Debentures** bearinterest at fixed rates ranging from 6.4 per cent to 7.3 per cent. TheCorporation has converted $100 million fixed interest rate debt with a rate of6.9 per cent to floating rates through the use of interest rate swaps (Note 9).These interest rate swaps mature in 2011. During 2009, the Corporation issued atotal of $600 million in debentures; $200 million was issued in May 2009at a fixed interest rate of 6.45 per cent, maturing in 2014 and $400 millionwas issued in November 2009 at a fixed rate of 6.4 per cent, maturing in2019.

 

**Senior Notes** U.S.$300million of the senior notes bear an interest rate of 5.75 per cent and maturein 2013 and another U.S.$300 million bear an interest rate of 6.75 per cent andmature in 2012. U.S.$500 million bear interest at 6.65 per cent and mature in2018, and the remaining U.S.$500 million of the senior notes were issued inNovember 2009 and bear an interest rate of 4.75 per cent and mature in2015. In addition, the Corporation converted U.S.$50 million and U.S.$150million fixed interest rate debt with rates of 5.8 per cent and 6.7 per cent,respectively, to floating rates through the use of interest rate swaps (Note9). These interest rate swaps mature in 2013 and 2018, respectively. A total ofU.S.$1,100 million of the senior notes has been designated as a hedge of theCorporation’s net investment of U.S. self-sustaining foreign operations.

 

**Non-Recourse Debt** consists ofproject financing debt, debt securities and senior secured bonds of CE Gen,debt related to the Wailuku River Hydroelectric L.P (“Wailuku”) acquisition,and debentures issued by Canadian Hydro. The CE Gen related assets have beenpledged as security for the project financing debt. The CE Gen debt hasmaturity dates ranging from 2010 to 2018 and interest rates ranging from 7.5per cent to 8.3 per cent. This debt is recorded at cost; the fair value as atDec. 31, 2009 was U.S.$184 million (2008–U.S.$208 million). Wailuku debtat Dec. 31, 2009 has a cost of U.S.$8 million (2008–U.S.$9 million) andbears interest at a floating rate currently of 1.2 per cent. The Canadian Hydrodebt has maturity dates ranging from 2010 to 2018 and interest rates rangingfrom 5.3 per cent to 10.9 per cent and includes debt with a cost of $355million and U.S.$20 million. This debt is recorded at cost; the fair value asat Dec. 31, 2009 was $376 million.

 

**Other** consist ofnotes payable for the Windsor Plant which bears interest at fixed rates and arerecourse to the Corporation through a standby letter of credit. These mature inNovember 2014. Also included is a commercial loan obligation which bearsan interest rate of 5.9 per cent and will mature in 2023. This is an unsecuredloan and requires annual payments of interest and principal.

 

**B.****     ****Principal Repayments**

 
| 2010                |       | 29        |       |
|---------------------|------------|-----------|------------|
| 2011                |       | 251       |       |
| 2012                |       | 1,090     |       |
| 2013                |       | 659       |       |
| 2014                |       | 231       |       |
| 2015 and thereafter |       | 2,203     |       |
| **Total****(1)**    | ** ** | **4,463** | ** ** |

 

*1** **Excludes impact of derivatives and include credit facilities that are currentlyscheduled to mature in 2012 and 2013.*

 

**C.****     ****InterestExpense**

 
| **Year ended Dec. 31** | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|----------|------------|
| Interest on long-term debt  | ** ** | **183**  |       | 177      |       | 171      |       |
| Interest income             | ** ** | **(6**   | **)**      | (46      | )          | (32      | )          |
| Capitalized interest        | ** ** | **(36**  | **)**      | (21      | )          | (6       | )          |
| Other                       | ** ** | **3**    |       | –   |       | –   |       |
| **Net interest  expense**   | ** ** | **144**  |       | 110      |       | 133      |       |

 

The Corporation capitalizes interest during the constructionphase of longer-term capital projects. The capitalized interest in 2009 relatesprimarily to Keephills 3 and associated mine capital, Blue Trail, andSummerview II. In 2008 the capitalized interest related to the Corporation’sinvestment in Keephills 3 and associated mine capital, Kent Hills, Summerview,and Blue Trail.

 

In 2008, an appeal was resolved pertaining to the timing ofrevenue recognition and deductions on previous years’ tax returns based onapplicable income tax laws. Consequently, a $30 million interest refund fromtaxation authorities was recorded as interest income.

 

 

Notes to Consolidated Financial Statements  |  33

 

----

 

**D.****     ****Guarantees**

 

**I.****       ****Letters of Credit**

 

Letters of credit are issued to counterparties under somecontractual arrangements with certain subsidiaries of the Corporation. If theCorporation or its subsidiary does not perform under such contracts, thecounterparty may present its claim for payment to the financial institutionthrough which the letter of credit was issued. Any amounts owed by theCorporation or its subsidiaries are reflected in the Consolidated BalanceSheets. All letters of credit expire within one year and are expected to berenewed, as needed, through the normal course of business. The totaloutstanding letters of credit as at Dec. 31, 2009 totalled $334 million(2008–$430 million) with nil (2008–nil) amounts exercised by third partiesunder these arrangements. TransAlta has a total of $2.1 billion of committedcredit facilities of which $0.7 billion is not drawn and is available as ofDec. 31, 2009, subject to customary borrowing conditions.

 

***18.****** ******ASSETRETIREMENT OBLIGATION***

 

A reconciliation between the openingand closing asset retirement obligation balances is provided below:

 
| Balance, Dec. 31, 2008               |       | 297     |       |
|-------------------------------------------|------------|---------|------------|
| Liabilities incurred in period            |       | 3       |       |
| Liabilities settled in period             |       | (35     | )          |
| Accretion expense                         |       | 24      |       |
| Revisions in estimated cash flows         |       | 10      |       |
| Acquisition of Canadian Hydro *(Note 24)* |       | 3       |       |
| Change in foreign exchange rates          |       | (20     | )          |
|                                      | ** ** | **282** | ** ** |
| Less: current portion                     |       | (32     | )          |
| **Balance,  Dec. 31, 2009**          | ** ** | **250** | ** ** |

 

The Corporation has a right torecover a portion of future asset retirement costs.

 

TransAlta estimates that the undiscounted amount of cashflow required to settle the asset retirement obligation is approximately $0.8billion which will be incurred between 2010 and 2072. The majority of the costswill be incurred between 2020 and 2030. An average discount rate of eight percent and an inflation rate of two per cent were used to calculate the carryingvalue of the asset retirement obligation. At Dec. 31, 2009, theCorporation had provided a surety bond in the amount of U.S.$192 million(2008–U.S.$192 million) in support of future retirement obligations at the Centraliacoal mine. At Dec. 31, 2009, the Corporation had provided letters ofcredit in the amount of $67 million (2008–$57 million) in support of futureretirement obligations at the Alberta mines.

 

***19.****** ******DEFERREDCREDITS AND OTHER LONG-TERM LIABILITIES***

 
| **As at Dec. 31**                                      | ** ** | **2009** | ** ** | **2008** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred coal revenues *(Note 25)*                          | ** ** | **51**   | ** ** | 31       | ** ** |
| Sale of emission credits                                    | ** ** | **1**    |       | 7        |       |
| Power purchase arrangement in  limited partnership          | ** ** | **21**   |       | 23       |       |
| Accrued benefit liability *(Note 31)*                       | ** ** | **49**   |       | 49       |       |
| Other                                                       | ** ** | **14**   |       | 21       |       |
| **Total deferred  credits and other long-term liabilities** | ** ** | **136**  |       | 131      |       |

 

The power purchase arrangement in the limited partnershiprepresents the fair value adjustments for the Sheerness Generating Station todeliver power at less than the prevailing market price at the time of theacquisition of the plant by TransAlta Cogeneration, L.P. (“TA Cogen”). Thepower purchase arrangement is amortized on a straight-line basis over the lifeof the contract.

 

***20.****** ******COMMONSHARES***

 

**A.****     ****Issuedand Outstanding**

 

The Corporation is authorized to issue an unlimited numberof voting common shares without nominal or par value.

 
| **Year ended Dec. 31**                    | ** ** | **         2009** | ** ** | **        2008** | ** ** |
|------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                     | ** ** | **Common**                                           | ** ** | ** **                                          | ** ** | **Common** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **shares**                                           | ** ** | ** **                                          | ** ** | **shares** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **(millions)**                                       | ** ** | **Amount**                                          | ** ** | **(millions)** | ** ** | **Amount** | ** ** |
| **Issued and  outstanding, beginning of year** | ** ** | **197.6**                                            | ** ** | **1,761**                                           |       | 200.9 |   | 1,781 |   |
| Issued under stock option plans                | ** ** | **–**                                           | ** ** | **–**                                          |       | 0.4 |   | 8 |   |
| Issued under Performance Share  Ownership Plan | ** ** | **0.2**                                              | ** ** | **6**                                               |       | 0.2 |   | 7 |   |
| Shares purchased under NCIB *(Note 21)*        | ** ** | **–**                                           | ** ** | **–**                                          |       | (3.9 | ) | (35 | ) |
| Issued, net of tax(1)                          | ** ** | **20.6**                                             | ** ** | **402**                                             |       | – |   | – |   |
| **Issued and  outstanding, end of year**       | ** ** | **218.4**                                            | ** ** | **2,169**                                           |       | 197.6 |   | 1,761 |   |

* *

*1** **Net of issuance costs of $16 million and tax expense of $4 million.*

 

 

34  |  TransAlta Corporation

 

----

 

At Dec. 31, 2009 the Corporation had 1.5 millionoutstanding employee stock options (2008 – 1.7 million). For the year endedDec. 31, 2009, no options were exercised.

 

**B.****     ****ShareholderRights Plan**

 

The primary objective of the Shareholder Rights Plan is toprovide the Corporation’s Board of Directors sufficient time to explore anddevelop alternatives for maximizing shareholder value if a takeover bid is madefor the Corporation and to provide every shareholder with an equal opportunityto participate in such a bid. The plan was originally approved in 1992, and hasbeen revised since that time to ensure conformity with current practices. Theplan is put before the shareholders every three years for approval, and waslast approved on April 26, 2007. 

 

When an acquiring shareholder commences a bid to acquire 20per cent or more of the Corporation’s common shares, other than by way of aPermitted Bid, where the offer is made to all shareholders by way of a takeoverbid circular, the rights granted under the Shareholder Rights Plan becomeexercisable by all shareholders except those held by the acquiring shareholder.Each right will entitle a shareholder other than the acquiring shareholder, toacquire an additional $200 worth of common shares for $100.

 

**C.****     ****DividendReinvestment and Share Purchase (“DRASP”) Plan**

 

Under the terms of the DRASP plan, participants are able topurchase additional common shares by reinvesting dividends. Shares purchasedunder the DRASP plan are acquired in the open market at 100 per cent of theaverage purchase price of common shares acquired on the Toronto Stock Exchangeon the investment dates.

 

**D.****     ****EarningsPer Share (“EPS”)**

 
| **Year ended Dec. 31**                                                 | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Net earnings**                                                            | ** ** | **181**  |       | 235      |       | 309      |       |
| **Basic and diluted  weighted average number of common shares outstanding** | ** ** | **201**  |       | 199      |       | 202      |       |
| **Earnings per share**                                                      |       |     |       |     |       |     |       |
| Basic and diluted                                                           | ** ** | **0.90** |       | 1.18     |       | 1.53     |       |

 

The effect of the PSOP does notmaterially affect the calculation of the total weighted average number ofcommon shares outstanding *(Note 30)*.

 

***21.****** ******SHAREHOLDERS’EQUITY***

 
| ** **                                                                                                                                                      | ** ** | ** ** | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** **             | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|--------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                                                                                                                      | ** ** | ** ** | ** ** | ** **   | ** ** | **other**         | ** ** | **Total**              | ** ** |
| ** **                                                                                                                                                      | ** ** | **Common** | ** ** | **Retained** | ** ** | **comprehensive** | ** ** | **shareholders’** | ** ** |
| ** **                                                                                                                                                      | ** ** | **shares** | ** ** | **earnings** | ** ** | **income/(loss)** | ** ** | **equity**             | ** ** |
| **Balance,  Dec. 31, 2008**                                                                                                                                |       | 1,761      |       | 688          |       | 61                |       | 2,510                  |       |
| Net earnings                                                                                                                                                    |       | –     |       | 181          |       | –            |       | 181                    |       |
| Common shares issued                                                                                                                                            |       | 408        |       | –       |       | –            |       | 408                    |       |
| Dividends declared                                                                                                                                              |       |       |       | (235         | )          |              |       | (235                   | )          |
| Losses on  translating net assets of self-sustaining foreign operations, net of hedges  and of tax                                                              |       | –     |       | –       |       | (69               | )          | (69                    | )          |
| Gains on derivatives designated as  cash flow hedges, net of tax                                                                                                |       | –     |       | –       |       | 280               |       | 280                    |       |
| Derivatives  designated as cash flow hedges in prior periods transferred to the Consolidated  Balance Sheets and net earnings in the current period, net of tax |       | –     |       | –       |       | (146              | )          | (146                   | )          |
| **Balance,  Dec. 31, 2009**                                                                                                                                | ** ** | **2,169**  | ** ** | **634**      | ** ** | **126**           | ** ** | **2,929**              | ** ** |

 

**Components of AOCI**

** **
| **As at Dec. 31**                                                                                             | ** ** | **2009** | ** ** | **2008** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cumulative unrealized (losses)  gains on translating self-sustaining foreign operations, net of hedges and of  tax | ** ** | **(63**  | **)**      | 6        |       |
| Cumulative unrealized gains on cash  flow hedges, net of tax                                                       | ** ** | **189**  |       | 55       |       |
| **Total accumulated  other comprehensive income**                                                                  | ** ** | **126**  |       | 61       |       |

 

**Normal CourseIssuer Bid (“NCIB”) program**

 

On May 6, 2009, TransAlta announced plans to renew theNCIB program until May 6, 2010. The Corporation received the approval topurchase, for cancellation, up to 9.9 million of its common shares representingfive per cent of the 198 million common shares issued and outstanding as atApril 30, 2009. Any purchases undertaken will be made on the open marketthrough the Toronto Stock Exchange at the market price of such shares at thetime of acquisition.

 

No purchases were made under the NCIB program in 2009.

 

For the year ended Dec. 31, 2008, TransAlta purchased3,886,400 shares at an average price of $33.46 per share for a total of $130million. For the year ended Dec. 31, 2007, TransAlta purchased 2,371,800shares at an average of $31.59 per share for a total of $75 million.

 

 

Notes to Consolidated Financial Statements  |  35

 

----

** **

***22.****** ******CHANGES INNON-CASH OPERATING WORKING CAPITAL***

 
| **Year ended Dec. 31**                       | ** ** | **2009**   | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|---------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Source (use):                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Accounts receivable                               |       | 114        |       | 80         |       | 44         |       |
| Prepaid expenses                                  | ** ** | **(7**     | **)**      | 3          |       | (3         | )          |
| Income taxes receivable                           | ** ** | **(1**     | **)**      | (20        | )          | (29        | )          |
| Inventory                                         | ** ** | **(42**    | **)**      | (10        | )          | 22         |       |
| Accounts payable and accrued  liabilities         | ** ** | **(208**   | **)**      | 157        |       | 32         |       |
| Income taxes payable                              | ** ** | **(5**     | **)**      | –     |       | –     |       |
| **Change in non-cash  operating working capital** | ** ** | **(149**   | **)**      | 210        |       | 66         |       |

 

***23.****** ******CAPITAL***

 

TransAlta’s components of capital arelisted below:

 
| ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Increase/**  | ** ** |
|-----------------------------------|------------|------------|------------|------------|------------|----------------|------------|
| **As at Dec. 31**            | ** ** | **2009**   | ** ** | **2008**   | ** ** | **(decrease)** | ** ** |
| Current portion of long-term debt |       | **31**     | ** ** | 244        |       | (213           | )          |
| Less: cash and cash equivalents   |       | **(82**    | **)**      | (50        | )          | (32            | )          |
|                              |       | **(51**    | **)**      | 194        |       | (245           | )          |
| Long-term debt                    |       | ** ** | ** ** |       |       |           |       |
| Recourse                          | ** ** | **3,857**  |       | 2,332      |       | 1,525          |       |
| Non-recourse                      | ** ** | **554**    |       | 232        |       | 322            |       |
| Non-controlling interests         | ** ** | **478**    |       | 469        |       | 9              |       |
| Common shareholders’ equity  |       |       |       |       |       |           |       |
| Common shares                     | ** ** | **2,169**  |       | 1,761      |       | 408            |       |
| Retained earnings                 | ** ** | **634**    |       | 688        |       | (54            | )          |
| AOCI                              | ** ** | **126**    |       | 61         |       | 65             |       |
| ** **                        | ** ** | **7,818**  |       | 5,543      |       | 2,275          |       |
| **Total capital**                 | ** ** | **7,767**  |       | 5,737      |       | 2,030          |       |

 

The long-term portion of recourse debt increased fromDec. 31, 2008 as a result of the issuance of senior notes and debenturesprimarily related to the acquisition of Canadian Hydro. This increase inlong-term debt was partially offset by scheduled repayments and changes inexchange rates.

 

TransAlta’s strategy for managing capital remained unchangedfrom Dec. 31, 2008.

 

TransAlta’s objectives in managing capital are to:

 

**A.****     ****Maintain an Investment Grade CreditRating:**

 

The Corporation operates in a long-cycle and capitalintensive commodity business, and it is therefore a priority to maintain aninvestment grade credit rating as it allows the Corporation to access capitalmarkets at reasonable rates. TransAlta monitors key capital ratios similar tothose used by key rating agencies. While these ratios are not publiclyavailable from credit agencies, TransAlta’s management has defined these ratiosand manages capital in line with those expectations:

 

Cash flow to interestcoverage Cash flow from operating activities before changes inworking capital plus net interest expense divided by interest on debt lessinterest income. TransAlta targets this ratio to be in a range of four to fivetimes.

 

Cash flow to debt Cash flowfrom operating activities before changes in working capital divided by averagetotal debt. TransAlta targets this ratio to be 20 to 25 per cent.

 

Debt to investedcapital Debt less cash and cash equivalents divided by debt,non-controlling interests, and shareholders’ equity less cash and cashequivalents. TransAlta targets this ratio to be 55 to 60 per cent.

 

 

36  |  TransAlta Corporation

 

----

 

These ratios are presented below:

 
| **Year ended Dec. 31**                | ** ** | **2009** | ** ** | **2008** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|
| Cash flow to interest coverage  (times)(1) | ** ** | **4.9**  |       | 7.2      |       |
| Cash flow to debt (%)(1)                   | ** ** | **20.1** |       | 31.1     |       |
| Debt to invested capital (%)               | ** ** | **56.1** |       | 48.1     |       |

 

*1 Last 12 months.*

 

The decrease in cash flow to interest coverage resulted fromdecreased cash flows from operating activities and higher interest expense. Thedecrease in cash flow to debt resulted from a decrease in cash flows fromoperating activities and an increase in debt balances *(Note 17)*.The increase in debt to invested capital resulted from an increase in debtbalances *(Note 17)*. TransAlta routinely monitorsforecasts for net earnings, capital expenditures, and scheduled repayment ofdebt with a goal of meeting the above ratio targets.

 

**B.****     ****Ensure Sufficient Cash and Credit isAvailable to Fund Operations, Pay Dividends, and Invest in Capital Assets:**

 

These amounts are summarized in thetable below:

 
| **Year ended Dec. 31**         | ** ** | **2009** | ** ** | **2008** | ** ** | **Increase/  (decrease)** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|---------------------------|------------|
| Cash flow from operating activities | ** ** | **580**  |       | 1,038    |       | (458                      | )          |
| Dividends paid                      | ** ** | **(226** | **)**      | (212     | )          | (14                       | )          |
| Capital asset expenditures          | ** ** | **(904** | **)**      | (1,006   | )          | 102                       |       |
| **Net cash outflow**                | ** ** | **(550** | **)**      | (180     | )          | (370                      | )          |

 

The decrease in the total net cash flows primarily resultedfrom lower cash flows from operating activities. TransAlta seeks to maintainsufficient cash balances and committed credit facilities to fund periodic netcash outflows related to its business. At Dec. 31, 2009, $0.7 billion ofthe Corporation’s available credit facilities were not drawn.

 

While any of the existing debentures are outstanding, theCorporation will not issue or in any other manner become liable for anyindebtedness, unless the aggregate principal amount of the Corporation’sindebtedness, as defined in the Corporation’s trust indenture, does not exceed75 per cent of total capital.

 

TransAlta’s credit facilities are unsecured and providefunds in either Canadian or U.S. currencies. They contain standard terms andconditions including covenants with respect to financial leverage and cash flowcoverage that would be considered typical of bank credit facilities of thisnature.

 

During 2009, the Corporation issued a total of $600 millionin debentures; $200 million was issued in May 2009 at a fixed interestrate of 6.45 per cent, maturing in 2014 and $400 million was issued inNovember 2009 at a fixed rate of 6.4 per cent, maturing in 2019. Bothissuances have financial terms and conditions similar to the other debenturesof the Corporation. The financial terms and conditions of all other debenturesremain unchanged from Dec. 31, 2008. During 2009, the Corporation alsoissued U.S.$500 million in senior notes at an interest rate of 4.75 per centand mature in 2015.

 

During 2009, the Corporation issued 20.8 million commonshares for total net proceeds of $408 million.

 

TransAlta’s formal dividend policy targets to payshareholders an annual dividend in the range of 60 to 70 per cent of comparablenet earnings. TransAlta’s management defines comparable net earnings as netearnings adjusted for items that would not be considered to be part of normaloperations.

 

 

Notes to Consolidated Financial Statements  |  37

 

----

 

***24.****** ******ACQUISITIONS ANDDISPOSALS***

** **

**A.****     ****Acquisitions**

 

On Oct. 23, 2009, TransAlta acquired 87 per cent ofCanadian Hydro through the purchase of the issued and outstanding shares ofCanadian Hydro. On Nov. 4, 2009, TransAlta acquired the remaining 13 percent of the issued and outstanding shares. The total cash consideration was$785 million. The results of Canadian Hydro are included in the consolidatedfinancial statements of the Corporation from the acquisition date ofOct. 23, 2009.

 

The details of the cash consideration are as follows:

 
| Total shares acquired (millions) |       | 143.8   |       |
|----------------------------------|------------|---------|------------|
| Price per share                  |       | 5.25    |       |
| Total consideration paid         |       | 755     |       |
| Transaction costs                |       | 30      |       |
| **Total cash  consideration**    | ** ** | **785** | ** ** |

 

The allocation of the aggregate purchase price based on theestimated fair values of the assets of Canadian Hydro on the acquisition dateis as follows:

 
| **Assets:**                               | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|------------|------------|------------|------------|
| Cash                                      | ** ** | 19         | ** ** | ** ** | ** ** |
| Accounts receivable                       |       | 25         |       |       |       |
| Prepaid expenses                          |       | 5          |       |       |       |
| Property, plant, and equipment            |       | 1,291      |       |       |       |
| Intangible assets                         |       | 176        |       |       |       |
| Development costs                         |       | 22         |       |       |       |
| Goodwill                                  |       | 304        |       |       |       |
| Total assets acquired                     |       |       |       | 1,842      |       |
| **Liabilities:**                          |       |       |       |       |       |
| Accounts payable and accrued  liabilities |       | 54         |       |       |       |
| Current risk management liabilities       |       | 6          |       |       |       |
| Long-term risk management  liabilities    |       | 34         |       |       |       |
| Long-term debt                            |       | 931        |       |       |       |
| Future income tax liabilities             |       | 29         |       |       |       |
| Asset retirement obligation               |       | 3          |       |       |       |
| Total liabilities assumed                 |       |       |       | 1,057      |       |
| **Total purchase  price**                 |       |       | ** ** | **785**    | ** ** |

 

The long-term risk management liabilities consist offinancial contracts used to hedge exposures to fluctuations in electricityprices. These contracts qualify for hedge accounting treatment.

 

Although TransAlta does not anticipate material changes tothis preliminary allocation, the values may change when the evaluation of fairvalue information is complete. Any subsequent adjustments will be accounted forin the period incurred.

 

 

38  |  TransAlta Corporation

 

----

** **

**B.****     ****Disposals**

 

On Oct. 8, 2008, TransAlta successfully completed thesale of the Mexican equity investment to InterGen for a sale price of $334million. The sale included the plants at both facilities and all associatedcommercial arrangements.

 

The details of the sale are as follows:

 
| Contractual proceeds                                                                                              |   |   |       | 334    |       |
|-------------------------------------------------------------------------------------------------------------------|--------|--------|------------|--------|------------|
| Less: closing costs                                                                                               |   |   |       | (3     | )          |
| Net proceeds excluding cash on hand  of $1 million                                                                |   |   |       | 331    |       |
| Book value of investment                                                                                          |   |   |       | 420    |       |
| Loss before deferred foreign  exchange losses                                                                     |   |   |       | 89     |       |
| Deferred foreign exchange losses on  the net assets of the Mexican equity investment                              |   | 147    |       |   |       |
| Deferred gains on financial  instruments designated as hedges of the net assets of the Mexican equity  investment |   | (148   | )          |   |       |
| Income tax expense on financial  instruments                                                                      |   | 9      |       |   |       |
| Deferred foreign exchange losses                                                                                  |   |   |       | 8      |       |
| Loss before income taxes                                                                                          |   |   |       | 97     |       |
| Income tax recovery                                                                                               |   |   |       | 35     |       |
| **Net loss**                                                                                                      |   |   | ** ** | **62** | ** ** |

 

Included in the book value of the investment is a provisionfor representations and warranties of $2 million (2008–$ 13 million).

 

During 2007, the Mexican equity investment incurred a lossof $50 million.

 

***25.****** ******RELATED PARTYTRANSACTIONS***

 

On Jan. 1, 2009, TAU and TransAlta Energy Corporationtransferred certain generation and transmission assets to a newly formedinternal partnership, TransAlta Generation Partnership (“TAGP”), beforeamalgamating with TransAlta Corporation.

 

On Dec.16, 2006, predecessors of TAGP, a firm owned by theCorporation and one of its subsidiaries, entered into an agreement with thepartners of the Keephills 3 joint venture project to supply coal for thecoal-fired plant. The joint venture project is held in a partnership owned byKeephills 3 Limited Partnership (“K3LP”), a wholly owned subsidiary of theCorporation, and Capital Power Corporation. TAGP will supply coal until theearlier of the permanent closure of the Keephills 3 facility or the earlytermination of the agreement by TAGP and the partners of the joint venture. Asat Dec. 31, 2009, TAGP had received $51 million from K3LP for future coaldeliveries. Commercial operation of the Keephills plant is scheduled tocommence in the second quarter of 2011. Payments received prior to that datefor future coal deliveries are recorded in deferred revenues and will beamortized into revenue over the life of the coal supply agreement when TAGPstarts delivering coal for commissioning activities.

 

CE Gen has entered into contracts with related parties toprovide administrative and maintenance services. The total value of thesecontracts are U.S.$3 million per year for the years ending Dec. 31, 2009and 2010.

 

For the period November 2002 to November 2012, oneof TransAlta’s subsidiaries, TA Cogen, entered into various transportation swaptransactions with TAGP. TAGP operates and maintains TA Cogen’s threecombined-cycle power plants in Ontario and a plant in Fort Saskatchewan,Alberta. TAGP also provides management services to the Sheerness thermal plant,which is operated by Canadian Utilities Limited. The business purpose of thesetransportation swaps is to provide TA Cogen with the delivery of fixed pricegas without being exposed to escalating costs of pipeline transportation forthree of its plants over the period of the swap. The notional gas volume in theswap transactions is equal to the total delivered fuel for each of the facilities.Exchange amounts are based on the market value of the contract. TransAltaentered into an offsetting contract and therefore has no risk other thancounterparty risk.

 

 

Notes to Consolidated Financial Statements  |  39

 

----

 

***26.****** ******CONTINGENCIES***

 

TransAlta is occasionally named as a party in various claimsand legal proceedings which arise during the normal course of its business.TransAlta reviews each of these claims, including the nature of the claim, theamount in dispute or claimed and the availability of insurance coverage.Although there can be no assurance that any particular claim will be resolvedin the Corporation’s favour, the Corporation does not believe that the outcomeof any claims or potential claims of which it is currently aware, when taken asa whole, will have a material adverse effect on the Corporation.

 

***27.****** ******COMMITMENTS***

 

The Corporation has entered into a number of long-term gaspurchase agreements, transportation and transmission agreements, royalty andright-of-way agreements in the normal course of operations.

 

Approximate future payments under the fixed price purchasecontracts, transmission, operating leases, mining agreements, interest onlong-term debt, and growth project commitments are as follows:

 
| ** **          | ** ** | **Fixed price**  | ** ** | ** **       | ** ** | ** **    | ** ** | **Coal supply** | ** ** | **Long-term** | ** ** | **Interest on** | ** ** | ** **         | ** ** | ** ** | ** ** |
|---------------------|------------|------------------|------------|------------------|------------|---------------|------------|-----------------|------------|---------------|------------|-----------------|------------|--------------------|------------|------------|------------|
| ** **          | ** ** | **gas purchase** | ** ** | ** **       | ** ** | **Operating** | ** ** | **and mining**  | ** ** | **service**   | ** ** | **long-term**   | ** ** | **Growth project** | ** ** | ** ** | ** ** |
| ** **          | ** ** | **contracts**    | ** ** | **Transmission** | ** ** | **leases**    | ** ** | **agreements**  | ** ** | **agreement** | ** ** | **debt****(1)** | ** ** | **commitments**    | ** ** | **Total**  | ** ** |
| 2010                |       | 8                |       | –           |       | 10            |       | 51              |       | 14            |       | 224             |       | 497                |       | 804        |       |
| 2011                |       | 7                |       | 2                |       | 10            |       | 47              |       | 16            |       | 203             |       | 87                 |       | 372        |       |
| 2012                |       | 7                |       | 3                |       | 9             |       | 47              |       | 16            |       | 183             |       | 14                 |       | 279        |       |
| 2013                |       | 7                |       | 3                |       | 9             |       | 47              |       | 16            |       | 170             |       | –             |       | 252        |       |
| 2014                |       | 7                |       | 3                |       | 8             |       | 51              |       | 16            |       | 142             |       | –             |       | 227        |       |
| 2015 and thereafter |       | 25               |       | 38               |       | 56            |       | 269             |       | 18            |       | 600             |       | –             |       | 1,006      |       |
| **Total**           | ** ** | **61**           | ** ** | **49**           | ** ** | **102**       | ** ** | **512**         | ** ** | **96**        | ** ** | **1,522**       | ** ** | **598**            | ** ** | **2,940**  | ** ** |

 

*1 Includes impact of derivatives.*

** **

**A.****     ****Fixed Price Gas Purchase Contracts**

 

Centralia Gas and the Corporation’s Australia operationshave contracts in place for the fixed portion of the gas costs at the plants.

 

**B.****     ****Transmission**

 

During 2008, TransAlta entered into several five-yearagreements with Bonneville Power Administration Transmission (“BPAT”) topurchase 400 megawatts (“MW”) of Pacific Northwest transmission networkcapacity. Provided BPAT can meet certain conditions for delivering the service,the Corporation is committed to taking the services at BPAT’s tariff ratewhether it is awarded immediately or delivered in the future after additionalfacilities are constructed.

 

**C.****     ****Operating Leases**

 

TransAlta has operating leases in place for buildings,vehicles and various types of equipment.

 

**D.****     ****Coal Supply and Mining Agreements**

 

At Centralia Thermal, a significant portion of production issubject to short- to medium-term energy sales contracts. Centralia Thermal alsohas various coal supply and associated rail transport contracts to provide coalfor use in production. During 2008, TransAlta entered into various coal supplyagreements with three suppliers for the Centralia Thermal plant. The coalsupply agreements allow TransAlta to take delivery of coal at fixed volumes andprices, with dates ranging from June 1, 2008 to Dec. 31, 2013.

 

At Alberta Thermal, the mines areoperated by a third party who is paid a fixed amount to provide a budgetedsupply of coal.

 

**E.****     ****Long-Term Service Agreements**

 

TransAlta has various service agreements in place primarilyfor repairs and maintenance that may be required on turbines at various windgenerating facilities.

 

**F.****     ****Growth Project Commitments**

 

On Jan. 11, 2010, TransAlta announced the expansion ofits existing 96 MW Kent Hills wind facility. The capital cost of the project isestimated at $100 million and is expected to begin commercial operations by theend of 2010. As at Dec. 31, 2009 total capital incurred on this project was$18 million. Natural Forces will have the option to purchase up to a 17 percent interest in the new operating facility upon completion.

 

As part of the acquisition of Canadian Hydro onOct. 23, 2009, TransAlta assumed the plans to design, build, and operate BoneCreek, an 18 MW hydro facility in British Columbia. The capital cost of theproject is estimated at $48 million and is expected to begin commercialoperations in the first quarter of 2011. As at Dec. 31, 2009, the totalcapital incurred on this project was $4 million.

 

 

40  |  TransAlta Corporation

 

----

 

On April 28, 2009, TransAlta announced plans to design,build, and operate Ardenville, a 69 MW wind power project in southern Alberta.The capital cost of the project is estimated at $135 million. Included in thepurchase was an operational 3 MW wind power project in southern Alberta. As atDec. 31, 2009, the total capital incurred on this project was $27 million.Commercial operations of the remainder of the facility are expected to commencein the first quarter of 2011.

 

On Jan. 29, 2009, TransAlta announced two efficiencyuprates at its Keephills plant in Alberta. Both Keephills units 1 and 2 will beupgraded by 23 MW each, to a total of 450 MW, and are expected to beoperational by the end of 2011 and 2012, respectively. The capital cost of theprojects is estimated at $68 million. As at Dec. 31, 2009, the totalcapital incurred on these projects was $2 million.

 

On May 27, 2008, TransAlta announced a 66 MW expansionof its Summerview wind farm located in southern Alberta near Pincher Creek. Thecapital cost of the project is estimated at $123 million with constructioncommencing in the second quarter of 2009 and commercial operations expected tobegin in the first quarter of 2010. As at Dec. 31, 2009, total capitalspend on this project was $106 million. Commercial operations commenced on Feb.23, 2010 and the total capital cost of the project was $123 million *(Note 33).*

 

Keephills 3 plant construction and associated mine capitalcosts are anticipated to be approximately $1.9 billion with final payments forgoods and services due by 2011. TransAlta’s proportionate share isapproximately $988 million. As at Dec. 31, 2009, total spend on thisproject was $707 million.

 

On June 21, 2007, TAGP entered into an agreement withBucyrus Canada Limited and Bucyrus International Inc. for the purchase of adragline to be used primarily in the supply of coal to the Keephills 3 jointventure project. The total dragline purchase costs include approximately $121million for the purchase of the equipment, and an additional $29 million forthe assembly and commissioning of the dragline, for a total of approximately$150 million, with final payments for goods and services due by completion andacceptance of the asset in the third quarter of 2010. As at Dec. 31, 2009,total payments under this agreement were $125 million.

 

Growth project commitments are as follows:

 
| ** **          | ** ** | ** **     | ** ** | ** **     | ** ** | ** **     | ** ** | **Keephills**     | ** ** | **Keephills**     | ** ** | ** **     | ** ** | **Keephills** | ** ** | ** ** | ** ** |
|---------------------|------------|----------------|------------|----------------|------------|----------------|------------|-------------------|------------|-------------------|------------|----------------|------------|---------------|------------|------------|------------|
| ** **          | ** ** | **Kent Hills** | ** ** | **Bone Creek** | ** ** | **Ardenville** | ** ** | **Unit 1 uprate** | ** ** | **Unit 2 uprate** | ** ** | **Summerview** | ** ** | **Unit 3**    | ** ** | **Total**  | ** ** |
| 2010                |       | 82             |       | 44             |       | 108            |       | 3                 |       | 5                 |       | 17             |       | 238           |       | 497        |       |
| 2011                |       | –         |       | –         |       | –         |       | 30                |       | 14                |       | –         |       | 43            |       | 87         |       |
| 2012                |       | –         |       | –         |       | –         |       | –            |       | 14                |       | –         |       | –        |       | 14         |       |
| 2013                |       | –         |       | –         |       | –         |       | –            |       | –            |       | –         |       | –        |       | –     |       |
| 2014                |       | –         |       | –         |       | –         |       | –            |       | –            |       | –         |       | –        |       | –     |       |
| 2015 and thereafter |       | –         |       | –         |       | –         |       | –            |       | –            |       | –         |       | –        |       | –     |       |
| **Total**           | ** ** | **82**         | ** ** | **44**         | ** ** | **108**        | ** ** | **33**            | ** ** | **33**            | ** ** | **17**         | ** ** | **281**       | ** ** | **598**    | ** ** |

 

**G.****     ****Other**

 

A significant portion of the Corporation’s electricity andthermal sales revenues are subject to PPAs and long-term contracts. CommencingJan. 1, 2001, a large portion of Alberta’s coal generating assets becamesubject to long-term PPAs for a period approximating the remaining life of eachplant or unit. These PPAs set a production requirement and availability targetfor each plant or unit and the price at which each MWh will be supplied to thecustomer. Remaining coal capacity in Alberta is sold on the open electricitymarket.

 

A portion of Poplar Creek’s electrical and all of its steamcapacity is committed to the customer under a long-term contract. The remainingelectrical capacity may be taken by the customer at market prices or sold onthe open electricity market by TransAlta. Other gas-fired facilities in Albertasupply steam and/or electricity to specified customers under long-termcontracts with additional requirements for availability, reliability, and otherplant-specific performance measures.

 

Sarnia has 20-year contracts with a customer group withthree five-year options for extensions to the contracts. The contracts allowfor up to 40 per cent of the plant’s maximum capacity. These contracts setpayments for peak MWs, total MWhs supplied to the customers and steam consumed,while TransAlta assumes the availability and heat rate risk. On Sept. 30, 2009,TransAlta signed a new agreement with the Ontario Power Authority to supply upto 444 MWs of electricity to the Ontario electricity market, which waseffective on July 1, 2009 and expires on Dec. 31, 2025. The remainingcapacity at Sarnia is available for export to the merchant market, based onmarket prices. Electrical production at the remaining Ontario plants is subjectto contracts expiring in three to eight years. 

 

Mississauga, Windsor-Essex, and Ottawa have contracts thatset availability targets and the price at which the plant will be paid per MWhproduced, as well as risk sharing of fuel costs based on market prices. Thermalenergy contracts for Mississauga and Windsor expire at the same time as theenergy production contracts and are with a different customer base. Ottawa hasthermal contracts with three different customers. The contract with the maincustomer expires at the end of 2022. These contracts set payments for volumesconsumed, while TA Cogen assumes the heat rate risk. On Oct. 12, 2007, theCorporation signed an agreement amending the original PPA with the OntarioElectricity Financial Corporation (“OEFC”) for the Ottawa Cogeneration PowerPlant. The agreement was entered into to ensure continued plant productionfollowing the expiry of long-term natural gas supply contracts. The agreementis in effect from Nov. 1, 2007 until Dec. 31, 2012.

 

 

Notes to Consolidated Financial Statements  |  41

 

----

 

***28.  PRIOR PERIOD REGULATORYDECISION***

 

In response to a complaint filed by San Diego Gas &Electric Company under Section 206 of the Federal Power Act (“FPA”), theFederal Energy Regulatory Commission (“FERC”) established a claim ofapproximately U.S.$46 million in refunds owing by TransAlta for sales made byit in the organized markets of the California Power Exchange (“PX”) and theCalifornia Independent System Operator (“ISO”) during the Oct. 2, 2000through June 20, 2001 period (the “Main Refund Transactions”). TransAltahas provided U.S.$46 million to account for refund liabilities relating to MainRefund Transactions. TransAlta filed a cost-of-service-based petition forrelief from these refund obligations. FERC rejected TransAlta’s reliefpetition. On Dec. 1, 2006, TransAlta filed for rehearing of FERC’srejection. On Aug. 24, 2007, the U.S. Court of Appeals for the NinthCircuit granted the appeal. TransAlta has requested a rehearing; however, FERChas yet to make a ruling on such a request and such a decision is not expectedin the near future.

 

During settlement negotiations, the California parties havesought to obtain refunds for two sets of transactions beyond the Main RefundTransactions. The first set includes sales made by sellers in the PX and ISOmarkets in the period May 1 to Oct. 1, 2001 (the “Summer Transactions”).The other set includes bilateral transactions between all sellers and acomponent of the California Department of Water Resources (“CDWR”) referred toas CERS (the “CERS Transactions”). FERC has specifically rejected attempts tointroduce refunds for the Summer and CERS Transactions. Nonetheless, theCalifornia parties have sought rehearing of FERC’s refusal and appealed therefusal to the U.S. Court of Appeals for the Ninth Circuit. The Ninth Circuitheld that FERC’s authorization of market-based rate tariffs in theseproceedings complied with the FPA, but that FERC erred in refusing refunds onthe grounds that it lacked authority to order refunds for violations of itsreporting requirement and remanded the case for further refund proceedings. Thecourt did not itself order any refunds, leaving it to FERC to considerappropriate remedial options.

 

On March 21, 2008, FERC issued an Order on Remandestablishing a refund hearing before an Administrative Law Judge to determinewhether any individual public utility seller’s violation of FERC’s market-basedrate quarterly reporting requirement failed to disclose an increased marketshare sufficient to give it the ability to exercise market power and thus causeits market-based rates to be unjust and unreasonable in California during the2000–2001 period. The California parties appealed FERC’s basis for determiningrefund liability but the appeal was denied by FERC on Oct. 6, 2008. TheCalifornia Parties have sought rehearing of FERC’s refusal and appealed therefusal to the U.S. Court of Appeals for the Ninth Circuit. In a decisionissued Aug. 24, 2007, which denied rehearing remanded matters to FERC, theNinth Circuit ruled that FERC had properly excluded both the SummerTransactions and the CERS Transactions from the complaint proceeding. FERC hasyet to respond to the remand.

 

TransAlta does not presently believe the California partieswill be successful in obtaining refunds alleged for the Summer and CERStransactions. TransAlta has not made any provision for such alleged refunds atthis time.

 

 

***29.  SEGMENT DISCLOSURES***

 

**A.      Descriptionof Reportable Segments**

 

The Corporation has two reportable segments as described inNote 1.

 

Each business segment assumes responsibility for itsoperating results measured as operating income or loss.

 

Generation expenses include COD’s intersegment charge forenergy marketing and financial risk management services in the amount of $32million (2008–$30 million, 2007–$27 million). COD’s operating expenses arepresented net of these intersegment charges.

 

The accounting policies of the segments are the same asthose described in Note 1. Intersegment transactions are accounted for on acost-recovery basis that approximates market rates.

 

 

**42 **|  TransAlta Corporation

----

 

**B.      ReportedSegment Earnings and Segment Assets**

 

**I.        Earningsinformation**

 
| **Year ended Dec. 31, 2009**                               | ** ** | **Generation** | ** ** | **COD**    | ** ** | **Corporate** | ** ** | **Total**  | ** ** |
|-----------------------------------------------------------------|------------|----------------|------------|------------|------------|---------------|------------|------------|------------|
| Revenues                                                        | ** ** | **2,723**      | ** ** | **47**     | ** ** | **–**    | ** ** | **2,770**  | ** ** |
| Fuel and purchased power                                        | ** ** | **(1,228**     | **)**      | **–** | ** ** | **–**    | ** ** | **(1,228** | **)**      |
| ** **                                                      | ** ** | **1,495**      | ** ** | **47**     | ** ** | **–**    | ** ** | **1,542**  | ** ** |
| Operations, maintenance, and  administration                    |       | **550**        | ** ** | **31**     | ** ** | **86**        | ** ** | **667**    | ** ** |
| Depreciation and amortization                                   | ** ** | **453**        | ** ** | **4**      | ** ** | **18**        | ** ** | **475**    | ** ** |
| Taxes, other than income taxes                                  | ** ** | **22**         | ** ** | **–** | ** ** | **–**    | ** ** | **22**     | ** ** |
| Intersegment cost allocation                                    | ** ** | **32**         | ** ** | **(32**    | **)**      | **–**    | ** ** | **–** | ** ** |
|                                                            | ** ** | **1,057**      | ** ** | **3**      | ** ** | **104**       | ** ** | **1,164**  | ** ** |
|                                                            | ** ** | **438**        | ** ** | **44**     | ** ** | **(104**      | **)**      | **378**    | ** ** |
| Foreign exchange gain *(Note 7)*                                |       |           |       |       |       |          | ** ** | **8**      | ** ** |
| Writedown of mining development  costs *(Note 3)*               |       |           |       |       |       |          | ** ** | **(16**    | **)**      |
| Net interest expense *(Notes 7 and 17)*                         |       |           |       |       |       |          | ** ** | **(144**   | **)**      |
| Other income *(Note 4)*                                         |       |           |       |       |       |          | ** ** | **8**      | ** ** |
| **Earnings before  non-controlling interests and income taxes** |       |           |       |       |       |          | ** ** | **234**    | ** ** |

 
| **Year ended Dec. 31, 2008**                               | ** ** | **Generation** | ** ** | **COD**    | ** ** | **Corporate** | ** ** | **Total**  | ** ** |
|-----------------------------------------------------------------|------------|----------------|------------|------------|------------|---------------|------------|------------|------------|
| Revenues                                                        |       | 3,005          |       | 105        |       | **–**    |       | 3,110      |       |
| Fuel and purchased power                                        |       | (1,493         | )          | **–** |       | **–**    |       | (1,493     | )          |
|                                                            |       | 1,512          |       | 105        |       | **–**    |       | 1,617      |       |
| Operations, maintenance, and  administration                    |       | 487            |       | 53         |       | 97            |       | 637        |       |
| Depreciation and amortization                                   |       | 409            |       | 3          |       | 16            |       | 428        |       |
| Taxes, other than income taxes                                  |       | 19             |       | **–** |       | **–**    |       | 19         |       |
| Intersegment cost allocation                                    |       | 30             |       | (30        | )          | **–**    |       | **–** |       |
|                                                            |       | 945            |       | 26         |       | 113           |       | 1,084      |       |
|                                                            |       | 567            |       | 79         |       | (113          | )          | 533        |       |
| Foreign exchange loss *(Note 7)*                                |       |           |       |       |       |          |       | (12        | )          |
| Net interest expense *(Notes 7 and 17)*                         |       |           |       |       |       |          |       | (110       | )          |
| Equity loss *(Note 24)*                                         |       |           |       |       |       |          |       | (97        | )          |
| Other income *(Note 4)*                                         |       |           |       |       |       |          |       | 5          |       |
| **Earnings before  non-controlling interests and income taxes** |       |           |       |       |       |          |       | 319        |       |

 
| **Year ended Dec. 31, 2007**                               | ** ** | **Generation** |   | **COD**    | ** ** | **Corporate** |   | **Total**  | ** ** |
|-----------------------------------------------------------------|------------|----------------|--------|------------|------------|---------------|--------|------------|------------|
| Revenues                                                        |       | 2,720          |   | 55         |       | **–**    |   | 2,775      |       |
| Fuel and purchased power                                        |       | (1,231         | )      | **–** |       | **–**    |   | (1,231     | )          |
|                                                            |       | 1,489          |   | 55         |       | **–**    |   | 1,544      |       |
| Operations, maintenance, and  administration                    |       | 447            |   | 34         |       | 96            |   | 577        |       |
| Depreciation and amortization                                   |       | 391            |   | 1          |       | 14            |   | 406        |       |
| Taxes, other than income taxes                                  |       | 20             |   | **–** |       | **–**    |   | 20         |       |
| Intersegment cost allocation                                    |       | 27             |   | (27        | )          | **–**    |   | **–** |       |
|                                                            |       | 885            |   | 8          |       | 110           |   | 1,003      |       |
|                                                            |       | 604            |   | 47         |       | (110          | )      | 541        |       |
| Foreign exchange gain *(Note 7)*                                |       |           |   |       |       |          |   | 3          |       |
| Net interest expense *(Notes 7 and 17)*                         |       |           |   |       |       |          |   | (133       | )          |
| Equity loss *(Note 24)*                                         |       |           |   |       |       |          |   | (50        | )          |
| Other income *(Note 4)*                                         |       |           |   |       |       |          |   | 16         |       |
| **Earnings before  non-controlling interests and income taxes** |       |           |   |       |       |          |   | 377        |       |

 

Included above in Generation is $9 million (2008–$5 million,2007–$5 million) of incentives received under a Government of Canada program inrespect of power generation from qualifying wind and hydro projects.

 

 

Notes toConsolidated Financial Statements  | **43**

----

 

**II.       SelectedConsolidated Balance Sheets information**

 
| **As at Dec. 31, 2009**  | ** ** | **Generation** | ** ** | **COD** | ** ** | **Corporate** | ** ** | **Total** | ** ** |
|-------------------------------|------------|----------------|------------|---------|------------|---------------|------------|-----------|------------|
| Goodwill *(Note 14)*          | ** ** | **404**        | ** ** | **30**  | ** ** | **–**    | ** ** | **434**   | ** ** |
| Total segment assets          | ** ** | **9,133**      | ** ** | **148** | ** ** | **481**       | ** ** | **9,762** | ** ** |
| ** **                    |       |           |       |    |       |          |       |      |       |
| **As at  Dec. 31, 2008** |       |           |       |    |       |          |       |      |       |
| Goodwill *(Note 14)*          |       | 112            |       | 30      |       | –        |       | 142       |       |
| Total segment assets          |       | 7,119          |       | 206     |       | 499           |       | 7,824     |       |

 

A portion of goodwill is related to CE Gen, aself-sustaining foreign operation denominated in U.S. dollars. Unrealizedforeign exchange gains and losses related to the translation of self-sustainingforeign operations do not affect net earnings and as such translation gains andlosses are reflected in AOCI.

 

**III.      SelectedConsolidated Statements of Cash Flows information**

 
| **Year ended Dec. 31, 2009** | ** ** | **Generation** | ** ** | **COD** | ** ** | **Corporate** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|----------------|------------|---------|------------|---------------|------------|-----------|------------|
| Capital expenditures              | ** ** | **879**        | ** ** | **5**   | ** ** | **20**        | ** ** | **904**   | ** ** |

 
| **Year ended  Dec. 31, 2008** |   |   |   |   |   |   |   |   |   |
|------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Capital expenditures               |   | 992    |   | 7      |   | 7      |   | 1,006  |   |

 
| **Year ended  Dec. 31, 2007** |   |   |   |   |   |   |   |   |   |
|------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Capital expenditures               |   | 577    |   | 5      |   | 17     |   | 599    |   |

 

**IV.     Depreciationand amortization on the Consolidated Statements of Cash Flows**

 

The reconciliation between depreciation expense on theConsolidated Statements of Earnings and Consolidated Statements of Cash Flowsis presented below:

 
| **Year ended Dec. 31**                                                       | ** ** |   | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** |   |
|-----------------------------------------------------------------------------------|------------|--------|------------|----------|------------|----------|------------|----------|--------|
| Depreciation and amortization  expense on the Consolidated Statements of Earnings | ** ** |   |       | **475**  |       | 428      |       | 406      |   |
| Depreciation included in fuel and  purchased power                                | ** ** |   |       | **40**   |       | 38       |       | 30       |   |
| Accretion expense included in  depreciation and amortization expense              | ** ** |   |       | **(24**  | **)**      | (22      | )          | (24      | )      |
| Other                                                                             | ** ** |   |       | **2**    |       | 7        |       | 3        |   |
| **Depreciation and  amortization on the Consolidated Statements of Cash Flows**   | ** ** |   |       | **493**  |       | 451      |       | 415      |   |

 

**C.      GeographicInformation**

 

**I.        Revenues**

 
| **Year ended Dec. 31** | ** ** |   | ** ** | **2009**  | ** ** | **2008** | ** ** | **2007** |   |
|-----------------------------|------------|--------|------------|-----------|------------|----------|------------|----------|--------|
| Canada                      | ** ** |   |       | **1,631** |       | 1,839    |       | 1,742    |   |
| U.S.                        | ** ** |   |       | **1,042** |       | 1,165    |       | 932      |   |
| Australia                   | ** ** |   |       | **97**    |       | 106      |       | 101      |   |
| **Total revenue**           | ** ** |   |       | **2,770** |       | 3,110    |       | 2,775    |   |

 

**II.       Property,Plant, and Equipment and Goodwill**

 
| ** **             | ** ** | **Property, Plant, and**    |       |                       |       |
|------------------------|------------|-----------------------------|------------|----------------------------|------------|
| ** **             | ** ** | **Equipment *(****Note 13)* |       | **Goodwill *(****Note 14)* |       |
| **As at Dec. 31** | ** ** | **2009**                    | ** ** | **2008**                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| Canada                 | ** ** | **6,220**                   |       | 4,464                      | ** ** | **360** |   | 57 |   |
| U.S.                   | ** ** | **1,182**                   |       | 1,418                      | ** ** | **74** |   | 85 |   |
| Australia              | ** ** | **176**                     |       | 152                        | ** ** | **–** |   | – |   |
| **Total**              | ** ** | **7,578**                   |       | 6,034                      | ** ** | **434** |   | 142 |   |

 

A change in foreign exchange rates from 2008 to 2009 hasresulted in a $179 million decrease in net book value of PP&E and a $12million decrease in goodwill. The change in foreign exchange rates related totranslation of self-sustaining foreign operations does not affect net earnings;rather any cumulative translation gains and losses are reflected in AOCI.

 

 

**44 **|  TransAlta Corporation

----

** **

***30.  STOCK-BASED COMPENSATIONPLANS***

 

At Dec. 31, 2009, the Corporation had two types ofstock-based compensation plans and an employee share purchase plan.

 

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

 

**A.      FixedStock Option Plans**

 

**I.        CanadianEmployee Plan**

 

This plan is offered to all full-time and part-timeemployees in Canada at or below the level of manager. Options granted underthis plan may not be exercised until one year after grant and thereafter at anamount not exceeding 25 per cent of the grant per year on a cumulative basis untilthe fifth year, after which the entire grant may be exercised until the tenthyear, which is the expiry date.

 

**II.       U.S.Plan**

 

This plan mirrors the rules of the Canadian plan.

 

**III.      AustralianPhantom Plan**

 

This plan came into effect in 2001 and was offered to allfull-time and part-time employees in Australia, excluding directors andofficers. Options under this plan are not physically granted; rather, employeesreceive the equivalent value of shares in cash when exercised. Options grantedunder this plan may not be exercised until one year after grant and thereafterat an amount not exceeding 25 per cent of the grant per year on a cumulativebasis until the fifth year, after which the entire grant may be exercised untilthe tenth year, which is the expiry date.

 

The total options outstanding and exercisable under thesefixed stock option plans at Dec. 31, 2009 are shown below:

 
|                                     |       | **Options outstanding** |       | **Options exercisable** |       |
|------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
|                                     |       |                    | ** ** | **Weighted**            |       |   |   |   |   |   |   |
|                                     | ** ** | **Number**              | ** ** | **average**             | ** ** | **Weighted** | ** ** | **Number** | ** ** | **Weighted** | ** ** |
|                                     | ** ** | **outstanding at**      | ** ** | **remaining**           | ** ** | **average** | ** ** | **exercisable at** | ** ** | **average** | ** ** |
|                                     | ** ** | **Dec. 31, 2009**  | ** ** | **contractual**         | ** ** | **exercise price** | ** ** | **Dec. 31, 2009** | ** ** | **exercise price** | ** ** |
| **Range of exercise prices (per share)** | ** ** | **(millions)**          | ** ** | **life (years)**        | ** ** | **(per share)** | ** ** | **(millions)** | ** ** | **(per share)** | ** ** |
| 11.47–17.70                         |       | 0.2                     |       | 2.9                     |       | 14.81 |   | 0.2 |   | 14.81 |   |
| 17.71–23.94                         |       | 0.4                     |       | 4.2                     |       | 18.81 |   | 0.4 |   | 18.81 |   |
| 23.95–30.18                         |       | 0.1                     |       | 1.3                     |       | 27.70 |   | 0.1 |   | 27.70 |   |
| 30.19–36.41                         |       | 0.8                     |       | 8.1                     |       | 32.29 |   | 0.2 |   | 32.29 |   |
| 11.47–36.41                         |       | 1.5                     |       | 5.9                     |       | 26.36 |   | 0.9 |   | 22.28 |   |

 

The change in the number of optionsoutstanding under the fixed option plans are outlined below:

 
| **Year ended Dec. 31**    |       | **2009**          | ** ** | **2008**           |       | **2007**          | ** ** |
|--------------------------------|------------|-------------------|------------|--------------------|------------|-------------------|------------|
|                           |       |              | ** ** | **Weighted**       | ** ** |              |       | **Weighted** | ** ** |   |   | **Weighted** |   |
|                           | ** ** | **Number of**     |       | **average**        | ** ** | **Number of**     | ** ** | **average** | ** ** | **Number of** |   | **average** | ** ** |
|                           | ** ** | **share options** |       | **exercise price** | ** ** | **share options** | ** ** | **exercise price** | ** ** | **share options** |   | **exercise price** | ** ** |
|                           | ** ** | **(millions)**    |       | **(per share)**    | ** ** | **(millions)**    | ** ** | **(per share)** | ** ** | **(millions)** |   | **(per share)** | ** ** |
| Outstanding, beginning of year | ** ** | **1.7**           |       | **26.80**          |       | 1.2               |       | 19.69 |   | 2.2 |   | 20.20 |   |
| Granted                        | ** ** | **–**        |       | **–**         |       | 1.0               |       | 32.10 |   | – |   | – |   |
| Exercised                      | ** ** | **–**        |       | **–**         |       | (0.3              | )          | 20.52 |   | (0.8 | ) | 21.39 |   |
| Cancelled or expired           | ** ** | **(0.2**          | **)**      | **26.47**          |       | (0.2              | )          | 27.96 |   | (0.2 | ) | 17.52 |   |
| **Outstanding, end  of year**  | ** ** | **1.5**           |       | **26.36**          |       | 1.7               |       | 26.80 |   | 1.2 |   | 19.69 |   |

 

Notes toConsolidated Financial Statements  | **45**

----

 

**B.      PerformanceShare Ownership Plan (“PSOP”)**

 

Under the terms of the PSOP, which commenced in 1997, theCorporation is authorized to grant to employees and directors up to anaggregate of 4.0 million common shares. The number of common shares that couldbe issued under both the PSOP and the share option plans, however, can notexceed 13.0 million common shares. Participants in the PSOP receive grantswhich, after three years, make them eligible to receive a set number of commonshares or cash equivalent up to the maximum of the grant amount plus anyaccrued dividends thereon. Once a participant’s PSOP eligibility has beenestablished, 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.The actual number of common shares or cash equivalent a participant may receiveis determined by the percentile ranking of the total shareholder return overthree years of the Corporation’s common shares amongst the companies comprisingthe comparator group. Expense related to this plan is recorded during theperiod earned, with the corresponding payable recorded in liabilities.

 
| **Year  ended Dec. 31 (millions)**         | **2009** |   | **2008** |   | **2007** |   |
|-------------------------------------------------|----------|--------|----------|--------|----------|--------|
| Number of awards outstanding, beginning of year | **0.9**  |   | 1.0      |   | 1.2      |   |
| Granted                                         | **0.5**  |   | 0.2      |   | 0.4      |   |
| Exercised                                       | **(0.2** | **)**  | (0.2     | )      | (0.1     | )      |
| Cancelled or expired                            | **(0.2** | **)**  | (0.1     | )      | (0.5     | )      |
| **Number of awards outstanding, end of year**   | **1.0**  |   | 0.9      |   | 1.0      |   |

 

In 2009, PSOP compensation expense was $7 million after-tax(2008–$5 million after-tax, 2007–$7 million after-tax), which is included inOM&A expense in the Consolidated Statements of Earnings. In 2009, 224,591common shares were issued at $22.08 per share. In 2008, 221,855 common shareswere issued at $24.30 per share. In 2007, 103,896 common shares were issued at$33.35 per share.

 

**C.      EmployeeShare Purchase Plan**

 

Under the terms of the employee share purchase plan, theCorporation will extend an interest-free loan (up to 30 per cent of anemployee’s base salary) to employees below executive level and allow forpayroll deductions over a three-year period to repay the loan. Executives arenot eligible for this program in accordance with the Sarbanes-Oxleylegislation. The Corporation will purchase these common shares on the openmarket on behalf of employees at prices based on the market price of the sharesas determined on the date of purchase. Employee sales of these shares arehandled in the same manner. At Dec. 31, 2009, accounts receivable fromemployees under the plan totalled $3 million (2008–$3 million).

 

**D.      Stock-BasedCompensation**

 

At Dec. 31, 2009, the Corporation had 1.5 millionoutstanding employee stock options (2008–1.7 million). 

 

The Corporation uses the fair value method of accounting forawards granted under its fixed stock option plans.

 

The estimated fair value of these options granted wasdetermined using the Black-Scholes option-pricing model in 2008 and thebinomial model in 2005 and 2002 using the following assumptions:

 
|                                                          | ** ** | **2008** | ** ** | **2005** | ** ** | **2002** | ** ** |
|---------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Weighted average fair value per  option                       |       | 6.31     |       | 6.84     |       | 4.25     |       |
| Risk-free interest rate (%)                                   |       | 3.6      |       | 4.3      |       | 5.9      |       |
| Expected life of the options  (years)                         |       | 7        |       | 10       |       | 7        |       |
| Dividend rate (%)                                             |       | 3.4      |       | 5.6      |       | 4.9      |       |
| Volatility in the price of the  Corporation’s shares (%) |       | 23.2     |       | 47.0     |       | 28.3     |       |

 

***31.  EMPLOYEE FUTURE BENEFITS***

 

**A.      Description**

 

The Corporation has registered pension plans in Canada andthe U.S. covering substantially all employees of the Corporation in thesecountries and specific named employees working internationally. These planshave defined benefit and defined contribution options, and in Canada there isan additional supplemental defined benefit plan for certain employees whoseannual earnings exceed the Canadian income tax limit. The defined benefitoption of the registered pension plans has been closed for new employees forall periods presented.

 

The latest actuarial valuations for accounting purposes ofthe registered and supplemental pension plans were as at Dec. 31, 2009.The measurement date used to determine plan assets and accrued benefitobligation was Dec. 31, 2009. The last actuarial valuation for fundingpurposes of the registered plan was Dec. 31, 2007, and the effective dateof the next required valuation for funding purposes is Dec. 31, 2010. Thesupplemental pension plan is solely the obligation of the Corporation. The Corporationis not obligated to fund the supplemental plan but is obligated to pay benefitsunder the terms of the plan as they come due. The Corporation has posted aletter of credit in the amount of $58 million to secure the obligations underthe supplemental plan.

 

 

**46 **|  TransAlta Corporation

----

 

The Corporation provides other health and dental benefits tothe age of 65 for both disabled members (other post-employment benefits) andretired members (other post-retirement benefits). The latest actuarialvaluation of these other plans was as at Dec. 31, 2007. The measurementdate used to determine the accrued benefit obligation was also Dec. 31,2009.

 

**B.      CostsRecognized**

 

The costs recognized during the year on the defined benefit,defined contribution, and other health and dental benefit plans are as follows:

 
| **Year ended Dec. 31, 2009**                                                                  | ** ** | **Registered** | ** ** | **Supplemental** | ** ** | **Other**  | ** ** | **Total**  | ** ** |
|----------------------------------------------------------------------------------------------------|------------|----------------|------------|------------------|------------|------------|------------|------------|------------|
| Current service cost                                                                               | ** ** | **2**          | ** ** | **1**            | ** ** | **2**      | ** ** | **5**      | ** ** |
| Interest cost                                                                                      | ** ** | **22**         | ** ** | **3**            | ** ** | **2**      | ** ** | **27**     | ** ** |
| Actual return on plan assets                                                                       | ** ** | **(38**        | )          | –           | ** ** | –     | ** ** | **(38**    | )          |
| Actuarial loss                                                                                     | ** ** | **36**         | ** ** | **7**            | ** ** | **13**     | ** ** | **56**     | ** ** |
| Difference between expected return  and actual return on plan assets                               | ** ** | **19**         | ** ** | –           | ** ** | –     | ** ** | **19**     | ** ** |
| Difference between amortized and  actuarial gain on accrued benefit obligation for the year        | ** ** | **(33**        | )          | **(6**           | )          | **(12**    | )          | **(51**    | )          |
| Amortization of net transition  asset                                                              | ** ** | **(9**         | )          | –           | ** ** | –     | ** ** | **(9**     | )          |
| Defined benefit (income) expense                                                                   | ** ** | **(1**         | )          | **5**            | ** ** | **5**      | ** ** | **9**      | ** ** |
| Defined contribution option expense  of registered pension plan                                    | ** ** | **18**         | ** ** | –           | ** ** | –     | ** ** | **18**     | ** ** |
| **Net expense**                                                                                    | ** ** | **17**         | ** ** | **5**            | ** ** | **5**      | ** ** | **27**     | ** ** |
| ** **                                                                                         | ** ** | ** **     | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Year ended Dec. 31, 2008**                                                                  | ** ** | **Registered** | ** ** | **Supplemental** | ** ** | **Other**  | ** ** | **Total**  | ** ** |
| Current service cost                                                                               |       | 3              |       | 1                |       | 1          |       | 5          |       |
| Interest cost                                                                                      |       | 20             |       | 3                |       | 1          |       | 24         |       |
| Actual return on plan assets                                                                       |       | 55             |       | –           |       | –     |       | 55         |       |
| Actuarial gain                                                                                     |       | (49            | )          | (5               | )          | (4         | )          | (58        | )          |
| Difference between expected return  and actual return on plan assets                               |       | (79            | )          | –           |       | –     |       | (79        | )          |
| Difference between amortized and  actuarial loss on accrued benefit obligation for the year        |       | 50             |       | 6                |       | 5          |       | 61         |       |
| Past service costs                                                                                 |       | –         |       | 2                |       | –     |       | 2          |       |
| Difference between amortized and  actual plan amendments of past service costs for the year        |       | –         |       | (2               | )          | –     |       | (2         | )          |
| Amortization of net transition  asset                                                              |       | (9             | )          | –           |       | –     |       | (9         | )          |
| Defined benefit (income) expense                                                                   |       | (9             | )          | 5                |       | 3          |       | (1         | )          |
| Defined contribution option expense  of registered pension plan                                    |       | 17             |       | –           |       | –     |       | 17         |       |
| **Net expense**                                                                                    |       | 8              |       | 5                |       | 3          |       | 16         |       |
| ** **                                                                                         | ** ** | ** **     | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Year ended Dec. 31, 2007**                                                                  | ** ** | **Registered** | ** ** | **Supplemental** | ** ** | **Other**  | ** ** | **Total**  | ** ** |
| Current service cost                                                                               |       | 4              |       | 2                |       | 1          |       | 7          |       |
| Interest cost                                                                                      |       | 19             |       | 2                |       | 2          |       | 23         |       |
| Actual return on plan assets                                                                       |       | (10            | )          | –           |       | –     |       | (10        | )          |
| Actuarial (gain) loss                                                                              |       | (15            | )          | 6                |       | (2         | )          | (11        | )          |
| Difference between expected return  and actual return on plan assets                               |       | (15            | )          | –           |       | –     |       | (15        | )          |
| Difference between amortized and  actuarial loss (gain) on accrued benefit obligation for the year |       | 16             |       | (4               | )          | 2          |       | 14         |       |
| Amortization of net transition  asset                                                              |       | (9             | )          | –           |       | –     |       | (9         | )          |
| Defined benefit (income) expense                                                                   |       | (10            | )          | 6                |       | 3          |       | (1         | )          |
| Defined contribution option expense  of registered pension plan                                    |       | 15             |       | –           |       | –     |       | 15         |       |
| **Net expense**                                                                                    |       | 5              |       | 6                |       | 3          |       | 14         |       |

 

In 2009, 2008, and 2007, the entirenet expense is related to continuing operations.

 

 

Notes toConsolidated Financial Statements  |  **47**

----

 

**C.      Statusof Plans**

 

The status of the defined benefit andother health and dental benefit plans is as follows:

 
| **Year ended Dec. 31, 2009**                                     | ** ** | **Registered** |   | **Supplemental** | ** ** | **Other**  |       | **Total**  | ** ** |
|-----------------------------------------------------------------------|------------|----------------|--------|------------------|------------|------------|------------|------------|------------|
| Fair value of plan assets                                             | ** ** | **299**        |   | **3**            | ** ** | –     |       | **302**    | ** ** |
| Accrued benefit obligation                                            | ** ** | **358**        |   | **55**           | ** ** | **33**     |       | **446**    | ** ** |
| Funded status–plan deficit                                       | ** ** | **(59**        | **)**  | **(52**          | **)**      | **(33**    | **)**      | **(144**   | **)**      |
| Amounts not yet recognized in the  consolidated financial statements: |       |           |   |             |       |       |       |       |       |
| Unrecognized past service costs                                       | ** ** | **1**          |   | **2**            | ** ** | **2**      |       | **5**      | ** ** |
| Unamortized transition (asset)  obligation                            | ** ** | **(9**         | **)**  | **1**            |       | –     | ** ** | **(8**     | **)**      |
| Unamortized net actuarial gains                                       | ** ** | **85**         |   | **15**           | ** ** | **11**     |       | **111**    | ** ** |
| Total recognized in the  consolidated financial statements:           |       |           |   |             |       |       |       |       |       |
| Accrued benefit asset (liability)                                     | ** ** | **18**         |   | **(34**          | **)**      | **(20**    | **)**      | **(36**    | **)**      |
| Amortization period in years                                          | ** ** | **14**         |   | **14**           | ** ** | **15**     |       |       | ** ** |
| ** **                                                            | ** ** | ** **     |   | ** **       | ** ** | ** ** |       | ** ** | ** ** |
| **Year ended Dec. 31, 2008**                                     | ** ** | **Registered** |   | **Supplemental** | ** ** | **Other**  |       | **Total**  | ** ** |
| Fair value of plan assets                                             |       | 279            |   | 3                |       | –     |       | 282        |       |
| Accrued benefit obligation                                            |       | 324            |   | 47               |       | 20         |       | 391        |       |
| Funded status–plan deficit                                       |       | (45            | )      | (44              | )          | (20        | )          | (109       | )          |
| Amounts not yet recognized in the  consolidated financial statements: |       |           |   |             |       |       |       |       |       |
| Unrecognized past service costs                                       |       | **–**     |   | 1                |       | 3          |       | 4          |       |
| Unamortized transition (asset)  obligation                            |       | (18            | )      | 1                |       | **–** |       | (17        | )          |
| Unamortized net actuarial gains                                       |       | 72             |   | 9                |       | **–** |       | 81         |       |
| Total recognized in the  consolidated financial statements:           |       |           |   |             |       |       |       |       |       |
| Accrued benefit liability                                             |       | 9              |   | (33              | )          | (17        | )          | (41        | )          |
| Amortization period in years                                          |       | 15             |   | 13               |       | 15         |       |       |       |

 

The current portion of the accrued benefit liability isincluded in accounts payable and accrued liabilities on the ConsolidatedBalance Sheets. The long-term portion is included in other assets and deferredcredits and other long-term liabilities.

 
| **Year ended Dec. 31, 2009**     | ** ** | **Registered** | ** ** | **Supplemental** | ** ** | **Other**  | ** ** | **Total**  | ** ** |
|---------------------------------------|------------|----------------|------------|------------------|------------|------------|------------|------------|------------|
| Accrued current liabilities           | ** ** | **–**     | ** ** | **3**            | ** ** | **2**      | ** ** | **5**      | ** ** |
| Other long-term (assets)  liabilities | ** ** | **(18**        | **)**      | **31**           | ** ** | **18**     | ** ** | **31**     | ** ** |
| Accrued benefit (asset) liability     | ** ** | **(18**        | **)**      | **34**           | ** ** | **20**     | ** ** | **36**     | ** ** |
| ** **                            | ** ** | ** **     | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Year ended Dec. 31, 2008**     | ** ** | **Registered** | ** ** | **Supplemental** | ** ** | **Other**  | ** ** | **Total**  | ** ** |
| Accrued current liabilities           |       | –         |       | –           |       | 1          |       | 1          |       |
| Other long-term (assets)  liabilities |       | (9             | )          | 33               |       | 16         |       | 40         |       |
| Accrued benefit (asset) liability     |       | (9             | )          | 33               |       | 17         |       | 41         |       |

 

**D.      Contributions**

 

Expected cash flows on the definedbenefit and other health and dental benefit plans are as follows:

 
|                      | ** ** | **Registered** | ** ** | **Supplemental** | ** ** | **Other** | ** ** | **Total** | ** ** |
|---------------------------|------------|----------------|------------|------------------|------------|-----------|------------|-----------|------------|
| Employer contributions    |       |           |       |             |       |      |       |      |       |
| 2010 (expected)           |       | 6              |       | 3                |       | 3         |       | 12        |       |
| Expected benefit payments |       |           |       |             |       |      |       |      |       |
| 2010                      |       | 26             |       | 3                |       | 3         |       | 32        |       |
| 2011                      |       | 27             |       | 3                |       | 3         |       | 33        |       |
| 2012                      |       | 27             |       | 3                |       | 3         |       | 33        |       |
| 2013                      |       | 27             |       | 3                |       | 3         |       | 33        |       |
| 2014                      |       | 28             |       | 3                |       | 3         |       | 34        |       |
| 2015–2019            |       | 141            |       | 18               |       | 14        |       | 173       |       |

 

 

**48**  |  TransAltaCorporation

----

** **

**E.       PlanAssets**

 

The plan assets of the definedbenefit and other health and dental benefit plans are as follows:

 
|                                                 | ** ** | **Registered** |   | **Supplemental** | ** ** | **Other**  |   | **Total** | ** ** |
|------------------------------------------------------|------------|----------------|--------|------------------|------------|------------|--------|-----------|------------|
| Fair value of plan assets at  Dec. 31, 2007     |       | 356            |   | 2                |       | –     |   | 358       |       |
| Contributions                                        |       | 3              |   | 4                |       | 2          |   | 9         |       |
| Benefits paid                                        |       | (27            | )      | (3               | )          | (2         | )      | (32       | )          |
| Effect of translation on U.S. plans                  |       | 2              |   | –           |       | –     |   | 2         |       |
| Actual return on plan assets(1)                      |       | (55            | )      | –           |       | –     |   | (55       | )          |
| Fair value of plan assets at  Dec. 31, 2008     |       | 279            |   | 3                |       | –     |   | 282       |       |
| Contributions                                        |       | 7              |   | 3                |       | 2          |   | 12        |       |
| Benefits paid                                        |       | (26            | )      | (3               | )          | (2         | )      | (31       | )          |
| Benefits transferred in(2)                           |       | 4              |   | –           |       | –     |   | 4         |       |
| Effect of translation on U.S. plans                  |       | (3             | )      | –           |       | –     |   | (3        | )          |
| Actual return on plan assets(1)                      |       | 38             |   | –           |       | –     |   | 38        |       |
| **Fair value of plan  assets at Dec. 31, 2009** | ** ** | **299**        |   | **3**            | ** ** | **–** |   | **302**   | ** ** |

* *

*1**        **Net of expenses.*

*2**        **Transfer of pension assets for addition of employees.*

 

The Corporation’s investment policy is to seek aconsistently high investment return over time while maintaining an acceptablelevel of risk to satisfy the benefit obligations of the pension plans. The goalis to maintain a long-term rate of return on the fund that at least equals thegrowth of liabilities, currently seven per cent. The pension fund may beinvested in a variety of permitted investments including publicly traded commonor preferred shares, rights or warrants, convertible debentures or preferredsecurities, bonds, debentures, mortgages, notes or other debt instruments ofgovernment agencies or corporations, private company securities, guaranteedinvestment contracts, term deposits, cash or money market securities, andmutual or pooled funds eligible for pension fund investment. The targeted assetallocation is 50 per cent equity and 50 per cent fixed income. Cash and moneymarket instruments may be held from time-to-time as short-term investments oras defensive reserves within the portfolios of each asset class. The fund mayinvest in derivatives for the purpose of hedging the portfolio or altering thedesired mix of the fund. Derivative transactions that leverage the fund in anyway are not permitted without the specific approval of the Corporation’sPension Committee.

 

The allocation of defined benefit plan assets by major assetcategory at Dec. 31, 2009 and 2008 is as follows:

 
| **Year ended Dec. 31, 2009** | ** ** | **Registered** | **Supplemental** | ** ** |
|-----------------------------------|------------|----------------|------------------|------------|
| Equity securities                 | ** ** | **52%**        | **–**       |       |
| Debt securities                   | ** ** | **45%**        | **–**       |       |
| Cash and cash equivalents         | ** ** | **3%**         | **100%**         |       |
| **Total**                         | ** ** | **100%**       | **100%**         |       |

 
| **Year ended Dec. 31, 2008** | ** ** | **Registered** | **Supplemental** | ** ** |
|-----------------------------------|------------|----------------|------------------|------------|
| Equity securities                 |       | 51%            | –           |       |
| Debt securities                   |       | 48%            | –           |       |
| Cash and cash equivalents         |       | 1%             | 100%             |       |
| Total                             |       | 100%           | 100%             |       |

 

Plan assets do not include any common shares of theCorporation at Dec. 31, 2009. The Corporation charged the registered plan$0.1 million for administrative services provided for the year endedDec. 31, 2009 (2008 – $0.1 million).

 

The fair value of the total definedbenefit plan assets by major asset category at Dec. 31, 2009 is asfollows:

 
| **Year ended Dec. 31, 2009** | ** ** | **Level I** | ** ** | **Level II** | ** ** | **Level III** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|-------------|------------|--------------|------------|---------------|------------|-----------|------------|
| Equity securities                 |       | 132         |       | 11           |       | 12            |       | 155       |       |
| Debt securities                   |       | 125         |       | 11           |       | –        |       | 136       |       |
| Cash and cash equivalents         |       | 11          |       | –       |       | –        |       | 11        |       |
| **Total**                         | ** ** | **268**     | ** ** | **22**       | ** ** | **12**        | ** ** | **302**   | ** ** |

 

 

Notes toConsolidated Financial Statements  |  49

----

 

The fair value of the Canadian defined benefit plan assetsby major category at Dec. 31, 2009 is as follows:

 
| **Year ended Dec. 31, 2009** | ** ** | **Level I** |   | **Level II** | ** ** | **Level III** |   | **Total** | ** ** |
|-----------------------------------|------------|-------------|--------|--------------|------------|---------------|--------|-----------|------------|
| Equity securities                 |       | 132         |   | –       |       | 12            |   | 144       |       |
| Debt securities                   |       | 125         |   | –       |       | –        |   | 125       |       |
| Cash and cash equivalents         |       | 7           |   | –       |       | –        |   | 7         |       |
| **Total**                         | ** ** | **264**     |   | **–**   | ** ** | **12**        |   | **276**   | ** ** |

 

The fair value of the U.S. definedbenefit plan assets by major category at Dec. 31, 2009 is as follows:

 
| **Year ended Dec. 31, 2009** | ** ** | **Level I** |   | **Level II** | ** ** | **Level III** |   | **Total** | ** ** |
|-----------------------------------|------------|-------------|--------|--------------|------------|---------------|--------|-----------|------------|
| Equity securities                 |       | –      |   | 11           |       | –        |   | 11        |       |
| Debt securities                   |       | –      |   | 11           |       | –        |   | 11        |       |
| Cash and cash equivalents         |       | 1           |   | –       |       | –        |   | 1         |       |
| **Total**                         | ** ** | **1**       |   | **22**       | ** ** | **–**    |   | **23**    | ** ** |

 

The fair value of the supplemental planassets by major category at Dec. 31, 2009 is as follows:

 
| **Year ended Dec. 31, 2009** | ** ** | **Level I** |   | **Level II** | ** ** | **Level III** |   | **Total** | ** ** |
|-----------------------------------|------------|-------------|--------|--------------|------------|---------------|--------|-----------|------------|
| Equity securities                 |       | –      |   | –       |       | –        |   | –    |       |
| Debt securities                   |       | –      |   | –       |       | –        |   | –    |       |
| Cash and cash equivalents         |       | 3           |   | –       |       | –        |   | 3         |       |
| **Total**                         | ** ** | **3**       |   | **–**   | ** ** | **–**    |   | **3**     | ** ** |

 

**F.       AccruedBenefit Obligation**

 

The accrued benefit obligation on thedefined benefit and other health and dental benefit plans is as follows:

 
|                                                     | ** ** | **Registered** |   | **Supplemental** | ** ** | **Other** |   | **Total** | ** ** |
|----------------------------------------------------------|------------|----------------|--------|------------------|------------|-----------|--------|-----------|------------|
| Accrued benefit obligation as at  Dec. 31, 2007     |       | 373            |   | 49               |       | 23        |   | **445**   |       |
| Current service cost                                     |       | 3              |   | 1                |       | 1         |   | **5**     |       |
| Past service cost                                        |       | –         |   | 2                |       | –    |   | **2**     |       |
| Interest cost                                            |       | 20             |   | 3                |       | 1         |   | **24**    |       |
| Benefits paid                                            |       | (27            | )      | (3               | )          | (2        | )      | **(32**   | **)**      |
| Effect of translation on U.S. plans                      |       | 4              |   | –           |       | 1         |   | **5**     |       |
| Actuarial gain                                           |       | (49            | )      | (5               | )          | (4        | )      | **(58**   | **)**      |
| Accrued benefit obligation as at  Dec. 31, 2008     |       | 324            |   | 47               |       | 20        |   | **391**   |       |
| Current service cost                                     |       | 2              |   | 1                |       | 2         |   | **5**     |       |
| Interest cost                                            |       | 22             |   | 3                |       | 2         |   | **27**    |       |
| Benefits paid                                            |       | (26            | )      | (3               | )          | (2        | )      | **(31**   | **)**      |
| Benefits transferred in(1)                               |       | 4              |   | –           |       | –    |   | **4**     |       |
| Effect of translation on U.S. plans                      |       | (4             | )      | –           |       | (2        | )      | **(6**    | **)**      |
| Actuarial loss                                           |       | 36             |   | 7                |       | 13        |   | **56**    |       |
| **Accrued benefit  obligation as at Dec. 31, 2009** | ** ** | **358**        |   | **55**           | ** ** | **33**    |   | **446**   | ** ** |

 

*1   Transferof accrued benefit obligation for addition of employees.*

 

 

50  |  TransAltaCorporation

----

 

**G.      Assumptions**

 

The significant actuarial assumptions adopted in measuringthe Corporation’s accrued benefit obligation on the defined benefit and otherhealth and dental benefit plans are as follows:

 
| **Year ended Dec. 31, 2009**                    | ** ** | **Registered** | **Supplemental** | ** ** | **Other**         | ** ** |
|------------------------------------------------------|------------|----------------|------------------|------------|-------------------|------------|
| Accrued benefit obligation at Dec. 31           |       |           |             |       |              |       |
| Discount rate (%)                                    | ** ** | **6.0**        | **6.0**          | ** ** | **5.7**           | ** ** |
| Rate of compensation increase (%)                    | ** ** | **3.0**        | **3.0**          | ** ** | **–**        | ** ** |
| Benefit cost for year ended  Dec. 31            |       |           |             |       |              |       |
| Discount rate (%)                                    | ** ** | **7.2**        | **7.3**          | ** ** | **7.0**           | ** ** |
| Rate of compensation increase (%)                    | ** ** | **3.2**        | **3.3**          | ** ** | **–**        | ** ** |
| Expected rate of return on plan assets  (%)          | ** ** | **7.1**        | **–**       | ** ** | **–**        | ** ** |
| Assumed health care cost trend rate  at Dec. 31 |       |           |             |       |              |       |
| Health care cost escalation (%)                      | ** ** | **–**     | **–**       | ** ** | **9.2–10.5** | **(1)**    |
| Dental care cost escalation (%)                      | ** ** | **–**     | **–**       | ** ** | **4.0**           | ** ** |
| Provincial health care premium  escalation (%)       | ** ** | **–**     | **–**       | ** ** | **6.0**           | ** ** |
| ** **                                           | ** ** | ** **     | ** **       | ** ** | ** **        | ** ** |
| **Year ended Dec. 31, 2008**                    | ** ** | **Registered** | **Supplemental** | ** ** | **Other**         | ** ** |
| Accrued benefit obligation at  Dec. 31          |       |           |             |       |              |       |
| Discount rate (%)                                    |       | 7.2            | 7.3              |       | 7.1               |       |
| Rate of compensation increase (%)                    |       | 3.2            | 3.3              |       | –            |       |
| Benefit cost for year ended  Dec. 31            |       |           |             |       |              |       |
| Discount rate (%)                                    |       | 5.5            | 5.5              |       | 5.7               |       |
| Rate of compensation increase (%)                    |       | 3.7            | 3.8              |       | –            |       |
| Expected rate of return on plan  assets (%)          |       | 7.1            | –           |       | –            |       |
| Assumed health care cost trend rate  at Dec. 31 |       |           |             |       |              |       |
| Health care cost escalation (%)                      |       | –         | –           |       | 9.0–10.5     | **(1)**    |
| Dental care cost escalation (%)                      |       | –         | –           |       | 4.0               |       |
| Provincial health care premium  escalation (%)       |       | –         | –           |       | 2.5               |       |

 

*1  Decreasing gradually to five per cent by 2018for Canadian plans and by 2017–2020 for U.S. plans and remaining at that levelthereafter.*

 

The expected long-term rate of return on plan assets isbased on past performance and economic forecasts for the types of investmentsheld by the plan.

 

**H.      SensitivityAnalysis**

 

The following changes would occur in the defined benefit andother health and dental benefit plans if there was a change of +/– onepercentage point in the discount rate, trend rate, or expected rate of returnon plan assets:

 

Canadian plans:

 
| **Year ended Dec. 31, 2009**                          | ** ** | **Registered** |   | **Supplemental** | ** ** | **Other**  |       |
|------------------------------------------------------------|------------|----------------|--------|------------------|------------|------------|------------|
| 1% increase in the discount rate                           |       |           |   |             |       |       |       |
| Impact on 2009 accrued benefit  obligation                 | ** ** | **(30**        | **)**  | **(6**           | **)**      | **(1**     | **)**      |
| Impact on 2010 estimated expense                           | ** ** | **(1**         | **)**  | **(1**           | **)**      | **–** |       |
| 1% decrease in the discount rate                           |       |           |   |             |       |       |       |
| Impact on 2009 accrued benefit  obligation                 | ** ** | **35**         |   | **8**            | ** ** | **2**      |       |
| Impact on 2010 estimated expense                           | ** ** | **1**          |   | **1**            | ** ** | **–** |       |
| 1% increase in the trend rate                              |       |           |   |             |       |       |       |
| Impact on 2009 accrued benefit  obligation                 | ** ** | **–**     |   | **–**       | ** ** | **2**      |       |
| Impact on 2010 estimated expense                           | ** ** | **–**     |   | **–**       | ** ** | **–** |       |
| 1% decrease in the trend rate                              |       |           |   |             |       |       |       |
| Impact on 2009 accrued benefit  obligation                 | ** ** | **–**     |   | **–**       | ** ** | **(1**     | **)**      |
| Impact on 2010 estimated expense                           | ** ** | **–**     |   | **–**       | ** ** | **–** |       |
| 1% increase in the expected rate of  return on plan assets |       |           |   |             |       |       |       |
| Impact on 2010 estimated expense                           | ** ** | **(3**         | **)**  | **–**       |       | **–** | ** ** |
| 1% decrease in the expected rate of  return on plan assets |       |           |   |             |       |       |       |
| Impact on 2010 estimated expense                           | ** ** | **3**          |   | **–**       | ** ** | **–** |       |

 

 

Notes toConsolidated Financial Statements  |  51

----

 

U.S.plans:

 
| **Year ended Dec. 31, 2009**                          | ** ** | **Pension** |   | **Other**  | ** ** |
|------------------------------------------------------------|------------|-------------|--------|------------|------------|
| 1% increase in the discount rate                           |       |        |   |       |       |
| Impact on 2009 accrued benefit  obligation                 | ** ** | **(2**      | **)**  | **(1**     | **)**      |
| Impact on 2010 estimated expense                           | ** ** | **–**  |   | **–** |       |
| 1% decrease in the discount rate                           |       |        |   |       |       |
| Impact on 2009 accrued benefit  obligation                 | ** ** | **3**       |   | **1**      |       |
| Impact on 2010 estimated expense                           | ** ** | **–**  |   | **–** |       |
| 1% increase in the trend rate                              |       |        |   |       |       |
| Impact on 2009 accrued benefit  obligation                 | ** ** | **–**  |   | **2**      |       |
| Impact on 2010 estimated expense                           | ** ** | **–**  |   | **–** |       |
| 1% decrease in the trend rate                              |       |        |   |       |       |
| Impact on 2009 accrued benefit  obligation                 | ** ** | **–**  |   | **(1**     | **)**      |
| Impact on 2010 estimated expense                           | ** ** | **–**  |   | **–** | ** ** |
| 1% increase in the expected rate of  return on plan assets |       |        |   |       |       |
| Impact on 2010 estimated expense                           | ** ** | **–**  |   | **–** | ** ** |
| 1% decrease in the expected rate of  return on plan assets |       |        |   |       |       |
| Impact on 2010 estimated expense                           | ** ** | **–**  |   | **–** | ** ** |

 

 

***32.  JOINT VENTURES***

 

Joint ventures at Dec. 31, 2009 included the following:

 
| **Joint venture**                |   | **Description**                                                                                                                                         |
|----------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
| Sheerness  joint venture         | 50%    | Coal-fired  plant in Alberta, of which TA Cogen has a 50 per cent interest, operated by  Canadian Utilities Limited                                     |
| Meridian  joint venture          | 50%    | Cogeneration  plant in Alberta, of which TA Cogen has a 50 per cent interest, operated by  TransAlta                                                    |
| Fort  Saskatchewan joint venture | 60%    | Cogeneration  plant in Alberta, of which TA Cogen has a 60 per cent interest, operated by  TransAlta                                                    |
| McBride  Lake joint venture      | 50%    | Wind  generation facilities in Alberta operated by TransAlta                                                                                            |
| Goldfields  Power joint venture  | 50%    | Gas-fired  plant in Australia operated by TransAlta                                                                                                     |
| CE  Generation LLC               | 50%    | Geothermal  and gas plants in the United States operated by CE Gen affiliates                                                                           |
| Genesee  3                       | 50%    | Coal-fired  plant in Alberta operated by Capital Power Corporation                                                                                      |
| Wailuku                          | 50%    | A  run-of-river generation facility in Hawaii operated by MidAmerican Energy  Holdings Company                                                          |
| Keephills  3                     | 50%    | Coal-fired  plant under construction in Alberta. The plant is being developed jointly  with Capital Power Corporation and will be operated by TransAlta |
| Taylor  Hydro                    | 50%    | Hydro  facility in Alberta operated by TransAlta                                                                                                        |
| Soderglen                        | 50%    | Wind  generation facilities in Alberta operated by TransAlta                                                                                            |
| Pingston                         | 50%    | Hydro  facility in British Columbia operated by TransAlta                                                                                               |

 

 

52  |  TransAltaCorporation

----

 

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

 
|                                                          | ** ** | **2009**  |   | **2008** | ** ** | **2007** |   |
|---------------------------------------------------------------|------------|-----------|--------|----------|------------|----------|--------|
| **Results of  operations**                                    |       |      |   |     |       |     |   |
| Revenues                                                      | ** ** | **539**   |   | 619      |       | 609      |   |
| Expenses                                                      | ** ** | **(409**  | **)**  | (494     | )          | (454     | )      |
| Non-controlling interests                                     | ** ** | **(34**   | **)**  | (55      | )          | (44      | )      |
| Proportionate share of net earnings                           | ** ** | **96**    |   | 70       |       | 111      |   |
| **Cash flows**                                                |       |      |   |     |       |     |   |
| Cash flow from operations                                     | ** ** | **111**   |   | 273      |       | 112      |   |
| Cash flow used in investing  activities                       | ** ** | **(168**  | **)**  | (376     | )          | (147     | )      |
| Cash flow (used in) from financing  activities                | ** ** | **(60**   | **)**  | 30       |       | (93      | )      |
| Proportionate share of decrease in  cash and cash equivalents | ** ** | **(117**  | **)**  | (73      | )          | (128     | )      |
| **Financial position**                                        |       |      |   |     |       |     |   |
| Current assets                                                | ** ** | **147**   |   | 166      |       | 91       |   |
| Long-term assets                                              | ** ** | **2,371** |   | 2,144    |       | 1,924    |   |
| Current liabilities                                           | ** ** | **(114**  | **)**  | (202     | )          | (144     | )      |
| Long-term liabilities                                         | ** ** | **(356**  | **)**  | (503     | )          | (390     | )      |
| Non-controlling interests                                     | ** ** | **(325**  | **)**  | (351     | )          | (373     | )      |
| Proportionate share of net assets                             | ** ** | **1,723** |   | 1,254    |       | 1,108    |   |

 

 

***33.  SUBSEQUENT EVENTS***

 

TransAlta has evaluated subsequent events through toFeb. 23, 2010, which represents the date the consolidated financialstatements were issued. TransAlta has not evaluated any subsequent events afterthat date.

 

**Summerview2**

 

On Feb. 23, 2010, the 66 MW Summerview 2 wind farm begancommercial operations on budget and ahead of schedule. The total cost of theproject was $123 million.

 

**Kent Hills Expansion**

 

On Jan. 11, 2010, TransAlta announced that it had beenawarded a 25-year contract to provide an additional 54 MW of wind power to NewBrunswick Power Distribution and Customer Service Corporation. Under theagreement, TransAlta will expand its existing 96 MW Kent Hills wind facility.The total capital cost of the project is estimated to be $100 million and isexpected to begin commercial operations by the end of 2010. Natural Forces willhave the option to purchase up to a 17 per cent interest in the new operatingfacility upon completion.

 

 

Notes toConsolidated Financial Statements  |  53

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