<PAGE>
 
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                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                               ----------------
                                   FORM 10-K
 
                               ----------------
 
  (MARK ONE)
 X  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
    ACT OF 1934
 
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
 
                                      OR
 
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
    EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM         TO
 
                        COMMISSION FILE NUMBER 2-23416
 
                              BOSTON GAS COMPANY
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
             MASSACHUSETTS                           04-1103580
    (STATE OR OTHER JURISDICTION OF     (I.R.S. EMPLOYER IDENTIFICATION NO.)
    INCORPORATION OR ORGANIZATION)     
                                       
           ONE BEACON STREET
      BOSTON, MASSACHUSETTS 02108                  (617) 742-8400             
    (ADDRESS OF PRINCIPAL EXECUTIVE       (REGISTRANT'S TELEPHONE NUMBER) 
               OFFICES)
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
 
<TABLE>
<CAPTION>
         TITLE
         OF EACH                       NAME OF EACH EXCHANGE ON
         CLASS                              WHICH REGISTERED
         -------                        ------------------------
         <S>                            <C>
           None                                   None
</TABLE>
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
                                     None
 
  Indicate by Check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
 
                              Yes  X         No
 
  Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this form 10-K or any
amendment to this form 10-K.
 
  Indicate the number of shares outstanding of the registrant's class of
common stock as of March 10, 1997.
 
      ALL COMMON STOCK, 514,184 SHARES, ARE HELD BY EASTERN ENTERPRISES.
 
  The registrant meets the conditions set forth in General Instruction
(J)(1)(a) and (b) of Form 10-K and is therefore filing this form with the
reduced disclosure format.
 
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<PAGE>
 
                               BOSTON GAS COMPANY
                                   FORM 10-K
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
 
                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION> 
PART I
  Item 1.         Business
                                                                                                   PAGE
                                                                                                   ----
<S>                                                                                                <C>
           General................................................................................   1
           Markets and Competition................................................................   1
           Gas Throughput.........................................................................   1
           Gas Supply.............................................................................   2
           Regulation.............................................................................   3
           Seasonality and Working Capital........................................................   3
           Environmental Matters..................................................................   4
           Employees..............................................................................   4
  Item 2.  Properties.............................................................................   4
  Item 3.  Legal Proceedings......................................................................   4
  Item 4.  Submission of Matters to a Vote of Security Holders....................................   4
  Glossary........................................................................................   5
PART II
  Item 5.  Market for the Registrant's Common Equity and Related Stockholder Matters..............   6
  Item 6.  Selected Financial Data................................................................   6
  Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations..   6
  Item 8.  Financial Statements and Supplementary Data............................................   7
  Item 9.  Changes in and disagreements with Accountants on Accounting and Financial Disclosure...   7
PART III
  Item 10. Directors and Executive Officers of the Registrant.....................................   7
  Item 11. Executive Compensation.................................................................   7
  Item 12. Security Ownership of Certain Beneficial Owners and Management.........................   7
  Item 13. Certain Relationships and Related Transactions.........................................   7
PART IV
  Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K........................   8
</TABLE>
 
<PAGE>
 
                                    PART I
 
ITEM 1. BUSINESS.
 
GENERAL
 
  Boston Gas Company (the "Company"), is engaged in the transportation and
sale of natural gas to approximately 525,000 residential, commercial and
industrial customers in Boston, Massachusetts and 73 other communities in
eastern and central Massachusetts. The Company also sells gas for resale in
Massachusetts and other states. The Company has one subsidiary, Massachusetts
LNG Incorporated ("Mass LNG"), which holds a long-term lease on two liquefied
natural gas ("LNG") facilities. The Company is the largest natural gas
distribution company in New England, has been in business for 174 years and is
the second oldest gas company in the United States. All of the common stock of
the Company is held by Eastern Enterprises ("Eastern"), which is headquartered
in Weston, Massachusetts. Eastern has owned Boston Gas Company since 1929.
 
  For definition of certain industry specific terms, see the Glossary at the
end of Part I and appearing on page 5.
 
  The Company provides both local transportation services and gas supply for
all customer classes. All residential customers currently purchase combined or
"bundled" supply and transportation services from the Company. In 1993, the
Massachusetts Department of Public Utilities ("the Department") approved the
Company's proposal to unbundle local transportation service and gas sales
service for its largest commercial and industrial customers. In 1996, 143 of
the approximately 450 eligible customers purchased gas supplies from third
parties. In November 1996, the Department approved the Company's proposal to
offer unbundled transportation service to all of its commercial and industrial
customers, numbering over 41,000. In December 1996, an additional 129
customers chose to purchase gas from 14 third party suppliers. The Company
views these suppliers as partners in marketing gas and increasing throughput
on the Company's system and continues to work closely with them to ensure that
competitively priced gas supplies can be reliably delivered to customers.
 
  The Company offers both firm and non-firm services. Firm local
transportation services and sales are provided under rate tariffs filed with
the Department that typically obligate the Company to provide service without
interruption throughout the year. Non-firm transportation services and sales
are generally provided to large commercial and industrial customers who can
use gas and oil interchangeably, or to other gas companies for resale.
 
MARKETS AND COMPETITION
 
  The Company competes with other fuel distributors, primarily oil dealers,
throughout its service territory. Over the last six years, the Company has
increased its share in the total stationary energy market from 28% to 36%.
This market share compares to the national level of approximately 43%, and may
represent a growth opportunity for the Company. However, actual experience
cannot be predicted with certainty, and will depend on such factors as the
price of competitive energy sources, the level of investment by the Company
and customer perceptions of relative value.
 
  Residential customers comprise 92% of its customer base, while commercial
and industrial establishments account for the remaining 8%. Volumetrically,
residential customers account for 30% of total throughput and 36% of total
firm throughput, while commercial and industrial customers account for 70% of
total throughput and 64% of total firm throughput. In 1996, approximately 60%
of commercial and industrial customers' total throughput was local
transportation only services.
 
GAS THROUGHPUT
 
  The following table, in billions of cubic feet of natural gas at 1,000 Btu
per cubic foot ("BCF") provides information with respect to the volumes of gas
delivered by the Company during the three years 1994-1996.
<PAGE>
 
<TABLE>
<CAPTION>
                                                    YEARS ENDED DECEMBER 31,
                                                   ----------------------------
                                                     1996      1995      1994
                                                   --------  --------  --------
   <S>                                             <C>       <C>       <C>
   Residential....................................     42.8      39.7      41.4
   Commercial and industrial......................     39.4      48.1      46.7
   Off-system sales...............................     12.2       6.6       7.6
                                                   --------  --------  --------
     Total sales..................................     94.4      94.4      95.7
   Transportation of customer-owned gas...........     61.6      47.5      48.7
   Less: Off-system sales.........................    (12.2)     (6.6)     (7.6)
                                                   --------  --------  --------
     Total throughput.............................    143.8     135.3     136.8
                                                   ========  ========  ========
     Total firm throughput........................    118.7      94.9      95.5
                                                   ========  ========  ========
</TABLE>
 
  No customer, or group of customers under common control, accounted for 2% or
more of total firm revenues in 1996.
 
GAS SUPPLY
 
  The following table in BCF provides statistical information with respect to
the Company's sources of supply during 1994-1996.
 
<TABLE>
<CAPTION>
                                                    YEARS ENDED DECEMBER 31,
                                                   ----------------------------
                                                     1996      1995      1994
                                                   --------  --------  --------
   <S>                                             <C>       <C>       <C>
   Natural gas pipeline purchased.................     91.7      93.4      92.2
   Liquefied natural gas ("LNG") purchases........      5.2       3.1       5.1
                                                   --------  --------  --------
     Total purchases..............................     96.9      96.5      97.3
   Change in storage gas..........................     (3.4)      3.5       0.4
   Company use, unbilled and other................       .9      (5.6)     (2.0)
                                                   --------  --------  --------
     Total sales..................................     94.4      94.4      95.7
                                                   ========  ========  ========
</TABLE>
 
  Year to year variations in storage gas and unbilled gas reflects variations
in end-of-year customer requirements, due principally to weather. Given the
ready availability of supply, the Company purchased approximately two-thirds
of its peak pipeline supplies under firm short-term and spot contracts. The
balance of peak day pipeline requirements are purchased directly from domestic
and Canadian producers and marketers pursuant to long-term contracts which
have been reviewed and approved by the Department or by the Federal Energy
Regulatory Commission ("FERC").
 
  Pipeline supplies are transported on interstate pipeline systems to the
Company's service territory pursuant to long-term contracts. FERC-approved
tariffs provide for fixed demand charges for the firm capacity rights under
these contracts. The interstate pipeline companies that provide firm
transportation service to the Company's service territory, the peak daily and
annual capacity and the contract expiration dates are as follows:
 
<TABLE>
<CAPTION>
                                              CAPACITY IN (BCF)
                                              -------------------
                                                                   EXPIRATION
                    PIPELINE                   DAILY     ANNUAL      DATES
                    --------                  --------  ---------  ----------
   <S>                                        <C>       <C>        <C>
   Algonquin Gas Transmission Company ("Al-
    gonquin")................................     0.28       87.4  1997-2012
   Tennessee Gas Pipeline Company ("Tennes-
    see")....................................     0.18       66.9  2000-2012
                                              --------  ---------
                                                  0.46      154.3
                                              ========  =========
</TABLE>
 
  In addition, the Company has firm capacity contracts on interstate pipelines
upstream of Algonquin and Tennessee pipelines to transport natural gas
purchased by the Company from producing regions to the Algonquin and Tennessee
pipelines. In total, contracts comprising 59% of the Company's peak day
pipeline capacity entitlements expire before 2001.
 
                                       2
<PAGE>
 
  The Company has contracted with pipeline companies and others for the
storage of natural gas in underground storage fields located in Pennsylvania,
New York, Maryland and West Virginia. These contracts provide storage capacity
of 17.3 BCF and peak day deliverability of 0.16 BCF. The Company utilizes its
existing transportation contracts to transport gas from the storage fields to
its service territory. Supplemental supplies of LNG and propane are purchased
and produced from foreign and domestic sources.
 
  Peak day throughput in BCF was 0.69 in 1996 and 1995, and 0.65 in 1994. The
Company provides for peak period demand through a least cost portfolio of
pipeline, storage and supplemental supplies. The Company considers its peak
day sendout capacity, based on its total supply resources, to be adequate to
meet the requirements of its firm customers.
 
REGULATION
 
  The Company's operations are subject to Massachusetts statutes applicable to
gas utilities. Rates, gas purchases, pipeline safety regulations, issuance of
securities, and affiliate transactions are regulated by the Department. Rates
for firm transportation and sales provided by the Company are subject to
approval by, and are on file with, the Department. In addition, the Company
has a cost of gas adjustment clause that allows for the adjustment of billing
rates for firm gas sales to enable it to recover the actual cost of gas
delivered to firm customers, including the demand charges for capacity on the
interstate pipeline system.
 
  On November 29, 1996, the Department issued its order on the Company's rate
restructuring and unbundling plan. In its order, the Department granted a $6.3
million rate increase effective December, 1996 and modified the Company's
proposed performance-based regulatory plan. The Department ordered a five year
performance-based regulatory plan that prescribes the formula for annual rate
adjustments with a 2% productivity offset and service quality penalties with a
maximum exposure of $5 million, which significantly exceeded those proposed by
the Company. The Company will likely appeal the Department's Order.
 
  In its order, the Department approved the Company's proposal to facilitate
competition in the natural gas marketplace. Under the approved service
unbundling program, on an interim basis, eligible commercial and industrial
customers migrating from firm sales to firm transportation will be assigned,
at cost, a pro-rata share of the upstream pipeline capacity purchased by the
Company to serve them. The Department also stated that the permanent
assignment of upstream pipeline capacity would be addressed in future
regulatory proceedings. The permanent capacity assignment method approved by
the Department could permit capacity to be acquired by marketers at less than
cost. While there can be no assurance until the Department has addressed the
recoverability of such stranded costs for all gas utilities subject to its
jurisdiction, the Company is confident that it will be allowed a reasonable
opportunity to recover any non-mitigable stranded costs resulting from the
method approved.
 
  The Company and Eastern were granted an intrastate exemption from the
provisions of the Public Utility Holding Company Act of 1935 ("the Act") under
Section 3(a)(1) thereof, pursuant to an order of the Securities and Exchange
Commission (the "SEC") dated February 28, 1955, as amended by orders dated
November 3, 1967 and August 28, 1975.
 
SEASONALITY AND WORKING CAPITAL
 
  The Company's revenues, earnings and cash flow are highly seasonal as most
of its transportation services and sales are directly related to temperature
conditions. The majority of the Company's earnings are generated in the first
quarter with a seasonal loss occurring in the third quarter. Since the bulk of
its revenues are billed in
 
                                       3
<PAGE>
 
the November through April heating season, significant cash flows are
generated from late winter to early summer. In addition, through the cost of
gas adjustment clause, the Company bills its customers over the heating season
for pipeline demand charges paid by the Company over the entire year. This
difference, along with other costs of gas distributed but unbilled, is
reflected as deferred gas costs and is financed through short-term borrowings.
Short-term borrowings are also required from time to time to finance normal
business operations. As a result of these factors, short-term borrowings are
generally highest during the late fall and early winter.
 
ENVIRONMENTAL MATTERS
 
  The Company may have or share responsibility under applicable environmental
law for the remediation of certain former manufactured gas plant ("MGP")
sites, as described in Note 11 of Notes to Financial Statements. A subsidiary
of New England Electric System has assumed responsibility for remediating 11
of the 15 sites owned by the Company, subject to a limited contribution by the
Company. A 1990 regulatory settlement with the Department provides for
recovery by the Company of environmental costs associated with such sites over
separate, seven-year amortization periods without a return on the unamortized
balance. The Company does not possess at this time sufficient information to
reasonably determine the ultimate cost to it of such remediation and no
assurance can be given with respect to future recoverability of such costs.
However, in light of the factors discussed above, the Company believes that it
is not probable that such costs will materially affect its financial condition
or results of operations.
 
EMPLOYEES
 
  As of December 31, 1996, the Company had approximately 1,500 employees, 73%
of whom are organized in local unions with which the Company has collective
bargaining agreements that expire in 1999.
 
ITEM 2. PROPERTIES.
 
  The Company and Mass LNG own or lease facilities which enable them to
liquefy natural gas in periods of low demand, store the resulting LNG and
vaporize it for use in periods of high demand. The Company owns and operates
such a facility in Dorchester, Massachusetts, and Mass LNG leases one such
facility in Lynn, Massachusetts, and a storage facility in Salem,
Massachusetts. Negotiations are under way with the lessor of the Lynn and
Salem facilities in connection with the scheduled expiration of these leases
in June 1997. The Company owns propane-air facilities at several locations
throughout its service territory.
 
  On December 31, 1996, the Company's distribution system included
approximately 5,800 miles of gas mains, 399,000 services and 529,000 active
customer meters. A majority of the gas mains consist of cast iron and bare
steel which requires ongoing maintenance and replacement.
 
  The Company's gas mains and services are usually located on public ways or
private property not owned by it. In general, the Company's occupation of such
property is pursuant to easements, licenses, permits or grants of location.
Except as stated above, the principal items of property of the Company are
owned in fee.
 
  In 1996, the Company's capital expenditures were $58.5 million. Capital
expenditures were principally made for system replacement, for system
expansion to meet customer demand and productivity enhancement initiatives.
The Company plans to spend approximately $51 million for similar purposes in
1997.
 
ITEM 3. LEGAL PROCEEDINGS.
 
  Other than routine litigation incidental to the Company's business, there
are no material pending legal proceedings involving the Company.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
  No matter was submitted to a vote of Security Holders in the fourth quarter
of 1996.
 
                                       4
<PAGE>
 
                                   GLOSSARY
 
  BUNDLED SERVICE--Two or more services tied together as a single product.
Services include gas sales at the city gate, interstate transportation, local
transportation from the city gate to the customer's burner tip, balancing
daily swings in customer loads, storage, and peak-shaving services.
 
  CAPACITY--The maximum capability of pipelines and supplemental facilities to
deliver and/or store gas at a given time.
 
  CITY GATE--Physical interconnection between an interstate pipeline and the
local distribution company.
 
  CORE CUSTOMER--Generally, customers with no readily available energy
services alternative.
 
  FIRM SERVICE--Sales and/or transportation service provided without
interruption throughout the year. Uninterrupted seasonal services are also
available for less than 365 days. Firm services are provided under either
filed rate tariffs or through individually negotiated contracts.
 
  GAS MARKETER (BROKER)--A non-regulated buyer and seller of natural gas.
 
  LOCAL DISTRIBUTION COMPANY (LDC)--A utility that owns and operates a natural
gas distribution system for the delivery of gas supplies from the city gate to
end-user facilities.
 
  LOCAL TRANSPORTATION SERVICE--Transportation of gas by the LDC from the city
gate to the customer's burner tip.
 
  NON-CORE CUSTOMERS--Generally, those customers with readily available,
economically viable alternatives to natural gas, and/or are of sufficient size
to arrange for their own energy supplies.
 
  NON-FIRM SERVICE--Sales and transportation service that offers service at a
lower cost and level of reliability. Under this service, the LDC can interrupt
customers on short notice, typically during the winter season. Non-firm
services are provided through individually negotiated contracts and, in most
cases, the price charged takes into account the price of the customer's
alternative fuel.
 
  PERFORMANCE-BASED REGULATORY PLAN--Incentive ratemaking mechanism, typically
a price cap plan, where rates over a specified period are adjusted annually
pursuant to a pre-determined formula tied to a measure of inflation, less a
productivity offset, subject to the achievement of service quality thresholds
and the incurrence of exogenous costs.
 
  THROUGHPUT--volume delivered to customers through the local transportation
system.
 
  TRANSITION COSTS--Pursuant to FERC Order 636, these are costs incurred by
interstate pipelines as they unbundled their services and exited the merchant
business. Transition costs include uncovered gas costs at the time the
pipelines ceased the merchant function, stranded costs or unrecovered costs of
assets that cannot be assigned to customers of unbundled services, and gas
supply realignment costs or the costs of renegotiating existing gas supply
contracts with producers.
 
  UNBUNDLED SERVICE--Service that is offered and priced separately, such as
separating the cost of gas commodity delivered to the LDC's city gate from the
cost of transporting the gas from the city gate to the end use. Unbundled
services can also include daily or monthly balancing, back-up or stand-by
services and pooling. With unbundled services, customers have the opportunity
to select only the services they desire.
 
 
                                       5
<PAGE>
 
                                    PART II
 
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
 
  Eastern was the holder of record of all of the outstanding common equity
securities of the Company throughout the year ended December 31, 1996.
Dividends on such common equity amounted to $14.7 million and $11.9 million
for 1996 and 1995, respectively. At December 31, 1996, under the most
restrictive provision limiting dividend payments in the Company's financing
indentures, there were no restrictions on retained earnings.
 
ITEM 6. SELECTED FINANCIAL DATA.
 
  Not required.
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
 
1996 COMPARED TO 1995
 
  Net earnings applicable to common stock for 1996 were $29.1 million, an
increase of $5.8 million or 25% from 1995. This increase primarily reflects
colder billing temperatures ($3.0 million), increased consumption from new and
existing customers ($4.7 million) and the absence of reengineering related
charges ($3.9 million). Weather for 1996 was 5% colder than 1995 and 4% colder
than normal. These factors were somewhat offset by higher operating expenses,
principally wages, benefits and marketing related costs. Increased
depreciation charges and property tax expense reflect continued investments in
system expansion and replacement.
 
  The reduction in interest expense reflects the refinancing during the fourth
quarter of 1995 and lower borrowing requirements.
 
1995 COMPARED TO 1994
 
  Net earnings applicable to common stock for 1995 were $23.4 million, a
decrease of $1.8 million or 7% from 1994. Increased throughput to new and
existing customers, the recognition of lost margins associated with
conservation programs and the reimbursement of previously incurred
environmental expenses were primarily offset by lower customer consumption in
the heating markets and to a lesser extent weather. While weather in both 1995
and 1994 was essentially normal for the year as a whole, temperatures within
the year varied widely relative to normal.
 
  Higher operating costs, primarily non-recurring charges associated with
early retirement and severance programs for both management and union
employees, were somewhat offset by related labor savings and reduced weather-
related workload during the first half of the year. Work force reductions
resulted from the Company's reengineering project which focused on improving
customer service and lowering operating costs.
 
  Also contributing to lower earnings were increased depreciation and property
tax expenses related to continued investments in system replacement and
expansion partially offset by a reduced provision for uncollectible accounts.
 
LIQUIDITY AND CAPITAL RESOURCES
 
  To meet cash requirements and support its commercial paper program, the
Company has available up to $75.0 million of Eastern's committed credit
agreement and an uncommitted line of credit. The Company also maintains a bank
credit agreement which supports the issuance of up to $70.0 million of
commercial paper to fund its inventory of gas supplies.
 
  The Company expects capital expenditures for 1997 to be approximately $51.0
million. Capital expenditures will be largely for improvements to the
distribution system, for system expansion to meet customer demand and for
productivity improvements.
 
                                       6
<PAGE>
 
  The Company estimates that projected cash flow from operations, in
combination with currently available resources, is sufficient to meet 1997
capital expenditure and working capital requirements, normal debt repayments
and dividends to shareholders. The foregoing forward-looking statement
involves risks and uncertainties. The Company's actual experience may differ
materially from its current expectation for various reasons, including
unexpected capital expenditures or working capital requirements. Moreover,
there can be no assurance that the external capital resources which the
Company believes are currently available to it will continue to be available
or will be available on terms and conditions advantageous to the Company.
 
  On November 29, 1996, the Department issued its order on the Company's rate
restructuring and unbundling plan. In its order, the Department granted a $6.3
million rate increase effective December, 1996 and modified the Company's
proposed performance-based regulatory plan. The Department ordered a five year
performance-based regulatory plan that prescribes the formula for annual rate
adjustments with a 2% productivity offset and service quality penalties with a
maximum exposure of $5 million, which significantly exceeded those proposed by
the Company. The Company will likely appeal the Department's Order.
 
  In its order, the Department also approved the Company's proposal to
facilitate competition in the natural gas marketplace. Under the approved
service unbundling program, on an interim basis, eligible commercial and
industrial customers migrating from firm sales to firm transportation will be
assigned, at cost, a pro-rata share of the upstream pipeline capacity
purchased by the Company to serve them.
 
  The Company may have or share responsibility under applicable environmental
law for the remediation of certain former manufactured gas plant ("MGP")
sites, as described in Note 11 appearing on page F-15. A subsidiary of New
England Electric System has assumed responsibility for remediating 11 of the
15 sites owned by the Company, subject to a limited contribution by the
Company. A 1990 regulatory settlement with the Department provides for
recovery by the Company of environmental costs associated with such sites over
separate, seven-year amortization periods without a return on the unamortized
balance. The Company does not possess at this time sufficient information to
reasonably determine the ultimate cost to it of such remediation and no
assurance can be given with respect to the future recoverability of such
costs. However, in light of the factors discussed above, the Company believes
that it is not probable that such costs will materially affect its financial
condition or results of operations.
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
  Information with respect to this item appears commencing on Page F-1 of this
Report. Such information is incorporated herein by reference.
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
 
  None.
 
                                   PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.
 
  Not required.
 
ITEM 11. EXECUTIVE COMPENSATION.
 
  Not required.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
 
  Not required.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
 
  Not required.
 
 
                                       7
<PAGE>
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
 
LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES.
 
  Information with respect to these items appears on Page F-1 of this Report.
Such information is incorporated herein by reference.
 
(3) LIST OF EXHIBITS.
 
<TABLE>
 <C>   <S>
 3.1   --Restated Articles of Organization, as amended (Filed as Exhibit 3.1 to
         the registration statement of the Company on Form S-3 (File No. 33-
         48525)).*
 3.2   --By-Laws of the Company as amended (Filed as Exhibit 1 to the Annual
         Report of the Company on Form 10-K for the year ended December 31, 1976
         (File No. 2-23416)).*
         (Note: Certain instruments with respect to long-term debt of the
         Company or its subsidiary are not filed herewith since no such
         instrument authorizes securities in an amount greater than 10% of the
         total assets of the Company and its subsidiary on a consolidated basis.
         The Company agrees to furnish to the Securities and Exchange Commission
         upon request a copy of any such omitted instrument of the Company or
         its subsidiary.)
 4.1   --Indenture dated as of December 1, 1989 between the Company and The
         Bank of New York, Trustee (Filed as Exhibit 4.2 to the registration
         statement of the Company on Form S-3 (File No. 33-31869)).*
 4.1.1 --Agreement of Registration, Appointment and Acceptance dated as of
         November 18,1992 among the Company, The Bank of New York as Resigning
         Trustee, and The First National Bank of Boston as Successor Trustee.
         (Filed as an exhibit to registration statement of the Company on Form
         S-3 (File No. 33-31869)).*
 10.1  --Gas Transportation Contract between Boston Gas Company and Tennessee
         Gas Pipeline Company dated as of September 1, 1993 providing for
         transportation of approximately 94,000 dekatherms of natural gas per
         day (Filed as Exhibit 10.1 to the Annual Report of the Company on Form
         10-K for the year ended December 31, 1993).*
 10.2  --Gas Transportation Contract between Boston Gas Company and Texas
         Eastern dated December 30, 1993 providing for transportation of
         approximately 83,000 dekatherms of natural gas per day (Filed as
         Exhibit 10.2 to the Annual Report of the Company on Form 10-K for the
         year ended December 31, 1993).*
 10.3  --Gas Transportation Contract between Boston Gas Company and Texas
         Eastern dated December 30, 1993 providing for transportation of
         approximately 30,000 dekatherms of natural gas per day (Filed as
         Exhibit 10.3 to the Annual Report of the Company on Form 10-K for the
         year ended December 31, 1993).*
 10.4  --Gas Transportation Contract between Boston Gas Company and Algonquin
         dated December 30, 1993 providing for transportation of approximately
         48,000 dekatherms of natural gas per day (Filed as Exhibit 10.4 to the
         Annual Report of the Company on Form 10-K for the year ended December
         31, 1993).*
 10.5  --Gas Transportation Contract between Boston Gas Company and Algonquin
         dated December 30, 1993 providing for transportation of approximately
         97,000 dekatherms of natural gas per day (Filed as Exhibit to the
         Annual Report of the Company on Form 10-K for the year ended December
         31, 1993).*
 10.6  --Gas Storage Agreement between the Company and Consolidated Gas Supply
         Corporation dated February 18, 1980 (Filed as Exhibit 20.3 to the
         Quarterly Report of the Company on Form 10-Q for the quarter ended
         March 31, 1982).*
</TABLE>
 
                                       8
<PAGE>
 
<TABLE>
 <C>    <S>
 10.7   --Gas Storage Agreement between the Company and Honeoye Storage
          Corporation dated October 11, 1985 (Filed as Exhibit 10.17 to the
          Annual Report of the Company on Form 10-K for the year ended December
          31, 1985).*
 10.8   --Gas Storage Agreement between the Company and PennYork Energy
          Corporation dated as of December 21, 1984 (Filed as Exhibit 10.18 to
          the Annual Report of the Company on Form 10-K for the year ended
          December 31, 1985).*
 10.9   --Gas Sales Contract between the Company and Esso Resources Canada,
          Limited, (now Imperial Oil of Canada, Ltd.) dated as of May 1, 1989
          (Filed as Exhibit 10.12 to the Annual Report of the Company on Form
          10-K for the year ended December 31, 1989).*
 10.9.1 --Amendment to Exhibit 10.12 dated as of September 28, 1989 (Filed as
          Exhibit 10.12.1 to the 10.9.1 Annual Report of the Company on Form 10-
          K for the year ended December 31, 1989).*
 10.10  --Storage Service Agreement between the Company and Distrigas of
          Massachusetts Corporation dated as of December 17, 1988 (Filed as
          Exhibit 10.13 to the Annual Report of the Company on Form 10-K for the
          year ended December 31, 1989).*
 10.11  --Liquid Purchase Agreement between the Company and Distrigas of
          Massachusetts Corporation dated as of April 14, 1989 (Filed as Exhibit
          10.14 to the Annual Report of the Company on Form 10-K for the year
          ended December 31, 1989).*
 10.12  --Gas Sales Agreement between the Company and Alberta Northeast Gas,
          Ltd. dated as of February 7, 1991 (Filed as Exhibit 10.16 to the
          Annual Report of the Company on Form 10-K for the year ended December
          31, 1990).*
 10.13  --Firm Gas Transportation Agreement between the Company and Iroquois
          Gas Transmission System, L.P. dated as of February 7, 1991 (Filed as
          Exhibit 10.17 to the Annual Report of the Company on Form 10-K for the
          year ended December 31, 1990).*
 10.14  --Firm Gas Transportation Agreement between the Company and Tennessee
          Gas Pipeline Company dated as of February 7, 1991 (Filed as Exhibit
          10.18 to the Annual Report of the Company on Form 10-K for the year
          ended December 31, 1990).*
 10.15  --Lease Agreement between Industrial National Leasing Corporation,
          Lessor, and Massachusetts LNG Incorporated, Lessee, dated as of June
          1, 1972 (Filed as an exhibit to Certificate of Notification by
          Massachusetts LNG Incorporated (and others) dated June 9, 1972
          (File No. 70-5170)).*
 10.16  --Lease Supplement to Exhibit 10.12 between National Leasing
          Corporation and Massachusetts LNG Incorporated dated October 19, 1972
          (Filed as Exhibit 5.23.1 to the registration statement of the Company
          on Form S-7 (File No. 2-52522)).*
 10.17  --Credit Agreement dated as of December 22, 1993 by and among the
          Company, Morgan Guaranty Trust Company of New York, National
          Westminster Bank PLC, Shawmut Bank, N.A. and The First National Bank
          of Boston (Filed as Exhibit 10.17 to the Annual Report of the Company
          on Form 10-K for the year ended December 31, 1993).*
 10.18  --Sublease between the Company and Eastern Enterprises dated November
          5, 1987 (Filed as Exhibit 10.20 to the Annual Report of the Company on
          Form 10-K for the year ended December 31, 1987).*
 22     --Subsidiaries of the Company (Filed as Exhibit 22 to the Annual Report
          of the Company on Form 10-K for the year ended December 31, 1985).*
 27     --Financial Data Schedule.
</TABLE>
  There were no reports on Form 8-K filed in the Fourth Quarter of 1996.
--------
* Not filed herewith. In accordance with Rule 12(b)(32) of the General Rules
  and Regulations under the Securities Exchange Act of 1934, reference is made
  to the document previously filed with the Commission.
 
                                       9
<PAGE>
 
                                  SIGNATURES
 
  PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES AND
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED
ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
 
                                          Boston Gas Company
                                          Registrant
 
                                                     /s/ J.F. Bodanza
                                          By: _________________________________
                                            J.F. BODANZA SENIOR VICE PRESIDENT
                                            AND TREASURER (PRINCIPAL FINANCIAL
                                                  AND ACCOUNTING OFFICER)
 
Dated: March 14, 1997
 
  PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES INDICATED ON THE 14TH DAY OF MARCH 1997.
 
              SIGNATURE                              TITLE
 
            C. R. Messer                  Director and
-------------------------------------      President
            C. R. MESSER
 
          A. J. DiGiovanni                Director and Senior Vice
-------------------------------------      President
          A. J. DIGIOVANNI
 
            J. F. Bodanza                 Director and Senior Vice President
-------------------------------------      andTreasurer (Principal Financial
            J. F. BODANZA                  andAccounting Officer)
 
             J. A. Ives                   Director
-------------------------------------
             J. A. IVES
 
            R. R. Clayton                 Director
-------------------------------------
            R. R. CLAYTON
 
           W. J. Flaherty                 Director
-------------------------------------
           W. J. FLAHERTY
 
 
                                      10
<PAGE>
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
           INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
           (INFORMATION REQUIRED BY ITEMS 8 AND 14 (A) OF FORM 10-K)
 
<TABLE>
<S>                                                                <C>
Report of Independent Public Accountants..........................     F-17
  Consolidated Balance Sheets as of December 31, 1996 and 1995.... F-2 and F-3
  Consolidated Statements of Earnings for the Three Years Ended
   December 31, 1996..............................................     F-4
  Consolidated Statements of Retained Earnings for the Three Years
   Ended December 31, 1996........................................     F-5
  Consolidated Statements of Cash Flows for the Three Years Ended
   December 31, 1996..............................................     F-6
  Notes to Consolidated Financial Statements...................... F-7 to F-16
  Interim Financial Information for the Two Years Ended December
   31, 1996 (Unaudited)...........................................     F-18
  Schedules for the Three Years Ended December 31, 1996:
    II--Valuation and Qualifying Accounts......................... F-19 to F-21
</TABLE>
 
  Schedules other than those listed above have been omitted as the information
has been included in the consolidated financial statements and related notes
or is not applicable nor required.
 
  Separate financial statements of the Company are omitted because the Company
is primarily an operating company and its subsidiary is wholly-owned and is
not indebted to any person in an amount that is in excess of 5% of total
consolidated assets.
 
                                      F-1
<PAGE>
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
                          CONSOLIDATED BALANCE SHEETS
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                              -----------------
                                                                1996     1995
                                                              -------- --------
                                                               (IN THOUSANDS)
<S>                                                           <C>      <C>
Gas plant, at cost........................................... $812,114 $761,607
Construction work-in-progress................................    4,604      486
  Less--Accumulated depreciation.............................  290,492  254,448
                                                              -------- --------
  Net plant..................................................  526,226  507,645
Current assets:
  Cash.......................................................    1,474    5,841
  Accounts receivable, less reserves of $15,963 at December
   31, 1996 and $15,324 at December 31, 1995.................   76,832   74,519
  Deferred gas costs.........................................   75,337   71,940
  Natural gas and other inventories, at average cost.........   49,287   35,136
  Materials and supplies, at average cost....................    3,809    4,770
  Prepaid expenses...........................................    2,759    3,259
  Income taxes...............................................   10,411      368
                                                              -------- --------
    Total current assets.....................................  219,909  195,833
Other assets:
  Deferred postretirement benefits cost......................   88,563   93,829
  Deferred charges and other assets..........................   42,346   32,180
                                                              -------- --------
    Total other assets.......................................  130,909  126,009
                                                              -------- --------
    Total assets............................................. $877,044 $829,487
                                                              ======== ========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                      F-2
<PAGE>
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
                          CONSOLIDATED BALANCE SHEETS
 
                    LIABILITIES AND STOCKHOLDER'S INVESTMENT
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                              -----------------
                                                                1996     1995
                                                              -------- --------
                                                               (IN THOUSANDS)
<S>                                                           <C>      <C>
Capitalization:
 Stockholder's investment--
  Common stock, $100 par value--
   Authorized and outstanding--514,184 shares at December 31,
    1996 and 1995............................................ $ 51,418 $ 51,418
   Amounts in excess of par value............................   43,233   43,233
   Retained earnings.........................................  133,980  119,546
                                                              -------- --------
    Total common stockholder's investment....................  228,631  214,197
 Cumulative preferred stock, $1 par value,
  (liquidation preference, $25 per share)--
  Authorized and outstanding--1,200,000 shares at December
   31, 1996 and 1995.........................................   29,293   29,262
 Long-term obligations, less current portion.................  211,743  212,772
                                                              -------- --------
    Total capitalization.....................................  469,667  456,231
 Gas inventory financing.....................................   55,594   45,600
                                                              -------- --------
    Total capitalization and gas inventory financing.........  525,261  501,831
Current liabilities:
  Current portion of long-term obligations...................    1,029    1,509
  Notes payable..............................................   57,000   52,000
  Accounts payable...........................................   73,313   53,490
  Accrued taxes..............................................    1,206    1,011
  Accrued interest...........................................    4,339    3,959
  Customer deposits..........................................    2,382    2,789
  Refunds due customers......................................    3,384   13,173
  Pipeline transition costs..................................   16,494    9,510
                                                              -------- --------
    Total current liabilities................................  159,147  137,441
Commitments and contingencies:
Reserves and deferred credits:
  Deferred income taxes......................................   76,277   72,001
  Unamortized investment tax credits.........................    6,836    7,767
  Postretirement benefits obligation.........................   84,827   86,589
  Other......................................................   24,696   23,858
                                                              -------- --------
    Total reserves and deferred credits......................  192,636  190,215
                                                              -------- --------
    Total liabilities and stockholder's investment........... $877,044 $829,487
                                                              ======== ========
</TABLE>
 
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                      F-3
<PAGE>
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
                      CONSOLIDATED STATEMENTS OF EARNINGS
 
<TABLE>
<CAPTION>
                                                    YEARS ENDED DECEMBER 31,
                                                   ----------------------------
                                                     1996      1995      1994
                                                   --------  --------  --------
                                                         (IN THOUSANDS)
<S>                                                <C>       <C>       <C>
Operating revenues................................ $705,462  $653,073  $660,158
Cost of gas sold..................................  414,254   374,904   382,885
                                                   --------  --------  --------
Operating margin..................................  291,208   278,169   277,273
Operating expenses:
  Other operating expenses........................  156,105   156,794   150,847
  Maintenance.....................................   25,045    21,449    24,826
  Depreciation and amortization...................   41,607    38,264    35,809
  Income taxes....................................   20,017    16,258    17,737
                                                   --------  --------  --------
                                                    242,774   232,765   229,219
                                                   --------  --------  --------
Operating earnings................................   48,434    45,404    48,054
Other earnings, net...............................      564       726        65
                                                   --------  --------  --------
Earnings before interest expense..................   48,998    46,130    48,119
Interest expense:
  Long-term debt..................................   16,769    18,633    17,024
  Other, including amortization of debt expense...    1,688     2,693     4,841
  Less-Interest during construction...............     (525)     (499)     (894)
                                                   --------  --------  --------
                                                     17,932    20,827    20,971
                                                   --------  --------  --------
Net earnings......................................   31,066    25,303    27,148
Preferred stock dividends.........................    1,926     1,926     1,926
                                                   --------  --------  --------
Earnings applicable to common stock............... $ 29,140  $ 23,377  $ 25,222
                                                   ========  ========  ========
</TABLE>
 
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                      F-4
<PAGE>
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
                  CONSOLIDATED STATEMENTS OF RETAINED EARNINGS
 
<TABLE>
<CAPTION>
                                                   YEARS ENDED DECEMBER 31,
                                                  ----------------------------
                                                    1996      1995      1994
                                                  --------  --------  --------
                                                        (IN THOUSANDS)
<S>                                               <C>       <C>       <C>
Balance at Beginning of Year..................... $119,546  $108,098  $ 95,680
  Net earnings...................................   31,066    25,303    27,148
  Preferred stock dividends ($1.61 per share in
   1996, 1995 and 1994)..........................   (1,926)   (1,926)   (1,926)
  Cash dividends on common stock ($28.60 per
   share in 1996,
   $23.20 per share in 1995 and $24.90 per share
   in 1994)......................................  (14,706)  (11,929)  (12,804)
                                                  --------  --------  --------
Balance at End of Year........................... $133,980  $119,546  $108,098
                                                  ========  ========  ========
</TABLE>
 
 
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
 
                                      F-5
<PAGE>
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                    YEARS ENDED DECEMBER 31,
                                                   ----------------------------
                                                     1996      1995      1994
                                                   --------  --------  --------
                                                         (IN THOUSANDS)
<S>                                                <C>       <C>       <C>
Cash flows from operating activities:
 Net earnings....................................  $ 31,066  $ 25,303  $ 27,148
 Adjustments to reconcile net earnings to cash
  (used for) provided by operating activities:
  Depreciation and amortization..................    41,607    38,264    35,809
  Deferred taxes.................................     4,276     5,424     5,016
  Other changes in assets and liabilities:
   Accounts receivable...........................    (2,313)   (3,111)   17,688
   Inventory.....................................   (13,190)   12,001     6,264
   Deferred gas costs............................    (3,397)   17,763   (23,901)
   Accounts payable..............................    19,823    10,837   (10,121)
   Federal and state income taxes................   (10,043)    1,039     4,639
   Refunds due customers.........................    (9,789)   (5,546)   10,690
   Other.........................................    (2,543)     (969)    7,164
                                                   --------  --------  --------
Cash provided by operating activities............    55,497   101,005    80,396
                                                   --------  --------  --------
Cash flows from investing activities:
  Capital expenditures...........................   (58,504)  (57,322)  (53,504)
  Net cost of removal............................    (4,124)   (6,463)   (6,412)
                                                   --------  --------  --------
Cash used for investing activities...............   (62,628)  (63,785)  (59,916)
                                                   --------  --------  --------
Cash flows from financing activities:
  Changes in notes payable, net..................     5,000   (10,530)  (43,770)
  Changes in inventory financing.................     9,994    (7,978)   (5,719)
  Proceeds from issuance of long-term debt.......       --     60,000    50,000
  Repayment of long-term debt....................       --    (62,880)   (3,622)
  Amortization of preferred stock issuance
   costs.........................................        31        33        32
  Cash dividends paid on common and preferred
   stock.........................................   (12,261)  (13,855)  (14,730)
                                                   --------  --------  --------
Cash (used for) provided by financing activi-
 ties............................................     2,764   (35,210)  (17,809)
                                                   --------  --------  --------
Increase (decrease) in cash......................    (4,367)    2,010     2,671
Cash at beginning of year........................     5,841     3,831     1,160
                                                   --------  --------  --------
Cash at end of year..............................  $  1,474  $  5,841  $  3,831
                                                   ========  ========  ========
Supplemental disclosure of cash flow information:
 Cash paid during the year for:
   Interest, net of amounts capitalized..........  $ 18,960  $ 20,752  $ 20,193
   Income taxes..................................  $ 26,205  $ 10,128  $  8,151
</TABLE>
 
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                      F-6
<PAGE>
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(1) ACCOUNTING POLICIES
 
  The accounting policies of Boston Gas Company (the "Company") conform to
generally accepted accounting principles and reflect the effects of the
ratemaking process in accordance with Statement of Financial Accounting
Standards No. 71, ("SFAS 71") "Accounting for the Effects of Certain Types of
Regulation".
 
  The significant accounting policies followed by the Company and its
subsidiary are described below and in the following footnotes:
 
      Note 2--Cost of Gas Adjustment Clause and Deferred Gas Costs
      Note 3--Income Taxes
      Note 6--Pension Benefits
      Note 7--Postretirement Benefits Other Than Pensions
      Note 8--Leases
 
 Principles of Consolidation
 
  The Company is a wholly-owned subsidiary of Eastern Enterprises ("Eastern").
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, Massachusetts LNG Incorporated ("Mass LNG"). All
material intercompany balances and transactions between the Company and its
subsidiary have been eliminated in consolidation.
 
  The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
 
 Regulation and Operations
 
  The Company is a gas distribution company engaged in the transportation and
sale of natural gas to residential, commercial and industrial customers. The
Company's service territory includes Boston and 73 other communities in
eastern and central Massachusetts.
 
  The Company's operations are subject to Massachusetts statutes applicable to
gas utilities. Its revenues, earnings and cash flows are highly seasonal as
most of its throughput is directly related to temperature levels.
 
 Regulatory Assets and Liabilities
 
  The Company is regulated as to rates, accounting and other matters by the
Massachusetts Department of Public Utilities ("the Department"). Therefore,
the Company accounts for the economic effects of regulation in accordance with
the provisions of Statement of Financial Accounting Standards 71 ("SFAS 71")
"Accounting for the Effects of Certain Types of Regulation". In the event the
Company determines that it no longer meets the criteria for following SFAS 71,
the accounting impact would be an extraordinary, non-cash charge to operations
of an amount that could be material. Criteria that give rise to the
discontinuance of SFAS 71 include (1) increasing competition that restricts
the Company's ability to establish prices to recover specific costs and (2) a
significant change in the manner in which rates are set by regulators from
cost-based regulation to another regulation. The Company has reviewed these
criteria in conjunction with its 1996 Rate Order and believes that the
continuing application of SFAS 71 is appropriate.
 
  Regulatory assets have been established that represent probable future
revenue to the Company associated with certain costs which will be recovered
from customers through the ratemaking process. Regulatory liabilities
 
                                      F-7
<PAGE>
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
(1) ACCOUNTING POLICIES (CONTINUED)
 
represent probable future reductions in revenues associated with the amounts
that are to be credited to customers through the ratemaking process. The
following regulatory assets were reflected in the Consolidated Balance Sheets
as of December 31:
 
<TABLE>
<CAPTION>
                                                                1996     1995
                                                              -------- --------
                                                               (IN THOUSANDS)
     <S>                                                      <C>      <C>
     Postretirement benefit costs............................ $ 88,563 $ 93,829
     Deferred pipeline transition costs......................   16,494    9,510
     Deferred income taxes...................................      --       498
     Environmental costs.....................................    2,784    3,591
     Other...................................................    2,225    2,176
                                                              -------- --------
                                                              $110,066 $109,604
                                                              ======== ========
</TABLE>
 
  Regulatory liabilities total approximately $11,446,000 and $12,391,000 at
December 31, 1996 and 1995 and relate primarily to income taxes.
 
  As of December 31, 1996 all of the Company's regulatory assets and
regulatory liabilities are being reflected in rates charged to customers over
periods ranging from 1 to 23 years. For additional information regarding
deferred income taxes, postretirement benefit costs, environmental costs and
Order 636 transition costs, see footnotes 3, 7, 11, and 12 respectively.
 
 Impairment of Long-Lived Assets
 
  Statement of Financial Standards No. 121 ("SFAS 121") "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"
which became effective for 1996 establishes accounting standards for the
impairment of long-lived assets. SFAS 121 also requires that regulatory assets
which are no longer probable of recovery through future revenues be charged to
earnings. SFAS 121 did not have an impact on financial position or results of
operations upon adoption.
 
 Depreciation
 
  Depreciation is provided at rates designed to amortize the cost of
depreciable property, plant and equipment over their estimated remaining
useful lives. The composite depreciation rate, expressed as a percentage of
the average depreciable property in service, was 5.15% in 1996, 5.13% in 1995,
and 5.16% in 1994.
 
  Accumulated depreciation is charged with the original cost and cost of
removal, less salvage value, of units retired. Expenditures for repairs,
upkeep of units of property and renewal of minor items of property replaced
independently of the unit of which they are a part are charged to maintenance
expense as incurred.
 
 Gas Operating Revenues
 
  Gas operating revenues are recorded when billed. Revenue is not recorded for
the amount of gas distributed to customers, which is unbilled at the end of
the period; however, the cost of this gas is deferred as discussed in Note 2.
 
(2) COST OF GAS ADJUSTMENT CLAUSE AND DEFERRED GAS COSTS
 
  The cost of gas adjustment clause ("CGAC") requires the Company to adjust
its rates semi-annually for firm gas sales in order to track changes in the
cost of gas distributed with an annual adjustment of subsequent rates for any
collection over or under actual costs incurred. As a result, the Company
defers the cost of any firm
 
                                      F-8
<PAGE>
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
(2) COST OF GAS ADJUSTMENT CLAUSE AND DEFERRED GAS COSTS (CONTINUED)
 
gas that has been distributed, but is unbilled at the end of a period, to a
period in which the gas is billed to customers. In its order of November 29,
1996, the Department modified the CGAC to recover the gas cost portion of the
Company's bad debt write-offs effective December 1, 1996. The order also
granted a local distribution adjustment clause ("LDAC") which recovers the
amortization of all environmental response costs associated with former
manufactured gas plant ("MGP") sites, FERC Order 636 transition costs and
costs related to the Company's various conservation and load management
programs from the Company's firm sales and transportation customers. These
costs were previously recovered through the CGAC.
 
(3) INCOME TAXES
 
  The Company is a member of an affiliated group of companies that files a
consolidated federal income tax return. The Company follows the policy,
established for the group, of providing for income taxes which would be
payable on a separate company basis. The Company's effective income tax rate
was 39.2% in 1996, 39.1% in 1995, and 39.5% in 1994. State taxes represent the
majority of the difference between the effective rate and the Federal income
tax rate for 1996, 1995 and 1994.
 
  A summary of the provision for income taxes for the three years ended
December 31 is as follows:
 
<TABLE>
<CAPTION>
                                                         1996    1995    1994
                                                        ------- ------- -------
                                                            (IN THOUSANDS)
   <S>                                                  <C>     <C>     <C>
   Current--
     Federal........................................... $10,154 $10,603 $ 7,966
     State.............................................   2,004   2,136     591
                                                        ------- ------- -------
       Total current provision.........................  12,158  12,739   8,557
   Deferred--
     Federal...........................................   6,489   2,896   6,796
     State.............................................   1,370     623   2,384
                                                        ------- ------- -------
       Total deferred provision........................   7,859   3,519   9,180
                                                        ------- ------- -------
   Provision for income taxes.......................... $20,017 $16,258 $17,737
                                                        ======= ======= =======
</TABLE>
 
  Effective January 1, 1992, the Company adopted Statement of Financial
Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income Taxes." SFAS
109 requires adjustment of deferred tax assets and liabilities to reflect the
future tax consequences, at currently enacted rates, of items already
reflected in the financial statements. A regulatory asset of $1,880,000 was
established for the recovery of prepaid taxes established at the higher
federal tax rates in effect prior to 1988. At December 31, 1996 this
regulatory asset had been fully recovered from customers.
 
  A regulatory liability of $6,144,000 was established for the tax benefit of
unamortized investment tax credits, which SFAS 109 requires to be treated as a
temporary difference. This benefit will be passed on to customers over the
lives of property giving rise to the investment credits, consistent with the
1986 Tax Reform Act. The balance at December 31, 1996 was $3,839,000. The
regulatory liability for excess deferred taxes being returned to customers
over a 30 year period pursuant to a 1988 rate order was similarly increased by
$4,445,000 upon the adoption of SFAS 109. At December 31, 1996 the balance to
be returned to customers was $7,606,000.
 
  For income tax purposes, the Company uses accelerated depreciation and
shorter depreciation lives permitted by the Internal Revenue Service. Deferred
federal and state taxes are provided for the tax effects of all temporary
differences between financial reporting and taxable income. Significant items
making up deferred tax assets and deferred tax liabilities at December 31,
1996 and 1995, are as follows:
 
 
                                      F-9
<PAGE>
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
(3) INCOME TAXES (CONTINUED)
 
<TABLE>
<CAPTION>
                                                            1996       1995
                                                          ---------  ---------
                                                            (IN THOUSANDS)
     <S>                                                  <C>        <C>
     ASSETS:
       Unbilled revenues................................. $  22,392  $  24,637
       Reserve for uncollectible receivables.............     6,261      6,010
       Regulatory liabilities............................     4,490      4,860
       Other.............................................     8,925      9,323
                                                          ---------  ---------
       Total deferred tax assets......................... $  42,068  $  44,830
                                                          ---------  ---------
     LIABILITIES:
       Accelerated depreciation.......................... $ (80,894) $ (78,115)
       Deferred gas costs................................   (28,684)   (16,296)
       Other.............................................   (12,932)   (22,635)
                                                          ---------  ---------
       Total deferred tax liabilities.................... $(122,510) $(117,046)
                                                          ---------  ---------
       Total net deferred taxes.......................... $ (80,442) $ (72,216)
                                                          =========  =========
</TABLE>
 
  Investment tax credits are deferred and credited to income over the lives of
the property giving rise to such credits. The credit to income was
approximately $931,000 in 1996, $937,000 in 1995, and $723,000 in 1994.
 
(4) COMMITMENTS
 
 Long-term Obligations
 
  The following table provides information on long-term obligations as of
December 31:
 
<TABLE>
<CAPTION>
                                                            DECEMBER 31,
                                                          ------------------
                                                            1996      1995
                                                          --------  --------
                                                           (IN THOUSANDS)
   <S>                                                    <C>       <C>
   8.33%-9.75%, Medium-Term Notes, Series A, due 2005--
    2022.................................................  100,000   100,000
   6.93%-8.50%, Medium-Term Notes, Series B, due 2006--
    2024.................................................   50,000    50,000
   6.80%-7.25%, Medium-Term Notes, Series C, due 2012--
    2025.................................................   60,000    60,000
   Capital lease obligations (Note 8)....................    2,772     4,280
   Less current portion..................................   (1,029)   (1,508)
                                                          --------  --------
                                                          $211,743  $212,772
                                                          ========  ========
</TABLE>
 
  In 1995, the Company filed a shelf registration covering the issuance
through 1997 of up to $100,000,000 of Medium-Term Notes. In October and
November 1995, the Company issued $60,000,000 of Medium-Term Notes, Series C
with a weighted average maturity of 26 years and coupon of 7.08%. The proceeds
from this issuance were used to complete an in-substance defeasance of
$60,000,000 principal amount of 8.75% - 9.00% Debentures due 2001 which have
subsequently been called.
 
  Pursuant to regulatory accounting, the in-substance defeasance transaction
resulted in the deferral of $2,582,000 as debt issuance costs to be amortized
over the lives of the newly issued Medium-Term Notes. There are no sinking
fund requirements for the next five years related to the $210,000,000 of
Medium-Term Notes outstanding at December 31, 1996 and none are callable prior
to maturity.
 
  Annual maturities of capital lease obligations are $1,029,000, $507,000,
$561,000, $620,000 and $55,000 for 1997 through 2001, respectively.
 
 
                                     F-10
<PAGE>
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
(4) COMMITMENTS (CONTINUED)
 
  The terms of the various indentures referred to above, as supplemented,
provide that dividends may not be paid on common stock of the Company under
certain conditions. At December 31, 1996 there were no restrictions on
retained earnings available for payment of dividends.
 
 Gas Inventory Financing
 
  Under the terms of the general rate order issued by the Department effective
October 1, 1988, the Company funds its inventory of gas supplies through
external sources. All costs related to this funding are recoverable from its
customers. The Company maintains a long-term credit agreement with a group of
banks which provides for the borrowing of up to $70,000,000 for the exclusive
purpose of funding its inventory of gas supplies or for backing commercial
paper issued for the same purpose. The Company had $55,594,000 and $45,600,000
of commercial paper outstanding to fund its inventory of gas supplies at
December 31, 1996 and 1995, respectively. Since the commercial paper is
supported by the credit agreement, these borrowings have been classified as
non-current in the accompanying consolidated balance sheets. The credit
agreement includes a one year revolving credit facility which may be converted
to a two-year term loan at the Company's option if the one year revolving
credit facility is not renewed by the banks. The Company may select the agent
bank's prime rate or, at the Company's option, various pricing alternatives.
The agreement requires a facility fee of 1/12 of 1% on the commitment. No
borrowings were outstanding under this agreement during 1996 and 1995.
 
 Eastern Borrowing Arrangement
 
  Eastern maintains a credit agreement with a group of banks which provides
for the borrowing by Eastern of up to $100,000,000 (of which up to $75,000,000
may be borrowed or used to back commercial paper issued by the Company) at any
time through December 31, 2001. The interest rate for such borrowings is the
agent bank's prime rate, or at Eastern's option, various alternatives.
 
 Notes Payable
 
  The Company has an uncommitted line of credit which provide for interest as
a function of federal funds, money market or prime rates. This uncommitted
line of credit is used, in conjunction with commercial paper, for working
capital needs. The Company had outstanding borrowings of $57,000,000 and
$52,000,000 in commercial paper not related to gas inventory financing at
December 31, 1996 and 1995, respectively. The weighted average interest rate
on these borrowings was 5.99% at December 31, 1996 and 5.93% at December 31,
1995.
 
(5) PREFERRED STOCK
 
  The Company has outstanding 1,200,000 shares of 6.421% Cumulative Preferred
Stock, which is non-voting and has a liquidation value of $25 per share. The
preferred stock requires 5% annual sinking fund payments beginning on
September 1, 1999 with a final redemption on September 1, 2018. The preferred
stock is not callable prior to 2003.
 
(6) PENSION BENEFITS
 
  The Company, through retirement plans under collective bargaining agreements
and participation in Eastern's pension plans, provides retirement benefits for
substantially all of its employees. The benefits under these plans are based
on stated amounts for years of service or employee's average compensation
during the five years prior to retirement. The Company follows a policy of
funding retirement and employee benefit plans in accordance with the
requirements of the plans and agreements in sufficient amounts to satisfy the
"Minimum Funding Standards" of the Employee Retirement Income Security Act of
1974 ("ERISA").
 
                                     F-11
<PAGE>
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
(6) PENSION BENEFITS (CONTINUED)
 
  Net pension cost included the following components:
 
<TABLE>
<CAPTION>
                                                    1996      1995     1994
                                                  --------  --------  -------
                                                       (IN THOUSANDS)
   <S>                                            <C>       <C>       <C>
   Service cost-benefits earned during the
    year........................................   $  2,883  $  2,710  $ 2,637
   Interest cost on projected benefit
    obligation..................................      8,492     8,055    7,556
   Actual return on plan assets.................    (11,727)  (21,762)  (4,431)
   Net amortization and deferral................      3,225    13,773   (3,281)
                                                   --------  --------  -------
   Net pension cost.............................   $  2,873  $  2,776  $ 2,481
                                                   ========  ========  =======
</TABLE>
 
  For the periods 1996 and 1995, the expected long-term rate of return on
assets was 8.5% and the discount rate used in determining the actuarial
present value of the projected benefit obligation was 7.5%. The rate of
increase in future compensation levels was 4.75%-5.0% for 1996 and 1995.
 
  The following table sets forth the funded status of pension plans and
amounts recognized in the Company's consolidated balance sheets based on a
measurement date of October 1.
 
<TABLE>
<CAPTION>
                                                             1996       1995
                                                           ---------  ---------
                                                             (IN THOUSANDS)
   <S>                                                     <C>        <C>
   Actuarial present value of benefit obligations:
     Accumulated benefit obligation, including vested
      benefits of $97,180 in 1996 and $94,526 in 1995....  $ 106,180  $ 103,880
                                                           =========  =========
     Projected benefit obligation for service rendered to
      date...............................................   (117,729)  (116,358)
     Plan assets at fair value, primarily listed stocks,
      corporate bonds and U.S. bonds.....................    139,887    129,190
                                                           ---------  ---------
     Plan assets in excess of projected benefit
      obligation.........................................     22,158     12,832
     Unrecognized net obligation at January 1, 1986 being
      recognized over 15 years...........................        871      1,088
     Unrecognized net gain...............................    (26,820)   (19,886)
     Unrecognized prior service cost.....................     11,952     13,000
                                                           ---------  ---------
     Net pension asset...................................  $   8,161  $   7,034
                                                           =========  =========
</TABLE>
 
(7) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
 
  In addition to providing pension benefits, the Company, through
participation in Eastern administered plans and welfare plans under collective
bargaining agreements, provides certain health care and life insurance
benefits for retired employees. The expected cost of postretirement benefits
other than pensions is charged to expense during the period that the employee
renders service. As of the date of adoption of Statement of Financial
Accounting Standards No. 106 ("SFAS 106"), "Employers Accounting for
Postretirement Benefits Other Than Pensions" the cumulative effect of the
accounting change ("transition obligation") was $89,120,000. The 1996 rate
order allowed recovery of SFAS 106 costs which includes current SFAS 106
expense and the amortization of the regulatory asset related to the transition
obligation.
 
                                     F-12
<PAGE>
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
(7) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (CONTINUED)
 
  Net postretirement benefit costs included the following components:
 
<TABLE>
<CAPTION>
                                                        1996    1995    1994
                                                       ------  ------  ------
                                                          (IN THOUSANDS)
   <S>                                                 <C>     <C>     <C>
   Service cost-benefits earned during the year....... $  779  $  729  $  731
   Interest cost on accumulated benefit obligation....  5,749   5,645   5,238
   Net amortization and deferral of actuarial gains
    and losses........................................ (1,448) (4,752) (2,617)
   Actual return on plan assets....................... (1,355)  2,352    (755)
                                                       ------  ------  ------
   Postretirement benefit cost........................  3,725   3,974   2,597
   Amortization of regulatory asset...................  5,266   3,760   3,472
                                                       ------  ------  ------
   Net postretirement benefit cost.................... $8,991  $7,734  $6,069
                                                       ======  ======  ======
</TABLE>
 
  The following table sets forth the funded status of the plans and amounts
recognized in the Company's consolidated balance sheets based on a measurement
date of October 1.
 
<TABLE>
<CAPTION>
                                                             1996      1995
                                                           --------  --------
                                                            (IN THOUSANDS)
   <S>                                                     <C>       <C>
   Retirees............................................... $(58,131) $(57,580)
   Other fully eligible participants......................   (5,728)   (5,973)
   Other active participants..............................  (15,083)  (14,671)
                                                           --------  --------
                                                            (78,942)  (78,224)
   Plan assets at fair value..............................   17,918    16,563
                                                           --------  --------
   Accumulated postretirement benefits obligation in
    excess of plan assets.................................  (61,024)  (61,661)
   Unrecognized actuarial gain............................  (12,586)  (12,521)
   Unrecognized prior service costs.......................  (11,217)  (12,407)
                                                           --------  --------
   Accrued postretirement benefits........................ $(84,827) $(86,589)
                                                           ========  ========
</TABLE>
 
  The Company established a 501(c) (9) Voluntary Employee Beneficiary
Association ("VEBA") Trust in 1991 to begin funding its postretirement benefit
obligation for collectively bargained employees. The Company contributed
$2,600,000 to the VEBA in 1995. Plan assets are invested in equity securities,
fixed-income investments and money market instruments.
 
  The weighted average discount rate used in determining the accumulated post-
retirement benefit obligation was 7.5% in 1996 and 1995. A 7% and 10% annual
increase in the cost of covered health care benefits was assumed for 1996 and
1995, respectively. This rate of increase is assumed to remain at 7% through
1999, decrease to 6% in 2000 and 5% thereafter. A 1% increase in the assumed
health care cost trend would have increased the postretirement benefit cost by
$536,000 in 1996 and $541,000 in 1995, and the accumulated postretirement
benefit obligation by $6,253,000 in 1996 and $6,300,000 in 1995.
 
(8) LEASES
 
  The Company and its subsidiary lease certain facilities and equipment under
long-term leases which expire on various dates through the year 2001. Total
rentals charged to income under all lease agreements were approximately
$8,418,000 in 1996, $8,826,000 in 1995, and $8,323,000 in 1994.
 
  The Company capitalizes its financing leases which include liquefied natural
gas facilities and an operations center. The lease for the liquefied natural
gas facilities expires in June of 1997. The Company is in the process of
evaluating its alternatives with respect to these facilities. A summary of
property held under capital leases as of December 31 is as follows:
 
 
                                     F-13
<PAGE>
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
(8) LEASES (CONTINUED)
 
<TABLE>
<CAPTION>
                                                                 1996    1995
                                                                ------- -------
                                                                (IN THOUSANDS)
   <S>                                                          <C>     <C>
   LNG facilities.............................................. $15,600 $15,600
   Buildings...................................................   6,000   6,000
                                                                ------- -------
                                                                 21,600  21,600
   Less-Accumulated depreciation...............................  18,828  17,320
                                                                ------- -------
       Total Capital Leases.................................... $ 2,772 $ 4,280
                                                                ======= =======
</TABLE>
 
  Under the terms of SFAS 71, the timing of expense recognition on capitalized
leases should conform with regulatory rate treatment. The Company has included
the rental payments on its financing leases in its cost of service for rate
purposes. Therefore, the total depreciation and interest expense that was
recorded on the leases was equal to the rental payments included in other
operating and maintenance expense in the accompanying consolidated statements
of earnings.
 
  The Company also has various operating lease agreements for office
facilities and other equipment. The remaining minimum rental commitment for
these and all other noncancelable leases, including the financing leases, at
December 31, 1996 is as follows:
 
<TABLE>
<CAPTION>
                                                             CAPITAL OPERATING
   YEAR                                                      LEASES   LEASES
   ----                                                      ------- ---------
                                                              (IN THOUSANDS)
   <S>                                                       <C>     <C>
   1997.....................................................  1,269     4,548
   1998.....................................................    684     3,735
   1999.....................................................    686     3,385
   2000.....................................................    687     2,797
   2001.....................................................     57     2,119
   Later Years..............................................    --      1,108
                                                             ------   -------
   Total minimum lease payments............................. $3,383   $17,692
                                                             ======   =======
   Less-Amount representing interest and executory costs....    611
                                                             ------
   Present value of minimum lease payments on capital
    leases.................................................. $2,772
                                                             ======
</TABLE>
 
(9) FAIR VALUES OF FINANCIAL INSTRUMENTS
 
  The following methods and assumptions were used to estimate the fair values
of financial instruments:
 
 Cash
 
  The carrying amounts approximate fair value.
 
 Short-term Debt
 
  The carrying amounts of the Company's short-term debt, including notes
payable and gas inventory financing, approximate their fair value.
 
 Long-term Debt
 
  The fair value of long-term debt is estimated based on currently quoted
market prices.
 
 
                                     F-14
<PAGE>
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
(9) FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)
 
 Preferred Stock
 
  The fair value of the preferred stock for 1996 and 1995 is based on
currently quoted market prices.
 
  The carrying amounts and estimated fair values of the Company's financial
instruments at December 31, 1996 and 1995 are as follows:
 
<TABLE>
<CAPTION>
                                                   1996              1995
                                             ----------------- -----------------
                                             CARRYING   FAIR   CARRYING   FAIR
                                              AMOUNT   VALUE    AMOUNT   VALUE
                                             -------- -------- -------- --------
                                              (IN THOUSANDS)    (IN THOUSANDS)
<S>                                          <C>      <C>      <C>      <C>
Cash........................................ $  1,474 $  1,474 $  5,841 $  5,841
Short-term debt............................. $112,594 $112,594 $ 97,600 $ 97,600
Long-term debt.............................. $212,772 $223,001 $214,281 $241,757
Preferred stock............................. $ 29,293 $ 29,586 $ 29,262 $ 28,829
</TABLE>
 
(10) RELATED PARTY TRANSACTIONS
 
  The Company paid Eastern $4,048,000 in 1996, $4,117,000 in 1995, and
$3,669,000 in 1994 for legal, tax and corporate services rendered.
 
  In December 1996, Eastern Rivermoor Company, Inc. a wholly owned subsidiary
of Eastern, purchased the Company's primary operations center from a third
party and assumed the current lease agreement with the Company. There were no
payments made during 1996 to Eastern Rivermoor Company, Inc. by the Company.
 
  During 1996 Eastern entered into a joint venture with New England Electric
System to form AllEnergy Marketing Company, L.L.P., a new unregulated energy
marketing company. During 1996 AllEnergy purchased gas from the Company at
prices and terms equivalent to those used in transacting business with
unrelated parties. These purchases totalled $2,764,000.
 
(11) ENVIRONMENTAL ISSUES
 
  The Company, like many other companies in the natural gas industry, is party
to governmental actions requiring investigation and possible remediation of
former manufactured gas plant ("MGP") sites. The Company currently owns 15
former MGP sites. Massachusetts Electric Company (MEC), a wholly-owned
subsidiary of New England Electric System ("NEES"), has assumed full
responsibility for remediating one such
MGP site in Lynn, Massachusetts, pursuant to the decision of the First Circuit
Court of Appeals in The John S. Boyd, Inc., et al. v. Boston Gas Company, et
al, which affirmed that NEES and its subsidiaries are responsible for
remediating the site as prior owners and operators. Pursuant to a settlement
agreement between MEC and the Company (the "Settlement Agreement"), MEC
assumed responsibility for remediating ten other sites owned by the Company,
subject to limited contribution by the Company. The Company is working with
the Massachusetts Department of Environmental Protection (the "DEP") to
determine the extent of remediation which may be required at the four former
MGP sites currently owned by the Company and not covered by the Settlement
Agreement or the Boyd decision. The Company expects to spend approximately
$1,000,000 in 1997 for assessment and contribution costs associated with the
Company's and MEC's site investigations. Since the DEP has not yet approved a
remediation plan for any of these sites, the Company does not possess at this
time sufficient information to reasonably determine the ultimate cost of
remediation, and no assurance can be given with respect to the future
recoverability of such costs. However, management believes that it is not
probable that such costs will materially affect the Company's financial
condition or results of operations, particularly given the Company's limited
potential responsibility as a result of the Settlement Agreement and the rate
order
 
                                     F-15
<PAGE>
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
(11) ENVIRONMENTAL ISSUES (CONTINUED)
 
discussed below. Company experience to date indicates that assessment and
remediation costs of approximately $15,000,000 could be paid by the Company
with respect to these ten sites covered by the Settlement Agreement and the
four other sites.
 
  The Company is aware of 25 other former MGP sites within the Company's
service territory which the Company does not currently own. MEC has provided
full indemnification of the Company with respect to eight of these sites in
the Settlement Agreement. At this time, there is substantial uncertainty as to
whether the Company is responsible for remediating any of the other sites
either because the Company does not have successor liability for contamination
of these sites by earlier operators or site conditions do not require
remediation by the Company. The DEP has not issued a Notice of Responsibility
to the Company for any of these sites.
 
  By a rate order issued on May 25, 1990, the Department approved the recovery
of all environmental response costs associated with former MGP sites over
separate, seven-year amortization periods without a return on the unamortized
balance. The rate order also provides for no further investigation of the
prudency of any Massachusetts gas utility's past MGP operations.
 
(12) PIPELINE TRANSITION COSTS
 
  Pursuant to FERC Order 636, pipelines are currently recovering prudently
incurred transition costs, including (1) gas supply realignment costs or the
costs of renegotiating existing gas supply contracts with producers; (2)
unrecovered purchased gas adjustment costs or uncovered gas costs at the time
the pipelines ceased the merchant function; (3) stranded costs or the
unrecovered costs of assets that cannot be assigned to customers of unbundled
services; and (4) new facilities costs or the costs of new facilities required
to physically implement the order.
 
  On March 8, 1995 the Department issued an order allowing for the recovery of
the Company's transition costs liability from customers. The Company's
estimate of its total obligation for transition costs is $58,243,000. The
Company has recorded a regulatory asset of $16,494,000 which represents the
unrecovered balance of the Company's estimated obligation.
 
 
                                     F-16
<PAGE>
 
                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To Boston Gas Company:
 
  We have audited the accompanying consolidated balance sheets of Boston Gas
Company (a Massachusetts Corporation and wholly-owned subsidiary of Eastern
Enterprises) and subsidiary as of December 31, 1996 and 1995, and the related
consolidated statements of earnings, retained earnings and cash flows for each
of the three years in the period ended December 31, 1996. These consolidated
financial statements and the schedules referred to below are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.
 
  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
 
  In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Boston Gas Company and
subsidiary as of December 31, 1996 and 1995 and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1996, in conformity with generally accepted accounting
principles.
 
  Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedules listed in the index to
consolidated financial statements are presented for purposes of complying with
the Securities and Exchange Commission's rules and are not a part of the basic
financial statements. These schedules have been subjected to the auditing
procedures applied in the audits of the basic financial statements and, in our
opinion, fairly state, in all material respects, the financial data required
to be set forth therein in relation to the basic financial statements taken as
a whole.
 
                                          ARTHUR ANDERSEN LLP
 
Boston, Massachusetts
January 21, 1997
 
                                     F-17
<PAGE>
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
                         INTERIM FINANCIAL INFORMATION
             FOR THE TWO YEARS ENDED DECEMBER 31, 1996 (UNAUDITED)
 
  The following table summarizes the Company's reported quarterly information
for the years ended December 31, 1996 and 1995:
 
<TABLE>
<CAPTION>
                                                  THREE MONTHS ENDED
                                          ------------------------------------
                                          MARCH 31 JUNE 30  SEPT. 30  DEC. 31
                                          -------- -------- --------  --------
                                                    (IN THOUSANDS)
<S>                                       <C>      <C>      <C>       <C>
1996
Operating revenues....................... $343,341 $136,520 $59,453   $166,148
Operating margin.........................  122,174   59,309  34,733     74,992
Operating earnings (loss)................   30,334    6,339  (3,758)    15,519
Net earnings (loss) applicable to common
 stock...................................   25,021    1,842  (8,161)    10,438
1995
Operating revenues....................... $294,241 $129,616 $56,957   $172,259
Operating margin.........................  111,910   58,772  33,857     73,630
Operating earnings (loss)................   29,306    6,888  (4,732)    13,942
Net earnings (loss) applicable to common
 stock...................................   23,197    1,678  (9,833)     8,335
</TABLE>
 
                                      F-18
<PAGE>
 
                                                                     SCHEDULE II
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
                       VALUATION AND QUALIFYING ACCOUNTS
                      FOR THE YEAR ENDED DECEMBER 31, 1996
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                         ADDITIONS
                                     ------------------    NET
                          BALANCE,             CHARGED  DEDUCTIONS   BALANCE,
                        DECEMBER 31,  CHARGED  TO OTHER    FROM    DECEMBER 31,
DESCRIPTION                 1995     TO INCOME ACCOUNTS  RESERVES      1996
-----------             ------------ --------- -------- ---------- ------------
<S>                     <C>          <C>       <C>      <C>        <C>
RESERVES DEDUCTED FROM
 ASSETS:
 Reserves for doubtful
  accounts.............   $ 15,324    $12,942   $  --    $12,303     $ 15,963
                          ========    =======   ======   =======     ========
RESERVES NOT DEDUCTED
 FROM ASSETS:
 Accumulated deferred
  income taxes.........   $ 72,001    $(1,383)  $5,659   $   --      $ 76,277
                          --------    -------   ------   -------     --------
 Deferred investment
  tax credits..........   $  7,767    $  (931)  $  --    $   --      $  6,836
                          --------    -------   ------   -------     --------
 Postretirement benefit
  cost.................   $ 86,589    $ 3,725   $  --    $ 5,487     $ 84,827
                          --------    -------   ------   -------     --------
 Other reserves and
  deferred credits--
  Reserve for self-
   insurance...........      2,347      1,931      --      2,038        2,240
  SFAS 109 Regulatory
   Liability...........      4,440        --       --        601        3,839
  Deferred net
   normalization
   surplus.............      7,951        --       --        345        7,606
  Other................      9,120      7,054      --      5,163       11,011
                          --------    -------   ------   -------     --------
   Total other reserves
    and deferred
    credits............     23,858      8,985      --      8,147       24,696
                          --------    -------   ------   -------     --------
   Total reserves not
    deducted from
    assets.............   $190,215    $10,396   $5,659   $13,634     $192,636
                          ========    =======   ======   =======     ========
</TABLE>
 
                                      F-19
<PAGE>
 
                                                                     SCHEDULE II
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
                       VALUATION AND QUALIFYING ACCOUNTS
                      FOR THE YEAR ENDED DECEMBER 31, 1995
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                         ADDITIONS
                                     ------------------    NET
                          BALANCE,             CHARGED  DEDUCTIONS   BALANCE,
                        DECEMBER 31,  CHARGED  TO OTHER    FROM    DECEMBER 31,
      DESCRIPTION           1994     TO INCOME ACCOUNTS  RESERVES      1995
      -----------       ------------ --------- -------- ---------- ------------
<S>                     <C>          <C>       <C>      <C>        <C>
RESERVES DEDUCTED FROM
 ASSETS:
 Reserves for doubtful
  accounts.............   $ 15,621    $14,500   $  --    $14,797     $ 15,324
                          ========    =======   ======   =======     ========
RESERVES NOT DEDUCTED
 FROM ASSETS:
 Accumulated deferred
  income taxes.........   $ 66,577    $ 2,985   $2,439   $   --      $ 72,001
                          --------    -------   ------   -------     --------
 Deferred investment
  tax credits..........   $  8,704    $  (937)  $  --    $   --      $  7,767
                          --------    -------   ------   -------     --------
 Postretirement benefit
  cost.................   $ 90,214    $ 3,975   $  --    $ 7,600     $ 86,589
                          --------    -------   ------   -------     --------
 Other reserves and de-
  ferred credits--
  Reserve for self-in-
   surance.............      2,258      1,739      --      1,650        2,347
  SFAS 109 Regulatory
   Liability...........      5,045        --       --        605        4,440
  Deferred net normal-
   ization surplus.....      8,296        --       --        345        7,951
  Other................      6,068      6,955    1,521     5,424        9,120
                          --------    -------   ------   -------     --------
   Total other reserves
    and deferred cred-
    its................     21,667      8,694    1,521     8,024       23,858
                          --------    -------   ------   -------     --------
   Total reserves not
    deducted from as-
    sets...............   $187,162    $14,717   $3,960   $15,624     $190,215
                          ========    =======   ======   =======     ========
</TABLE>
 
                                      F-20
<PAGE>
 
                                                                     SCHEDULE II
 
                       BOSTON GAS COMPANY AND SUBSIDIARY
 
                       VALUATION AND QUALIFYING ACCOUNTS
                      FOR THE YEAR ENDED DECEMBER 31, 1994
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                         ADDITIONS
                                     ------------------     NET
                          BALANCE,             CHARGED   DEDUCTIONS   BALANCE,
                        DECEMBER 31,  CHARGED  TO OTHER     FROM    DECEMBER 31,
      DESCRIPTION           1993     TO INCOME ACCOUNTS   RESERVES      1994
      -----------       ------------ --------- --------  ---------- ------------
<S>                     <C>          <C>       <C>       <C>        <C>
RESERVES DEDUCTED FROM
 ASSETS:
 Reserves for doubtful
  accounts.............   $ 13,518    $15,830  $   --     $13,727     $ 15,621
                          ========    =======  =======    =======     ========
RESERVES NOT DEDUCTED
 FROM ASSETS:
 Accumulated deferred
  income taxes.........   $ 61,561    $ 4,923  $    93    $   --      $ 66,577
                          --------    -------  -------    -------     --------
 Deferred investment
  tax credits..........   $  9,427    $  (723) $   --     $   --      $  8,704
                          --------    -------  -------    -------     --------
 Postretirement benefit
  cost.................   $ 91,955    $ 2,597  $   --     $ 4,338     $ 90,214
                          --------    -------  -------    -------     --------
 Other reserves and de-
  ferred credits--
  Reserve for self-in-
   surance.............      2,270      1,429      --       1,441        2,258
  SFAS 109 Regulatory
   Liability...........      5,512        --       --         467        5,045
  Deferred net normal-
   ization surplus.....      8,494        --       --         198        8,296
  Other................      5,848      8,634   (3,658)     4,756        6,068
                          --------    -------  -------    -------     --------
   Total other reserves
    and deferred cred-
    its................     22,124     10,063   (3,658)     6,862       21,667
                          --------    -------  -------    -------     --------
   Total reserves not
    deducted from as-
    sets...............   $185,067    $16,860  $(3,565)   $11,200     $187,162
                          ========    =======  =======    =======     ========
</TABLE>
 
                                      F-21