##### 



InterOil Corporation
    
    (INTEROIL LOGO)Consolidated Financial Statements(Expressed in United States dollars)Years ended December 31, 2005, 2004 and 2003




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##### 



InterOil Corporation
    
    (INTEROIL LOGO)Consolidated Financial Statements(Expressed in United States dollars)
 Table of contents
 Managements Report
    
    
    1Auditors Report to the Shareholders
    
    
    2Consolidated Balance Sheets
    
    
    4Consolidated Statements of Operations
    
    
    5Consolidated Statements of Cash Flows
    
    
    6Consolidated Statements of Shareholders Equity
    
    
    7Notes to the Consolidated Financial Statements
    
    
    8Reconciliation to accounting principles generally accepted in the United States
    
    
    26




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##### 



InterOil Corporation
    

(INTEROIL LOGO)Consolidated Financial Statements(Expressed in United States dollars)
 MANAGEMENTS REPORT
      /s/ Phil MulacekPhil Mulacek
    
    /s/ Tom DonovanTom DonovanChief Executive Officer
    
    Chief Financial Officer
 - 1 -




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##### 



- 2 -




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##### 



AUDITORS REPORT TO THE SHAREHOLDERS
     
 COMMENTS BY AUDITORS FOR U.S. READERS ON CANADA U.S. REPORTING DIFFERENCE


- 3 -



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##### 



InterOil Corporation
    
(INTEROIL LOGO)Consolidated Balance Sheets(Expressed in United States dollars)
 As atDecember 31,
    
    December 31,
    
    December 31,2005
    
    2004
    
    2003$
    
    $
    
    $AssetsCurrent assets:Cash and cash equivalents (note 4)
    
    
    59,601,807
    
    
    
    28,544,398
    
    
    
    9,216,265Trade receivables (note 7)
    
    
    49,958,973
    
    
    
    58,698,069
    
    
    
    Commodity derivative contracts (note 6)
    
    
    1,482,798
    
    
    
    503,500
    
    
    
    Other assets
    
    
    1,011,195
    
    
    
    806,123
    
    
    
    486,584Inventories (note 8)
    
    
    44,087,484
    
    
    
    27,916,902
    
    
    
    Prepaid expenses
    
    
    638,216
    
    
    
    190,135
    
    
    
    488,532Restricted cash (note 6)
    
    
    16,662,269
    
    
    
    15,599,223
    
    
    
    24,820,989Total current assets
    
    
    173,442,742
    
    
    
    132,258,350
    
    
    
    35,012,370Deferred financing costs (note 16)
    
    
    1,256,816
    
    
    
    1,311,488
    
    
    
    551,000Plant and equipment (note 9)
    
    
    237,399,148
    
    
    
    244,363,355
    
    
    
    201,758,465Oil and gas properties (note 10)
    
    
    16,399,492
    
    
    
    6,605,360
    
    
    
    23,018,015Future income tax benefit (note 11)
    
    
    1,058,898
    
    
    
    1,303,631
    
    
    
    Total assets
    
    
    429,557,096
    
    
    
    385,842,184
    
    
    
    260,339,850Liabilities and shareholders equityCurrent liabilities:Accounts payable and accrued liabilities
    
    
    26,005,034
    
    
    
    26,328,544
    
    
    
    5,835,583Income tax payable
    
    
    3,900,459
    
    
    
    2,881,398
    
    
    
    Working capital facility  crude feedstock (note 12)
    
    
    70,724,322
    
    
    
    76,520,541
    
    
    
    Deferred hedge gain (note 6)
    
    
    1,016,998
    
    
    
    537,358
    
    
    
    Business combination financing (note 13)
    
    
    
    
    
    
    12,123,106
    
    
    
    Due to related parties (note 14)
    
    
    
    
    
    
    1,056,251
    
    
    
    1,478,751Unsecured loan (note 15)
    
    
    21,453,132
    
    
    
    
    
    
    
    Current portion of secured loan (note 16)
    
    
    9,000,000
    
    
    
    9,000,000
    
    
    
    9,000,000Current portion of indirect participation interest (note 17)
    
    
    35,092,558
    
    
    
    13,749,852
    
    
    
    Total current liabilities
    
    
    167,192,503
    
    
    
    142,197,050
    
    
    
    16,314,334Accrued financing costs (note 16)
    
    
    921,109
    
    
    
    863,329
    
    
    
    Secured loan (note 16)
    
    
    71,500,000
    
    
    
    76,000,000
    
    
    
    74,000,000Indirect participation interest (note 17)
    
    
    30,166,311
    
    
    
    
    
    
    
    Indirect participation interest  PNGDV(note 17)
    
    
    9,685,830
    
    
    
    10,608,830
    
    
    
    16,600,000Total liabilities
    
    
    279,465,753
    
    
    
    229,669,209
    
    
    
    106,914,334Non-controlling interest (note 18)
    
    
    6,023,149
    
    
    
    6,404,262
    
    
    
    6,467,496Shareholders equity:Share capital (note 19)
    
    
    223,934,500
    
    
    
    216,813,654
    
    
    
    157,449,200Authorised  unlimitedIssued and outstanding 29,163,320(Dec 31, 2004 - 28,310,884)(Dec 31, 2003 - 24,815,961)Contributed surplus
    
    
    2,933,586
    
    
    
    1,841,776
    
    
    
    540,222Warrants (note 21)
    
    
    2,137,852
    
    
    
    2,258,227
    
    
    
    Foreign currency translation adjustment
    
    
    477,443
    
    
    
    463,200
    
    
    
    Conversion options (note 17)
    
    
    25,475,368
    
    
    
    
    
    
    
    Accumulated deficit
    
    
    (110,890,555
    )
    
    
    (71,608,144
    )
    
    
    (11,031,402
    )Total shareholders equity
    
    
    144,068,194
    
    
    
    149,768,713
    
    
    
    146,958,020Total liabilities and shareholders equity
    
    
    429,557,096
    
    
    
    385,842,184
    
    
    
    260,339,850
 See accompanying notes to the consolidated financial statements
 Commitments and contingencies (note 23)
    - 4 -




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##### 



InterOil Corporation
    
(INTEROIL LOGO)Consolidated
Statements of Operations(Expressed in United States dollars)
 Year endedDecember 31,
    
    December 31,
    
    December 31,2005
    
    2004
    
    2003$
    
    $
    
    $RevenueSales and operating revenues
    
    
    481,180,645
    
    
    
    70,644,486
    
    
    
    Interest
    
    
    1,830,808
    
    
    
    382,461
    
    
    
    246,912Other
    
    
    528,270
    
    
    
    196,337
    
    
    
    12,368483,539,723
    
    
    
    71,223,284
    
    
    
    259,280ExpensesCost of sales and operating expenses
    
    
    467,246,990
    
    
    
    65,344,516
    
    
    
    Administrative and general expenses
    
    
    14,672,793
    
    
    
    7,831,550
    
    
    
    2,264,187Management fees for prior periods waived
    
    
    
    
    
    
    
    
    
    
    (840,000
    )Depreciation and amortization
    
    
    11,036,550
    
    
    
    639,075
    
    
    
    73,068Exploration
costs, excluding exploration impairment (note 10)
    
    
    
    
    
    
    2,903,313
    
    
    
    Exploration impairment (note 10)
    
    
    2,144,429
    
    
    
    35,566,761
    
    
    
    164,992Legal and professional fees
    
    
    3,606,415
    
    
    
    3,573,727
    
    
    
    1,421,390Short term borrowing costs
    
    
    8,855,857
    
    
    
    4,705,190
    
    
    
    Long term borrowing costs
    
    
    6,351,337
    
    
    
    1,401,256
    
    
    
    Accretion expense (note 17)
    
    
    5,647,491
    
    
    
    
    
    
    
    Foreign exchange loss
    
    
    796,590
    
    
    
    392,805
    
    
    
    678,774520,358,452
    
    
    
    122,358,193
    
    
    
    3,762,411Loss before income taxes and non-controlling interest
    
    
    (36,818,729
    )
    
    
    (51,134,909
    )
    
    
    (3,503,131
    )Income taxes (note 11)Current
    
    
    (2,605,265
    )
    
    
    (2,538,410
    )
    
    
    (37,339
    )Future
    
    
    (226,729
    )
    
    
    663,347
    
    
    
    (2,831,994
    )
    
    
    (1,875,063
    )
    
    
    (37,339
    )Loss before non-controlling interest
    
    
    (39,650,723
    )
    
    
    (53,009,972
    )
    
    
    (3,540,470
    )Non-controlling interest
    
    
    368,312
    
    
    
    70,091
    
    
    
    22,901Net loss
    
    
    (39,282,411
    )
    
    
    (52,939,881
    )
    
    
    (3,517,569
    )Basic loss per share(note 22)
    
    
    (1.36
    )
    
    
    (2.09
    )
    
    
    (0.16
    )Diluted loss per share (note 22)
    
    
    (1.36
    )
    
    
    (2.09
    )
    
    
    (0.16
    )Weighted average number of common shares outstandingBasic and diluted
    
    
    28,832,263
    
    
    
    25,373,575
    
    
    
    22,649,924
 -5-




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##### 



InterOil Corporation
    
(INTEROIL LOGO)Consolidated
Statements of Cash Flows(Expressed in United States dollars)
 Year endedDecember 31,
    
    December 31,
    
    December 31,2005
    
    2004
    
    2003$
    
    $
    
    $Cash flows provided by (used in):Operating activitiesNet (loss) (note 5)
    
    
    (39,282,411
    )
    
    
    (52,939,881
    )
    
    
    (3,517,569
    )Adjustments for non-cash transactionsNon-controlling interest
    
    
    (381,113
    )
    
    
    (70,091
    )
    
    
    (22,901
    )Depreciation and amortization
    
    
    11,036,550
    
    
    
    639,075
    
    
    
    73,068Future income tax asset
    
    
    244,733
    
    
    
    (663,347
    )
    
    
    Gain on sale of other assets
    
    
    
    
    
    
    (94,260
    )
    
    
    Gain on sale of plant and equipment
    
    
    (95,053
    )
    
    
    
    
    
    
    Amortization of deferred financing costs
    
    
    154,672
    
    
    
    268,873
    
    
    
    Amortization of discount on debt
    
    
    161,255
    
    
    
    604,045
    
    
    
    Accretion of discount on indirect participation interest
    
    
    5,647,491
    
    
    
    
    
    
    
    Debt conversion settlement expense  debentures
    
    
    
    
    
    
    77,589
    
    
    
    Interest expense forfeited by debenture holders
    
    
    
    
    
    
    998,438
    
    
    
    Management fee waived
    
    
    
    
    
    
    
    
    
    
    (840,000
    )Loss on unsettled hedge contracts
    
    
    119,200
    
    
    
    33,858
    
    
    
    Gain on derivative contracts
    
    
    (585,000
    )
    
    
    
    
    
    
    Stock compensation expense/(recovery)
    
    
    1,668,896
    
    
    
    1,209,921
    
    
    
    (39,654
    )Inventory revaluation
    
    
    355,215
    
    
    
    1,508,334
    
    
    
    Capitalized oil and gas properties expensed
    
    
    2,144,429
    
    
    
    35,566,761
    
    
    
    164,992Unrealized foreign exchange loss
    
    
    796,590
    
    
    
    392,805
    
    
    
    678,774Change in non-cash operating working capitalIncrease/(decrease) in foreign currency translation adjustment
    
    
    14,243
    
    
    
    463,200
    
    
    
    Decrease/(increase) in trade receivables
    
    
    8,739,096
    
    
    
    (50,456,671
    )
    
    
    (Increase) in commodity derivative contracts
    
    
    (33,858
    )
    
    
    
    
    
    
    Decrease/(increase) in other assets and prepaid expenses
    
    
    (653,153
    )
    
    
    982,014
    
    
    
    220,196(Increase) in inventories
    
    
    (16,525,797
    )
    
    
    (24,167,627
    )
    
    
    Increase/(decrease) in accounts payable, accrued liabilities
and income tax payable
    
    
    3,761,311
    
    
    
    5,880,047
    
    
    
    (236,058
    )(22,712,704
    )
    
    
    (79,766,917
    )
    
    
    (3,519,152
    )Investing activitiesExpenditure on oil and gas properties
    
    
    (11,249,477
    )
    
    
    (19,154,106
    )
    
    
    (19,987,946
    )Expenditure on plant and equipment
    
    
    (4,089,519
    )
    
    
    (38,947,904
    )
    
    
    (81,843,608
    )Proceeds from indirect participation interest
    
    
    80,410,591
    
    
    
    10,724,885Expenditure on oil and gas properties applied against
indirect participation interest (note 17)
    
    
    (31,774,513
    )
    
    
    
    
    
    
    Proceeds received on sale of assets
    
    
    112,229
    
    
    
    405,353
    
    
    
    Redemption/(investment) of cash on short-term investments
    
    
    
    
    
    
    24,723,572
    
    
    
    (17,617,871
    )Acquisition of InterOil Products Limited net of cash received
(note 13)
    
    
    
    
    
    
    4,631,904
    
    
    
    Repayment of business combination financing
    
    
    (12,226,581
    )
    
    
    
    
    
    
    Increase in restricted cash held as security on borrowings
    
    
    (1,063,046
    )
    
    
    (15,501,806
    )
    
    
    (97,417
    )Change in non-cash working capitalIncrease/(decrease) in accounts payable and accrued liabilities
    
    
    (3,165,756
    )
    
    
    4,094,594
    
    
    
    (1,351,521
    )15,468,253
    
    
    
    (29,023,508
    )
    
    
    (120,898,363
    )Financing activitiesProceeds from secured loan
    
    
    
    
    
    
    2,000,000
    
    
    
    52,000,000Repayments of secured loan
    
    
    (4,500,000
    )
    
    
    
    
    
    
    Proceeds from senior convertible debentures and warrants
    
    
    
    
    
    
    45,000,000
    
    
    
    Senior convertible debenture issuance costs
    
    
    
    
    
    
    (3,259,766
    )
    
    
    Proceeds from conversion options
    
    
    22,700,814
    
    
    
    6,259,967
    
    
    
    16,300,000Proceeds from related party borrowings
    
    
    
    
    
    
    1,775,565
    
    
    
    Repayments to related parties
    
    
    (1,056,251
    )
    
    
    (2,198,065
    )
    
    
    (776,902
    )Proceeds from short term borrowings
    
    
    21,453,132
    
    
    
    5,100,000
    
    
    
    Repayments of short term borrowings
    
    
    
    
    
    
    (5,100,000
    )
    
    
    Proceeds from/(repayments of) working capital facility
    
    
    (5,796,219
    )
    
    
    76,520,541
    
    
    
    Proceeds from issue of common shares
    
    
    5,500,384
    
    
    
    2,020,316
    
    
    
    62,822,14338,301,860
    
    
    
    128,118,558
    
    
    
    130,345,241Increase/(decrease) in cash and cash equivalents
    
    
    31,057,409
    
    
    
    19,328,133
    
    
    
    5,927,726Cash and cash equivalents, beginning of period
    
    
    28,544,398
    
    
    
    9,216,265
    
    
    
    3,288,539Cash and cash equivalents, end of period (note 4)
    
    
    59,601,807
    
    
    
    28,544,398
    
    
    
    9,216,265
 See accompanying notes to the consolidated financial statements
 See note 5 for non cash financing and investing activities




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##### 



InterOil Corporation
    
(INTEROIL LOGO)Consolidated
Statements of Shareholders Equity(Expressed in United States dollars)
 Year endedDecember 31,
    
    December 31,
    
    December 31,2005
    
    2004
    
    2003$
    
    $
    
    $Share capitalAt beginning of period
    
    
    216,813,654
    
    
    
    157,449,200
    
    
    
    94,120,609Adjustment to reflect change in accounting for
employee stock options (note 2n)
    
    
    
    
    
    
    92,434
    
    
    
    Issue of capital stock (note 19)
    
    
    7,120,846
    
    
    
    59,272,020
    
    
    
    63,328,591At end of period
    
    
    223,934,500
    
    
    
    216,813,654
    
    
    
    157,449,200Contributed surplusAt beginning of period
    
    
    1,841,776
    
    
    
    540,222
    
    
    
    769,964Adjustment to reflect change in accounting for
employee stock options (note 2n)
    
    
    
    
    
    
    645,216
    
    
    
    Stock compensation (note 20)
    
    
    1,091,810
    
    
    
    656,338
    
    
    
    (229,742
    )At end of period
    
    
    2,933,586
    
    
    
    1,841,776
    
    
    
    540,222WarrantsAt beginning of period
    
    
    2,258,227
    
    
    
    
    
    
    
    Movement for period (note 21)
    
    
    (120,375
    )
    
    
    2,258,227
    
    
    
    At end of period
    
    
    2,137,852
    
    
    
    2,258,227
    
    
    
    Foreign currency translation adjustmentAt beginning of period
    
    
    463,200
    
    
    
    
    
    
    
    Movement for period, net of tax
    
    
    14,243
    
    
    
    463,200
    
    
    
    At end of period
    
    
    477,443
    
    
    
    463,200
    
    
    
    Conversion optionsAt beginning of period
    
    
    
    
    
    
    
    
    
    
    Movement for period (note 17)
    
    
    25,475,368
    
    
    
    
    
    
    
    At end of period
    
    
    25,475,368
    
    
    
    
    
    
    
    Accumulated deficitAt beginning of period
    
    
    (71,608,144
    )
    
    
    (11,031,402
    )
    
    
    (7,513,833
    )Adjustment to reflect change in accounting for
employee stock options (note 2n)
    
    
    
    
    
    
    (737,650
    )
    
    
    Adjustment to cumulative debentures conversion expense
(note 21)
    
    
    
    
    
    
    (6,899,211
    )
    
    
    Net (loss) for period
    
    
    (39,282,411
    )
    
    
    (52,939,881
    )
    
    
    (3,517,569
    )At end of period
    
    
    (110,890,555
    )
    
    
    (71,608,144
    )
    
    
    (11,031,402
    )Shareholders equity at end of period
    
    
    144,068,194
    
    
    
    149,768,713
    
    
    
    146,958,020
 See accompanying notes to the consolidated financial statements
 -7-




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##### 



InterOil Corporation
    
(INTEROIL LOGO)Notes to Consolidated Financial Statements(Expressed in United States dollars)
 1. Nature of operations and organization
    2.
    
    Significant accounting policies
             -8-




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##### 



InterOil Corporation
    
(INTEROIL LOGO)Notes to Consolidated Financial Statements(Expressed in United States dollars)
 2.
    
    Significant accounting policies (contd)
            Refinery assets
  -9-




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##### 



InterOil Corporation
    
(INTEROIL LOGO)Notes to Consolidated Financial Statements(Expressed in United States dollars)
 2.
    
    Significant accounting policies (contd)
   Other assets
  Downstream
    
    
    0% - 25
    %Midstream
    
    
    1% - 33
    %Upstream
    
    
    4% - 100
    %Corporate
    
    
    13% - 33
    %
 Leased assets
  Asset retirement obligations
  Disposal of property, plant and equipment
  Environmental remediation
        -10-




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##### 



InterOil Corporation
    
(INTEROIL LOGO)Notes to Consolidated Financial Statements(Expressed in United States dollars)
 2.
    
    Significant accounting policies (contd)
   Revenue from midstream operations
  Revenue from downstream operations:
  Interest income:
           -11-




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##### 



InterOil Corporation
    
(INTEROIL LOGO)Notes to Consolidated Financial Statements(Expressed in United States dollars)
 2.
    
    Significant accounting policies (contd)
  Credit risk
  Product risk
  Geographic risk
    3.
    
    Segmented financial information
    ConsolidationYear ended December 2005
    
    Upstream
    
    Midstream
    
    Downstream
    
    Corporate
    
    adjustments
    
    TotalRevenues from external customers
    
    
    
    
    
    
    356,326,763
    
    
    
    124,853,882
    
    
    
    
    
    
    
    
    
    
    
    481,180,645Intersegment revenues
    
    
    
    
    
    
    80,094,501
    
    
    
    6,202
    
    
    
    1,941,163
    
    
    
    (82,041,866
    )
    
    
    Interest revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,830,808
    
    
    
    
    
    
    
    1,830,808Other unallocated revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    528,270
    
    
    
    
    
    
    
    528,270Total segment revenue
    
    
    
    
    
    
    436,421,264
    
    
    
    124,860,084
    
    
    
    4,300,241
    
    
    
    (82,041,866
    )
    
    
    483,539,723Cost of sales and operating expenses
    
    
    
    
    
    
    436,490,554
    
    
    
    110,857,139
    
    
    
    
    
    
    
    (80,100,703
    )
    
    
    467,246,990Office and admin and other expenses
    
    
    1,737,825
    
    
    
    10,639,111
    
    
    
    4,725,411
    
    
    
    8,255,301
    
    
    
    (2,061,804
    )
    
    
    23,295,844Exploration costs, excluding
exploration impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exploration impairment
    
    
    2,144,429
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,144,429Depreciation and amortisation
    
    
    314,467
    
    
    
    10,598,134
    
    
    
    204,247
    
    
    
    49,732
    
    
    
    (130,030
    )
    
    
    11,036,550Accretion expense
    
    
    5,647,491
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,647,491Interest expense
    
    
    
    
    
    
    10,161,899
    
    
    
    225,450
    
    
    
    806,694
    
    
    
    (206,895
    )
    
    
    10,987,148Income/(loss) from ordinary activities before
income taxes
    
    
    (9,844,212
    )
    
    
    (31,468,434
    )
    
    
    8,847,837
    
    
    
    (4,811,486
    )
    
    
    457,566
    
    
    
    (36,818,729
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    (2,755,845
    )
    
    
    (76,149
    )
    
    
    
    
    
    
    (2,831,994
    )Non controlling interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    368,312
    
    
    
    
    
    
    
    368,312Total net
income/(loss)
    
    
    (9,844,212
    )
    
    
    (31,468,434
    )
    
    
    6,091,992
    
    
    
    (4,519,323
    )
    
    
    457,566
    
    
    
    (39,282,411
    )Total assets
    
    
    75,587,143
    
    
    
    314,904,035
    
    
    
    47,342,109
    
    
    
    317,227,597
    
    
    
    (325,503,788
    )
    
    
    429,557,096
 
 -12-




---



##### 



InterOil Corporation
    
(INTEROIL LOGO)Notes to Consolidated Financial Statements(Expressed in United States dollars)
 
 3.
    
    Segmented financial information (contd)
 ConsolidationYear ended December 2004
    
    Upstream
    
    Midstream
    
    Downstream
    
    Corporate
    
    adjustments
    
    TotalRevenues from external customers
    
    
    
    
    
    
    26,309,547
    
    
    
    62,410,291
    
    
    
    
    
    
    
    (18,075,352
    )
    
    
    70,644,486Intersegment revenues
    
    
    
    
    
    
    
    
    
    
    489,111
    
    
    
    1,557,621
    
    
    
    (2,046,732
    )
    
    
    Interest revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    382,461
    
    
    
    
    
    
    
    382,461Other unallocated revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    196,337
    
    
    
    
    
    
    
    196,337Total segment revenue
    
    
    
    
    
    
    26,309,547
    
    
    
    62,899,402
    
    
    
    2,136,419
    
    
    
    (20,122,084
    )
    
    
    71,223,284Cost of sales and operating expenses
    
    
    
    
    
    
    27,685,347
    
    
    
    53,158,737
    
    
    
    
    
    
    
    (15,499,568
    )
    
    
    65,344,516Office and admin and other expenses
    
    
    1,649,191
    
    
    
    3,133,095
    
    
    
    3,146,905
    
    
    
    8,309,537
    
    
    
    (1,537,415
    )
    
    
    14,701,313Exploration costs, excluding
exploration impairment
    
    
    2,903,313
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,903,313Exploration impairment
    
    
    35,566,761
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    35,566,761Depreciation and amortisation
    
    
    12,510
    
    
    
    311,986
    
    
    
    224,214
    
    
    
    90,365
    
    
    
    
    
    
    
    639,075Interest expense
    
    
    4,932
    
    
    
    843,888
    
    
    
    455,368
    
    
    
    1,899,027
    
    
    
    
    
    
    
    3,203,215Income/(loss) from ordinary activities before
income taxes
    
    
    (40,136,707
    )
    
    
    (5,664,769
    )
    
    
    5,914,178
    
    
    
    (8,162,510
    )
    
    
    (3,085,101
    )
    
    
    (51,134,909
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    (1,899,803
    )
    
    
    24,740
    
    
    
    
    
    
    
    (1,875,063
    )Non controlling interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    70,091
    
    
    
    
    
    
    
    70,091Total net income/(loss)
    
    
    (40,136,707
    )
    
    
    (5,664,769
    )
    
    
    4,014,375
    
    
    
    (8,067,679
    )
    
    
    (3,085,101
    )
    
    
    (52,939,881
    )Total assets
    
    
    21,570,219
    
    
    
    310,941,494
    
    
    
    34,436,144
    
    
    
    211,530,962
    
    
    
    (192,636,636
    )
    
    
    385,842,184
 ConsolidationYear ended December 2003
    
    Upstream
    
    Midstream
    
    Downstream
    
    Corporate
    
    adjustments
    
    TotalRevenues from external customers
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Intersegment revenues
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,068,746
    
    
    
    (1,068,746
    )
    
    
    Interest revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    246,912
    
    
    
    
    
    
    
    246,912Other unallocated revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,368
    
    
    
    
    
    
    
    12,368Total segment revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,328,026
    
    
    
    (1,068,746
    )
    
    
    259,280Cost of sales and operating expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Office and admin and other expenses
    
    
    520,270
    
    
    
    222,067
    
    
    
    24,939
    
    
    
    3,730,502
    
    
    
    (1,078,801
    )
    
    
    3,418,977Exploration costs, excluding
exploration impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exploration impairment
    
    
    164,992
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    164,992Depreciation and amortisation
    
    
    10,282
    
    
    
    8,254
    
    
    
    
    
    
    
    54,532
    
    
    
    
    
    
    
    73,068Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    105,374
    
    
    
    
    
    
    
    105,374Income/(loss) from ordinary activities before
income taxes
    
    
    (695,544
    )
    
    
    (230,321
    )
    
    
    (24,939
    )
    
    
    (2,562,382
    )
    
    
    10,055
    
    
    
    (3,503,131
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (37,339
    )
    
    
    
    
    
    
    (37,339
    )Non controlling interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    22,901
    
    
    
    
    
    
    
    22,901Total net income/(loss)
    
    
    (695,544
    )
    
    
    (230,321
    )
    
    
    (24,939
    )
    
    
    (2,576,820
    )
    
    
    10,055
    
    
    
    (3,517,569
    )Total assets
    
    
    60,129,239
    
    
    
    198,176,962
    
    
    
    321,817
    
    
    
    169,378,391
    
    
    
    (167,666,559
    )
    
    
    260,339,850
 -13-




---



##### 



InterOil Corporation
    
(INTEROIL LOGO)Notes to Consolidated Financial Statements(Expressed in United States dollars)
 4. Cash and cash equivalents
  December 31,
    
    December 31,
    
    December 31,2005
    
    2004
    
    2003$
    
    $
    
    $Cash on deposit
    
    
    59,597,724
    
    
    
    24,224,523
    
    
    
    6,208,785Bank term deposits- Papua New Guinea kina
deposits
    
    
    
    
    
    
    4,315,513
    
    
    
    - Australian dollar deposits
    
    
    4,083
    
    
    
    4,362
    
    
    
    Papua New Guinea kina treasury
bills
    
    
    
    
    
    
    
    
    
    
    3,007,48059,601,807
    
    
    
    28,544,398
    
    
    
    9,216,265
 5. Supplemental cash flow information
 December 31,
    
    December 31,
    
    December 31,2005
    
    2004
    
    2003$
    
    $
    
    $Cash paid during the yearInterest
    
    
    13,373,832
    
    
    
    1,444,006
    
    
    
    4,138,290Income taxes
    
    
    1,656,985
    
    
    
    1,914,459
    
    
    
    64,891Interest received
    
    
    1,800,062
    
    
    
    671,479
    
    
    
    149,631Non-cash investing and financing activities:Deferred financing costs included in accounts payable and accrued liabilities
    
    
    100,000
    
    
    
    
    
    
    
    Accrued financing costs and deferred financing costs
    
    
    
    
    
    
    834,439
    
    
    
    Increase in additional paid up capital as a result of
a change in accounting policy for stock based compensation (note
2n)
    
    
    
    
    
    
    645,216
    
    
    
    Increase in due to related parties resulting from transfer of other assets
    
    
    
    
    
    
    
    
    
    
    311,093Increase in share capital from:the exercise of share options
    
    
    577,086
    
    
    
    646,216
    
    
    
    39,654the exercise of warrants
    
    
    120,375
    
    
    
    
    
    
    
    oil and gas property expenditure paid for with stock
    
    
    
    
    
    
    
    
    
    
    316,359change in accounting policy for stock based compensation (note 2n)
    
    
    
    
    
    
    92,434
    
    
    
    transfer of deferred transaction costs on conversion of the debenture
    
    
    
    
    
    
    (3,093,734
    )
    
    
    transfer of carrying value of debentures to share capital on conversion of the
securities
    
    
    
    
    
    
    42,890,448
    
    
    
    conversion of indirect participation interest into share capital
    
    
    923,000
    
    
    
    9,226,260
    
    
    
    shares issued to induce conversion of debentures
    
    
    
    
    
    
    6,976,800
    
    
    
    transaction costs being attributed to share capital transaction
    
    
    
    
    
    
    300,000
    
    
    
    Movement in
accumulated deficit as a result of the inducement paid on conversion of the debentures
    
    
    
    
    
    
    (6,899,211
    )
    
    
    
  -14-




---



##### 



InterOil Corporation
    
(INTEROIL LOGO)Notes to Consolidated Financial Statements(Expressed in United States dollars)
 6. Financial instruments
 Restricted cash
  December 31,
    
    December 31,
    
    December 31,2005
    
    2004
    
    2003$
    
    $
    
    $Cash deposit on working capital facility (2.9%)
    
    
    16,452,216
    
    
    
    15,497,127
    
    
    
    Cash deposit on secured loan (2.1%)
    
    
    106,267
    
    
    
    
    
    
    
    Bank term deposits on Petroleum Prospecting
Licenses (1.3%)
    
    
    103,786
    
    
    
    102,096
    
    
    
    97,417Managed trust
    
    
    
    
    
    
    
    
    
    
    24,626,154Pledged deposit
    
    
    
    
    
    
    
    
    
    
    97,41816,662,269
    
    
    
    15,599,223
    
    
    
    24,820,989
    Commodity derivative contracts
    Derivative
    
    Type
    
    
    Notional volumes (bbls)Crude swap
    
    Sell crude
    
    
    300,000Crude swap
    
    Buy crude
    
    
    250,000Jet kerosene crack spread swap
    
    Sell jet kerosene/buy crude
    
    
    249,999
 -15-




---



##### 



InterOil Corporation
    
(INTEROIL LOGO)Notes to Consolidated Financial Statements(Expressed in United States dollars)
 6.
    
    Financial instruments (contd)
  Derivative
    
    Type
    
    
    Notional volumes (bbls)Naphtha swap
    
    Sell naphtha
    
    
    50,000Naphtha crack spread swap
    
    Sell naphtha/buy crude
    
    
    50,000
 7. Trade receivables
   8.
    
    Inventories
 December 31,
    
    December 31,
    
    December 31,2005
    
    2004
    
    2003$
    
    $
    
    $Midstream (crude oil feedstock)
    
    
    5,019,580
    
    
    
    3,971,982
    
    
    
    Midstream (refined petroleum product)
    
    
    25,967,357
    
    
    
    16,396,975
    
    
    
    Downstream (refined petroleum product)
    
    
    13,100,547
    
    
    
    7,547,945
    
    
    
    44,087,484
    
    
    
    27,916,902
    
    
    
    
   9.
    
    Plant and equipment
   Corporate &Year ended December 31, 2005
    
    Upstream
    
    Midstream
    
    Downstream
    
    Consolidated
    
    TotalsPlant and equipment
    
    
    5,657,125
    
    
    
    238,078,544
    
    
    
    12,164,417
    
    
    
    331,183
    
    
    
    256,231,269Deferred project costs and
work in progress
    
    
    
    
    
    
    1,987,085
    
    
    
    1,386,488
    
    
    
    
    
    
    
    3,373,573Consolidation entries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,120,718
    )
    
    
    (3,120,718
    )Accumulated
depreciation and amortisation
    
    
    (308,378
    )
    
    
    (11,245,748
    )
    
    
    (7,332,042
    )
    
    
    (198,808
    )
    
    
    (19,084,976
    )Net book value
    
    
    5,348,747
    
    
    
    228,819,881
    
    
    
    6,218,863
    
    
    
    (2,988,343
    )
    
    
    237,399,148Capital expenditure
    
    
    
    
    
    
    3,284,108
    
    
    
    1,902,334
    
    
    
    95,782
    
    
    
    5,282,224
 -16-




---



##### 



InterOil Corporation
    
(INTEROIL LOGO)Notes to Consolidated Financial Statements(Expressed in United States dollars)
 9. Plant and equipment (contd)
 Corporate &Year ended December 31, 2004
    
    Upstream
    
    
    Midstream
    
    
    Downstream
    
    
    Consolidated
    
    
    TotalsPlant and equipment
    
    
    5,659,248
    
    
    
    236,551,876
    
    
    
    10,875,211
    
    
    
    263,217
    
    
    
    253,349,552Deferred project costs and work in progress
    
    
    
    
    
    
    
    
    
    
    949,924
    
    
    
    
    
    
    
    949,924Consolidation entries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,002,214
    )
    
    
    (2,002,214
    )Accumulated depreciation
and amortisation
    
    
    (19,792
    )
    
    
    (419,629
    )
    
    
    (7,317,596
    )
    
    
    (176,890
    )
    
    
    (7,933,907
    )Net book value
    
    
    5,639,456
    
    
    
    236,132,247
    
    
    
    4,507,539
    
    
    
    (1,915,887
    )
    
    
    244,363,355Capital expenditure
    
    
    1,131
    
    
    
    40,532,990
    
    
    
    1,320,644
    
    
    
    83,920
    
    
    
    41,938,685
 Corporate &Year ended December 31, 2003
    
    Upstream
    
    
    Midstream
    
    
    Downstream
    
    
    Consolidated
    
    
    TotalsPlant and equipment
    
    
    5,655,994
    
    
    
    43,218,420
    
    
    
    
    
    
    
    179,472
    
    
    
    49,053,886Deferred project costs and work in progress
    
    
    
    
    
    
    152,747,736
    
    
    
    321,817
    
    
    
    
    
    
    
    153,069,553Consolidation entries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (165,647
    )
    
    
    (165,647
    )Accumulated depreciation
and amortisation
    
    
    (5,159
    )
    
    
    (107,643
    )
    
    
    
    
    
    
    (86,525
    )
    
    
    (199,327
    )Net book value
    
    
    5,650,835
    
    
    
    195,858,513
    
    
    
    321,817
    
    
    
    (72,700
    )
    
    
    201,758,465Capital expenditure
    
    
    5,658,117
    
    
    
    81,226,712
    
    
    
    100,333
    
    
    
    53,791
    
    
    
    87,038,953
 10. Oil and gas properties
  December 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003$
    
    
    $
    
    
    $Drilling equipment
    
    
    15,100,860
    
    
    
    5,353,471
    
    
    
    6,992,867Petroleum Propsecting License Drilling programs at costPPL 238
    
    
    1,298,632
    
    
    
    1,251,889
    
    
    
    14,199,188Other properties
    
    
    
    
    
    
    
    
    
    
    1,825,96016,399,492
    
    
    
    6,605,360
    
    
    
    23,018,015
  December 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003$
    
    
    $
    
    
    $Exploration costs, excluding exploration impairment
    
    
    
    
    
    
    2,903,313
    
    
    
    Exploration impairmentCosts incurred in prior years
    
    
    2,059,367
    
    
    
    16,576,982
    
    
    
    70,016Costs incurred in current year
    
    
    85,062
    
    
    
    18,989,779
    
    
    
    94,9762,144,429
    
    
    
    35,566,761
    
    
    
    164,992
 - 17 -




---



##### 



InterOil
Corporation
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 11. Income taxes
  December 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003$
    
    
    $
    
    
    $(Loss) before income taxes and non controlling interest
    
    
    (36,818,729
    )
    
    
    (51,134,909
    )
    
    
    (3,503,131
    )Statutory income tax rate
    
    
    35.10
    %
    
    
    35.12
    %
    
    
    35.12
    %Computed tax (benefit)
    
    
    (12,923,374
    )
    
    
    (17,958,580
    )
    
    
    (1,230,300
    )Effect on income tax of:Losses in foreign jurisdictions not deductible
    
    
    2,834,689
    
    
    
    2,273,530
    
    
    
    (56,527
    )Non-deductible stock compensation expense
    
    
    585,783
    
    
    
    424,924
    
    
    
    (13,926
    )Gains and losses on foreign exchange
    
    
    268,843
    
    
    
    58,659
    
    
    
    302,499Tax rate differential in foreign jurisdictions
    
    
    1,224,361
    
    
    
    (341,613
    )
    
    
    143,502Over provision for tax in prior years
    
    
    (113,950
    )
    
    
    (42,874
    )
    
    
    Tax losses for which no future tax benefit has been brought to account
    
    
    9,845,189
    
    
    
    2,696,330
    
    
    
    836,142Temporary differences for which no future tax benefit has been brought to account
    
    
    1,123,458
    
    
    
    14,552,726
    
    
    
    Temporary differences brought to account on acquisition of subsidiary
    
    
    (34,902
    )
    
    
    (488,027
    )
    
    
    Other  net
    
    
    21,897
    
    
    
    699,988
    
    
    
    55,9492,831,994
    
    
    
    1,875,063
    
    
    
    37,339
  December 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003$
    
    
    $
    
    
    $Future tax assetsTemporary differencesPlant and equipment
    
    
    2,665,173
    
    
    
    2,263,654
    
    
    
    Exploration expenditure
    
    
    12,184,351
    
    
    
    11,541,022
    
    
    
    Other  net
    
    
    99,834
    
    
    
    127,240
    
    
    
    (1,194,314
    )14,949,358
    
    
    
    13,931,916
    
    
    
    (1,194,314
    )Losses carried forward
    
    
    17,373,507
    
    
    
    4,850,380
    
    
    
    2,558,40632,322,865
    
    
    
    18,782,296
    
    
    
    1,364,092Less valuation allowance
    
    
    (31,263,967
    )
    
    
    (17,478,665
    )
    
    
    (1,364,092
    )1,058,898
    
    
    
    1,303,631
    
    
    
    
   - 18 -




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 11. Income taxes (contd)
   12. Working capital facility  crude feedstock
    December 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003$
    
    
    $
    
    
    $Working capital credit facility
    
    
    150,000,000
    
    
    
    100,000,000
    
    
    
    Less amounts outstanding:Short term advances
    
    
    (47,527,408
    )
    
    
    (63,485,637
    )
    
    
    Discounted receivables (note 7)
    
    
    (23,196,914
    )
    
    
    (13,034,904
    )
    
    
    Letters of credit outstanding
    
    
    (33,765,000
    )
    
    
    (14,000,000
    )
    
    
    Hedging facility
    
    
    (1,500,000
    )
    
    
    
    
    
    
    Working capital credit facility available for use
    
    
    44,010,678
    
    
    
    9,479,459
    
    
    
    
   - 19 -




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 13. Acquisition of a subsidiary
  InterOil Products Limited
     $Cash
    
    
    5,859,517Trade receivables
    
    
    8,241,400Inventory
    
    
    6,759,089Other assets
    
    
    1,614,249Future income tax benefit
    
    
    640,284Property, plant and equipment
    
    
    3,180,530Total assets acquired
    
    
    26,295,069Accounts payable and accrued liabilities
    
    
    (13,399,720
    )Net assets acquired
    
    
    12,895,349
  14. Related parties
   - 20 -




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 14. Related parties (contd)
    15. Unsecured loan
  16. Secured loan
      - 21 -




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 17. Indirect participation interest
 Indirect participation interest
 December 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003$
    
    
    $
    
    
    $Current portion
    
    
    35,092,558
    
    
    
    13,749,852
    
    
    
    Non current portion
    
    
    30,166,311
    
    
    
    
    
    
    
    Total indirect participation interest
    
    
    65,258,869
    
    
    
    13,749,852
    
    
    
    
      Indirect participation interest  PNGDV
  Other
  - 22 -




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 18. Non controlling interest
   19. Share capital
  Common shares
  Number of shares
    
    $January 1, 2003
    
    
    20,585,943
    
    
    
    94,120,609Shares issued for cash
    
    
    3,817,500
    
    
    
    61,060,640Shares issued for conversion of convertible debt
    
    
    31,240
    
    
    
    316,359Shares issued on exercise of options
    
    
    381,278
    
    
    
    1,951,592December 31, 2003
    
    
    24,815,961
    
    
    
    157,449,200Shares issued for conversion of convertible debt and indirect participation interest
    
    
    3,184,828
    
    
    
    56,698,121Shares issued on exercise of options
    
    
    310,095
    
    
    
    2,666,333December 31, 2004
    
    
    28,310,884
    
    
    
    216,813,654Shares issued for indirect participation interest
    
    
    52,000
    
    
    
    923,000Shares issued on exercise of warrants
    
    
    19,168
    
    
    
    540,346Shares issued on exercise of options
    
    
    781,268
    
    
    
    5,657,500December 31, 2005
    
    
    29,163,320
    
    
    
    223,934,500
 - 23 -




---



##### 



InterOil
Corporation
 Notes to Consolidated Financial Statements
(Expressed in United States dollars)
 
   20. Stock options
   December 31, 2005
    
    December 31, 2004
    
    December 31, 2003Weighted
    
    
    
    
    
    Weighted
    
    
    
    
    
    WeightedNumber of
    
    average
    
    Number of
    
    average
    
    Number of
    
    averageStock options outstanding
    
    options
    
    exercise price $
    
    options
    
    exercise price $
    
    options
    
    exercise price $Outstanding at beginning of
year
    
    
    1,162,322
    
    
    
    9.91
    
    
    
    1,363,265
    
    
    
    7.55
    
    
    
    1,510,085
    
    
    
    5.48Granted
    
    
    516,450
    
    
    
    25.82
    
    
    
    224,460
    
    
    
    26.30
    
    
    
    257,802
    
    
    
    14.09Exercised
    
    
    (781,322
    )
    
    
    (6.50
    )
    
    
    (310,095
    )
    
    
    (6.52
    )
    
    
    (381,278
    )
    
    
    (4.62
    )Forfeited
    
    
    (74,000
    )
    
    
    (13.11
    )
    
    
    (100,308
    )
    
    
    (25.28
    )
    
    
    (23,344
    )
    
    
    (5.75
    )Expired
    
    
    (76,650
    )
    
    
    (26.01
    )
    
    
    (15,000
    )
    
    
    (8.00
    )
    
    
    
    
    
    
    Outstanding at end of year
    
    
    746,800
    
    
    
    22.27
    
    
    
    1,162,322
    
    
    
    9.91
    
    
    
    1,363,265
    
    
    
    7.55
 Options issued and outstanding
    
    
    
    
    
    Options exercisableWeighted averageRange of exercise
    
    
    
    
    
    Weighted average
    
    remaining term
    
    
    
    
    
    Weighted averageprices $
    
    Number of options
    
    exercise price $
    
    (years)
    
    Number of options
    
    exercise price $2.75 to 5.00
    
    
    20,000
    
    
    
    4.00
    
    
    
    0.47
    
    
    
    20,000
    
    
    
    4.005.01 to 8.00
    
    
    50,000
    
    
    
    5.62
    
    
    
    1.34
    
    
    
    40,000
    
    
    
    5.278.01 to 12.00
    
    
    69,700
    
    
    
    10.98
    
    
    
    0.93
    
    
    
    30,700
    
    
    
    10.2512.01 to 24.00
    
    
    287,000
    
    
    
    23.11
    
    
    
    3.08
    
    
    
    109,000
    
    
    
    23.9124.00 to 31.00
    
    
    320,100
    
    
    
    27.71
    
    
    
    2.94
    
    
    
    94,500
    
    
    
    30.25746,800
    
    
    
    22.27
    
    
    
    2.87
    
    
    
    294,200
    
    
    
    20.63
  21. Debentures and warrants
  - 24 -




---



##### 



InterOil
Corporation
 Notes to Consolidated Financial Statements
(Expressed in United States dollars)
 
   21. Debentures and warrants (contd)
  22. Loss per share
  23. Commitments and contingencies
  Less than
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    More than 5Total
    
    1 year
    
    1-2 years
    
    2-3 years
    
    3-4 years
    
    4-5 years
    
    years000
    
    000
    
    000
    
    000
    
    000
    
    000
    
    000Secured loan obligations
    
    
    80,500
    
    
    
    9,000
    
    
    
    9,000
    
    
    
    9,000
    
    
    
    9,000
    
    
    
    9,000
    
    
    
    35,500Unsecured loan obligations
    
    
    21,453
    
    
    
    21,453
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Indirect participation interest  PNGDV (a)
    
    
    5,500
    
    
    
    
    
    
    
    5,500
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Indirect participation interest (note 17)
    
    
    65,259
    
    
    
    35,093
    
    
    
    30,166
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Capital expenditure commitments relating to
refinery optimisation program (b)
    
    
    4,600
    
    
    
    4,600
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Petroleum prospecting and retention licenses (c)
    
    
    160
    
    
    
    160
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    177,472
    
    
    
    70,306
    
    
    
    44,666
    
    
    
    9,000
    
    
    
    9,000
    
    
    
    9,000
    
    
    
    35,500
 (a)
    
    The non current indirect participation interest terms provide for various conversion
options. The amount provided is the maximum amount that can be converted to debt and differs
to the amount presented in the December 31, 2005 Consolidated Balance Sheet due to conversion
requirements into the Companys full paid common shares. The non current indirect
participation interest balance of $9,685,830 is convertible into 237,356 common shares plus
$5,500,000 payable, at the Companys discretion, in cash or common shares based on the average
price of the Companys shares in the month preceding such payment. PNGDV has an interest in
the drilling program that will range from 6.75% to 11.25% depending upon various elections.(b)
    
    The company is in the process of a number of projects relating to optimizing the refinerys
output. Capital expenditure commitments of $4,600,000 have been made with respect to this
program.(c)
    
    The amount pertaining to the petroleum prospecting and retention licenses represents the
amount InterOil is required to spend over the next two years to maintain the exploration
licenses. The committed amount can be spent in any proportion over the two years. In addition
to this amount, InterOil must drill an exploration well on PPL 237 prior to March 2007. As
the cost of drilling this well cannot be estimated, it is not included within the above table.
   - 25 -




---



##### 



InterOil
Corporation
 Notes to Consolidated Financial Statements
(Expressed in United States dollars)
 
   24. Reconciliation to accounting principles generally accepted in the United States
  Consolidated statements of operations
  Year EndedDecember 31, 2005
    
    December 31, 2004
    
    December 31, 2003$
    
    $
    
    $Canadian GAAP
    
    U.S. GAAP
    
    Canadian GAAP
    
    U.S. GAAP
    
    Canadian GAAP
    
    U.S. GAAPRevenueSales and operating revenues (1)
    
    
    481,180,645
    
    
    
    481,180,645
    
    
    
    70,644,486
    
    
    
    121,974,268
    
    
    
    
    
    
    
    Interest income
    
    
    1,830,808
    
    
    
    
    
    
    
    382,461
    
    
    
    
    
    
    
    246,912
    
    
    
    Other income
    
    
    528,270
    
    
    
    
    
    
    
    196,337
    
    
    
    
    
    
    
    12,368
    
    
    
    483,539,723
    
    
    
    481,180,645
    
    
    
    71,223,284
    
    
    
    121,974,268
    
    
    
    259,280
    
    
    
    ExpensesCost of sales and operating expenses (excluding
depreciation shown below) (1)
    
    
    467,246,990
    
    
    
    467,400,576
    
    
    
    65,344,516
    
    
    
    129,871,126
    
    
    
    
    
    
    
    Administrative and general expenses (1), (2)
    
    
    14,672,793
    
    
    
    14,687,717
    
    
    
    7,831,550
    
    
    
    8,081,740
    
    
    
    2,264,187
    
    
    
    2,264,187Management fees for prior periods waived
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (840,000
    )
    
    
    (840,000
    )Depreciation and amortization (1)
    
    
    11,036,550
    
    
    
    10,836,696
    
    
    
    639,075
    
    
    
    1,462,953
    
    
    
    73,068
    
    
    
    73,068Exploration costs, excluding exploration impairment
    
    
    
    
    
    
    
    
    
    
    2,903,313
    
    
    
    2,903,313
    
    
    
    
    
    
    
    Exploration impairment
    
    
    2,144,429
    
    
    
    2,144,429
    
    
    
    35,566,761
    
    
    
    35,566,761
    
    
    
    164,992
    
    
    
    164,992Legal and professional fees (1)
    
    
    3,606,415
    
    
    
    3,606,415
    
    
    
    3,573,727
    
    
    
    3,655,631
    
    
    
    1,421,390
    
    
    
    1,421,390Short term borrowing costs
    
    
    8,855,857
    
    
    
    8,855,857
    
    
    
    4,705,190
    
    
    
    4,705,190
    
    
    
    
    
    
    
    Long term borrowing costs (1)
    
    
    6,351,337
    
    
    
    6,351,337
    
    
    
    1,401,256
    
    
    
    1,897,029
    
    
    
    
    
    
    
    Accretion expense
    
    
    5,647,491
    
    
    
    5,647,491
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Debt conversion expense (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,976,800
    
    
    
    
    
    
    
    Gain on revaluation of conversion options (6)
    
    
    
    
    
    
    (4,279,284
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Foreign exchange loss (2)
    
    
    796,590
    
    
    
    796,590
    
    
    
    392,805
    
    
    
    392,805
    
    
    
    678,774
    
    
    
    (7,392,002
    )Non-controlling interest (7)
    
    
    (368,312
    )
    
    
    (368,475
    )
    
    
    (70,091
    )
    
    
    (265,624
    )
    
    
    (22,901
    )
    
    
    94,341Interest income
    
    
    
    
    
    
    (1,830,808
    )
    
    
    
    
    
    
    (382,461
    )
    
    
    
    
    
    
    (246,912
    )Other income
    
    
    
    
    
    
    (528,270
    )
    
    
    
    
    
    
    (196,337
    )
    
    
    
    
    
    
    (12,368
    )519,990,140
    
    
    
    513,320,271
    
    
    
    122,288,102
    
    
    
    194,668,926
    
    
    
    3,739,510
    
    
    
    (4,473,304
    )Income/(loss) before income taxes
    
    
    (36,450,417
    )
    
    
    (32,139,626
    )
    
    
    (51,064,818
    )
    
    
    (72,694,658
    )
    
    
    (3,480,230
    )
    
    
    4,473,304Income tax expense (3)
    
    
    (2,831,994
    )
    
    
    (2,831,994
    )
    
    
    (1,875,063
    )
    
    
    (1,875,063
    )
    
    
    (37,339
    )
    
    
    (37,339
    )Income/(loss) before cumulative effect of accounting change
    
    
    (39,282,411
    )
    
    
    (34,971,620
    )
    
    
    (52,939,881
    )
    
    
    (74,569,721
    )
    
    
    (3,517,569
    )
    
    
    4,435,965Cumulative effect of accounting change (4)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (737,650
    )
    
    
    
    
    
    
    Net income/(loss)
    
    
    (39,282,411
    )
    
    
    (34,971,620
    )
    
    
    (52,939,881
    )
    
    
    (75,307,371
    )
    
    
    (3,517,569
    )
    
    
    4,435,965
 - 26 -




---



##### 



InterOil
Corporation
 Notes to Consolidated Financial Statements
(Expressed in United States dollars)
 
   24. Reconciliation to accounting principles generally accepted in the United States (contd)
 Statements of comprehensive income/(loss), net of tax
 Year EndedDecember 31,
    
    December 31,
    
    December 31,2005
    
    2004
    
    2003$
    
    $
    
    $Net income/(loss) in accordance with U.S. GAAP, net of tax
    
    
    (34,971,620
    )
    
    
    (75,307,371
    )
    
    
    4,435,965Foreign currency translation reserve, net of tax
    
    
    14,243
    
    
    
    463,200
    
    
    
    Deferred hedge gain, net of tax
    
    
    457,184
    
    
    
    537,358
    
    
    
    Total other comprehensive income, net of tax
    
    
    471,427
    
    
    
    1,000,558
    
    
    
    Comprehensive income/(loss), net of tax
    
    
    (34,500,193
    )
    
    
    (74,306,813
    )
    
    
    4,435,965
 Statements of accumulated other comprehensive income, net of tax (AOCI)
 TotalForeign
    
    
    
    
    
    accumulatedcurrency
    
    
    
    
    
    othertranslation
    
    Deferred hedge
    
    comprehensivereserve
    
    gain
    
    incomeAOCI balance as of December 31, 2001
    
    
    
    
    
    
    
    
    
    
    Current period change
    
    
    
    
    
    
    
    
    
    
    AOCI balance as of December 31, 2002
    
    
    
    
    
    
    
    
    
    
    Current period change
    
    
    
    
    
    
    
    
    
    
    AOCI balance as of December 31, 2003
    
    
    
    
    
    
    
    
    
    
    Current period change
    
    
    463,200
    
    
    
    537,358
    
    
    
    1,000,558AOCI balance as of December 31, 2004
    
    
    463,200
    
    
    
    537,358
    
    
    
    1,000,558Current period change
    
    
    14,243
    
    
    
    457,184
    
    
    
    471,427AOCI balance as of December 31, 2005
    
    
    477,443
    
    
    
    994,542
    
    
    
    1,471,985
 Per share amounts
   Weighted average number of shares on which earnings per
    
    Year ended December 31,share calculations are based in accordance with U.S. GAAP
    
    2005
    
    2004
    
    2003Basic
    
    
    28,832,263
    
    
    
    25,373,575
    
    
    
    22,649,924Effect of dilutive options
    
    
    
    
    
    
    
    
    
    
    1,542,214Diluted
    
    
    28,832,263
    
    
    
    25,373,575
    
    
    
    24,192,138Net income/(loss) per share in accordance with U.S. GAAPBasic
    
    
    (1.21
    )
    
    
    (2.97
    )
    
    
    0.20Diluted
    
    
    (1.21
    )
    
    
    (2.97
    )
    
    
    0.18
 - 27 -




---



##### 



InterOil
Corporation
 Notes to Consolidated Financial Statements
(Expressed in United States dollars)
 
   24. Reconciliation to accounting principles generally accepted in the United States (contd)
 Consolidated balance sheets
 December 31, 2005
    
    December 31, 2004
    
    December 31, 2003Canadian GAAP
    
    U.S. GAAP
    
    Canadian GAAP
    
    U.S. GAAP
    
    Canadian GAAP
    
    U.S. GAAPCurrent assets
    
    
    173,442,742
    
    
    
    173,442,742
    
    
    
    132,258,350
    
    
    
    132,258,350
    
    
    
    35,012,370
    
    
    
    35,012,370Oil and gas properties
    
    
    16,399,492
    
    
    
    16,399,492
    
    
    
    6,605,360
    
    
    
    6,605,360
    
    
    
    23,018,015
    
    
    
    23,018,015Capital assets (1), (2)
    
    
    237,399,148
    
    
    
    225,171,193
    
    
    
    244,363,355
    
    
    
    232,496,306
    
    
    
    201,758,465
    
    
    
    204,817,578Deferred financing costs
    
    
    1,256,816
    
    
    
    1,256,816
    
    
    
    1,311,488
    
    
    
    1,311,488
    
    
    
    551,000
    
    
    
    551,000Future income tax benefit (3)
    
    
    1,058,898
    
    
    
    1,058,898
    
    
    
    1,303,631
    
    
    
    1,303,631
    
    
    
    
    
    
    
    Total assets
    
    
    429,557,096
    
    
    
    417,329,141
    
    
    
    385,842,184
    
    
    
    373,975,135
    
    
    
    260,339,850
    
    
    
    263,398,963Current liabilities (2), (6)
    
    
    167,192,503
    
    
    
    188,187,731
    
    
    
    142,197,050
    
    
    
    141,659,692
    
    
    
    
    
    
    
    Accrued financing costs
    
    
    921,109
    
    
    
    921,109
    
    
    
    863,329
    
    
    
    863,329
    
    
    
    16,314,334
    
    
    
    16,314,334Long term debt (6)
    
    
    111,352,141
    
    
    
    110,536,000
    
    
    
    86,608,830
    
    
    
    86,608,830
    
    
    
    90,600,000
    
    
    
    90,600,000Non-controlling interest (7)
    
    
    6,023,149
    
    
    
    5,682,695
    
    
    
    6,404,262
    
    
    
    6,063,971
    
    
    
    6,467,496
    
    
    
    6,322,739Shareholders equity (1) (2) (4) (5) (6)
    
    
    144,068,194
    
    
    
    112,001,606
    
    
    
    149,768,713
    
    
    
    138,779,313
    
    
    
    146,958,020
    
    
    
    150,161,890Total liabilities and shareholders equity
    
    
    429,557,096
    
    
    
    417,329,141
    
    
    
    385,842,184
    
    
    
    373,975,135
    
    
    
    260,339,850
    
    
    
    263,398,963
 (1)
    
    OperationsThe Company determined that refinery operations commenced under U.S. GAAP at December 1,
2004, which is the date management assessed that construction of the refinery was
substantially complete and ready for its intended use. The Company ceased capitalization
of certain costs to the refinery project at this date and recognized one months results
from sales, related costs of sales and operating expenses and administrative and general
expenses in the statement of operations for the year ended December 31, 2004.As disclosed in note 2(h) in the consolidated financial statements, operations commenced on
January 1, 2005 under Canadian GAAP. Therefore, the Company continued to capitalize
December 2004s results to the refinery project. Due to the difference in the cost basis
of the refinery, the depreciation expense recorded under U.S. GAAP differs from that
recorded under Canadian GAAP during 2005.In the prior year, in addition to recognizing December 2004s results in the statement of
operations, one month of depreciation expense was also recorded under U.S. GAAP for the
refinery during 2004. The useful life for the refinery under U.S. GAAP is the same as that
disclosed under Canadian GAAP in note 2(h) in the consolidated financial statements.(2)
    
    Derivative instruments and hedgingThe Company accounts for derivatives and hedging activities in accordance with FASB
Statement No. 133, Accounting for Derivative Instruments and Certain Hedging Activities,
as amended (SFAS No. 133), which requires that all derivative instruments be recorded on
the balance sheet at their respective fair values.The Company elected not to adopt the FASBs optional hedge accounting provisions when SFAS
No. 133 became effective on January 1, 2001. Accordingly unrealized gains and losses
resulting from the valuation of derivatives at fair value arising during the year ended
December 31, 2003 were recognized in income as the gains and losses arose under U.S. GAAP.
Under Canadian GAAP for these years, the Company continued to recognize the gains and
losses on derivative contracts designated as hedges concurrently with the recognition of
the transactions being hedged.The Canadian Institute of Chartered Accountants issued Accounting Guideline 13 Hedging
Relationships (AcG-13), which became effective January 1, 2004. This guideline was
issued to align certain accounting principles under Canadian GAAP with SFAS No. 133,
including hedge documentation and assessing hedge effectiveness. The Company adopted the
hedge accounting provisions in AcG-13 and SFAS No. 133 in respect of the commodity forward
contracts it transacted beginning in July 2004. Under Canadian GAAP, the Company includes
hedges which are unsettled at period end in current liabilities based on a marked to market
calculation. Under SFAS No. 133 the marked to market amount for the unsettled hedges is included in
other comprehensive income to the extent that they are effective. The ineffective portion
is expensed. Details of the hedge accounting is disclosed in notes 2(f) and 6 in the
consolidated financial statements of the Company for the year ended December 31, 2005.
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##### 



InterOil Corporation
    
(INTEROIL LOGO)Notes to Consolidated Financial Statements
(Expressed in United States dollars)
 24. Reconciliation to accounting principles generally accepted in the United States (contd)
 (3)
    
    Income tax effect of adjustmentsThe income tax effect of U.S. GAAP adjustments was a reduction to the future tax asset of
$1,497,267 for the year ended December 31, 2005 due to a decrease in the loss carryforwards.
A corresponding decrease in the valuation allowance was recorded. No income tax expense was
recorded in the years ended December 31, 2005, 2004 and 2003 due to the tax holiday period in
PNG through five years after the refinery commences operations.(4)
    
    Stock based compensationFASB Statement No. 123, Accounting for Stock-based Compensation (SFAS No. 123),
establishes financial accounting and reporting standards for stock-based employee
compensation plans as well as transactions in which an entity issues its equity instruments
to acquire goods or services from non-employees.Prior and during the year ended December 31, 2003, the Company issued options to
non-employees that were direct awards of stock or that called for settlement by the issuance
of equity instruments using the fair value method. The Company followed the provisions of the
Canadian Institute of Chartered Accountants in Handbook Section 3870, Stock-based
compensation and other stock-based payments (CICA 3870), which resulted in recognition of
compensation expense for stock options issued to non-employees under Canadian GAAP on a basis
consistent with the requirements of SFAS No. 123.As permitted under SFAS No. 123, the Company also issued options to employees that were
direct awards of stock using the intrinsic value method, which is provided for in Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Where options
were granted with exercise prices equal to the market price when the options were granted, no
compensation expense was recorded at the time of the option grants. Had compensation cost for
the Companys stock options been determined based on the fair market value at the grant dates
of the awards, and amortized on a straight-line basis, consistent with methodology prescribed
by SFAS No. 123, the Companys net income and net income per share for the years ended
December 31, 2003 would have been the pro forma amounts indicated as follows:
 Year endedDecember 31, 2003Net income in accordance with U.S. GAAP
    
    
    4,435,965Pro forma stock based compensation
    
    
    (530,794
    )Pro forma net income
    
    
    3,905,171Earnings per share as reportedBasic
    
    
    0.20Diluted
    
    
    0.18Pro forma earnings per shareBasic
    
    
    0.17Diluted
    
    
    0.16
 The fair values of all common share options granted are estimated on the date of grant
using the Black-Scholes option-pricing model. The weighted average fair market value of
options granted during the year and the assumptions used in their determination are the same
as note 20 to the consolidated financial statements.At January 1, 2004, the Company adopted the provisions of CICA 3870 in respect of the
employee stock-based awards, which resulted in recognition of compensation expense for such
awards under Canadian GAAP on a basis consistent with the fair value provisions of SFAS No.
123. As disclosed in note 2(n) to the consolidated financial statements, the Company
retroactively applied the fair value method to all employee stock options granted on or after
January 1, 2002, without restatement to prior years.
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##### 



InterOil Corporation
    
(INTEROIL LOGO)Notes to Consolidated Financial Statements
(Expressed in United States dollars)
 24. Reconciliation to accounting principles generally accepted in the United States (contd)
 (4)
    
    Stock based compensation (contd)This is not consistent with the modified prospective transition method allowed for a
voluntary change to the fair value method under FASB Statement No. 148 Accounting for
Stock-Based Compensation  Transition and Disclosure, an amendment of FASB Statement No. 123
(SFAS No. 148). The modified prospective method requires retroactive consideration of all
employee stock awards granted, modified or settled on or after January 1, 1995. The Company
did not adjust for this GAAP difference as there were no options granted, modified or settled
between January 1, 1995 and January 1, 2002 that would have materially impacted net income
for the years ended December 31, 2005, 2004 and 2003.The cumulative effect of this change in accounting principle of $737,650 was recorded to
opening accumulated deficit under Canadian GAAP. This is required to be disclosed as a
cumulative change in accounting principle in the statement of operations under U.S. GAAP.(5)
    
    Debt conversion expenseAs disclosed in note 21 in the consolidated financial statements, 100% of the convertible
debentures were converted before December 31, 2004. The Company issued an additional 180,000
shares to induce conversion before the end of the year. Under Canadian GAAP, the fair value
of these shares was recorded as an increase in share capital of $6,976,800 with offsetting
adjustments to retained earnings of $6,899,211 and a conversion expense of $77,589.FASB Statement No. 84, Induced Conversions of Convertible Debt requires an expense to be
recorded when convertible debt is converted under an inducement. The Company recognized the
entire fair value of the inducement shares of $6,976,800 as a conversion expense under U.S.
GAAP.(6)
    
    Indirect participation interestAs disclosed in note 17 in the consolidated financial statements, the company entered into an
indirect participation interest agreement in exchange for proceeds of $125,000,000. Under
Canadian GAAP, this amount was apportioned between non financial liabilities and equity.EITF 00-19 Accounting for derivatives indexed to and potentially settled in a companys own
stock requires the conversion options to be treated as a current liability. As a result,
the conversion options should be adjusted to their fair market value on the reporting date.
As such the company has recognised a gain on the revaluation of conversion options totalling
$4,279,284 at December 31, 2005.Under Canadian GAAP, the company split $8,138,742 of transaction costs relating to the
indirect participation interest agreement between the indirect participation interest
liability ($6,364,523) and the conversion options ($1,774,219). Under US GAAP the full
amount of $8,138,742 has been allocated to the indirect participation interest liability.(7)
    
    Non controlling interestThe non-controlling interest movements are the result of the US GAAP adjustments relating to
the midstream operations described in points 1 to 4 above.
 Acquisition of InterOil Products Limited (IPL)
    
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##### 



InterOil Corporation
    
(INTEROIL LOGO)Notes to Consolidated Financial Statements
(Expressed in United States dollars)
 24. Reconciliation to accounting principles generally accepted in the United States (contd)
 Acquisition of InterOil Products Limited (IPL)
  InterOil
    
    
    IPL (1)
    
    
    Pro formaTwelve months ended December 31, 2004
    
    (audited)
    
    
    (unaudited)
    
    
    (unaudited)Sales and operating revenue  Canadian GAAP
    
    
    70,644,486
    
    
    
    27,317,000
    
    
    
    97,961,486Sales and operating revenue  US GAAP
    
    
    121,974,268
    
    
    
    27,317,000
    
    
    
    149,291,268Net profit/(loss)  Canadian GAAP
    
    
    (52,939,881
    )
    
    
    2,350,000
    
    
    
    (50,589,881
    )Net profit/(loss)  U.S. GAAP
    
    
    (75,307,371
    )
    
    
    2,350,000
    
    
    
    (72,957,371
    )Basic loss per share (cents per share)Canadian GAAP (2)
    
    
    (208
    )
    
    
    
    
    
    
    (199
    )U.S. GAAP (3)
    
    
    (297
    )
    
    
    
    
    
    
    (287
    )Diluted loss per share (cents per share)Canadian GAAP (2)
    
    
    (208
    )
    
    
    
    
    
    
    (199
    )U.S. GAAP (3)
    
    
    (297
    )
    
    
    
    
    
    
    (287
    )
 InterOil
    
    
    IPL (1)
    
    
    Pro formaTwelve months ended December 31, 2003
    
    (audited)
    
    
    (unaudited)
    
    
    (unaudited)Sales and operating revenue  Canadian and U.S. GAAP
    
    
    
    
    
    
    69,897,000
    
    
    
    69,897,000Net profit/(loss)  Canadian GAAP
    
    
    (3,517,569
    )
    
    
    6,474,000
    
    
    
    2,956,431Net profit  U.S. GAAP
    
    
    4,435,965
    
    
    
    6,474,000
    
    
    
    10,909,965Basic earnings/(loss) per share (cents per share)Canadian GAAP (2)
    
    
    (15
    )
    
    
    
    
    
    
    14U.S. GAAP (3)
    
    
    20
    
    
    
    
    
    
    
    49Diluted earnings/(loss) per share (cents per share)Canadian GAAP (2)
    
    
    (15
    )
    
    
    
    
    
    
    13U.S. GAAP (3)
    
    
    18
    
    
    
    
    
    
    
    45
 (1)
    
    Financial data for the year ended December 31, 2004 represents results for the period from
January 1, 2004 to April 28, 2004, the effective date the Company gained control of IPL, and
is derived from the unaudited management accounts of IPL. Financial data for the year ended
December 31, 2003 represents the actual results for the year ended December 31, 2003.(2)
    
    The weighted average number of shares used in the earnings per share information is
consistent with that used under Canadian GAAP for the respective periods.(3)
    
    The weighted average number of shares used in the earnings per share information is
consistent with that used under U.S. GAAP for the respective periods. - 31 -




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##### 



InterOil Corporation
    
(INTEROIL LOGO)Notes to Consolidated Financial Statements
(Expressed in United States dollars)
 24. Reconciliation to accounting principles generally accepted in the United States (contd)
  Accounting for inventory costs
  Accounting for exchanges of nonmonetary assets
  Accounting changes and error corrections
  - 32 -