##### 



Exhibit 2  InterOil Corporation
    
    (INTEROIL LOGO)
 Consolidated Financial Statements
(Audited, Expressed in United States dollars) Years ended December 31, 2004, 2003 and 2002 and cumulative




---



##### 



AUDITORS REPORT TO THE SHAREHOLDERS We have audited the consolidated balance sheets of InterOil Corporation as at December 31, 2004 and
2003 and the consolidated statements of earnings, retained earnings, and cash flows for each of the
years in the three-year period ended December 31, 2004. These financial statements are the
responsibility of the Companys management. Our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audit in accordance with Canadian generally accepted auditing standards. Those
standards require that we plan and perform an audit to obtain reasonable assurance 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. In our opinion, these consolidated financial statements present fairly, in all material respects,
the financial position of the Company as at December 31, 2004 and 2003 and the results of its
operations and its cash flows for each of the years in the three-year period ended December 31,
2004 in accordance with Canadian generally accepted accounting principles. KPMG Sydney, Australia
March 4, 2005 COMMENTS BY AUDITORS FOR U.S. READERS ON CANADA U.S. REPORTING DIFFERENCE In the United States, reporting standards for auditors require the addition of an explanatory
paragraph (following the opinion paragraph) when there is a change in accounting principles that
has a material effect on the comparability of the companys financial statements, such as the
change described in Note 1(c)  Stock-based compensation  to the Companys consolidated financial
statements as at December 31, 2004 and 2003, and for each of the years in the three-year period
ended December 31, 2004. Our report to the shareholders dated March 4, 2005 is expressed in
accordance with Canadian reporting standards which do not require a reference to such a change in
accounting principles in the auditors report when the change is properly accounted for and
adequately disclosed in the financial statements. KPMG Sydney, Australia
March 4, 2005




---



##### 



MANAGEMENTS REPORT The management of InterOil Corporation is responsible for the financial
information and operating data presented in this Annual Report. The consolidated financial statements have been prepared by management in
accordance with Canadian generally accepted accounting principles. When
alternative accounting methods exist, management has chosen those it deems
most appropriate in the circumstances. Financial statements are not precise
as they include certain amounts based on estimates and judgements.
Management has determined such amounts on a reasonable basis in order to
ensure that the financial statements are presented fairly, in all material
respects. Financial information presented elsewhere in this Annual Report
has been prepared on a basis consistent with that in the consolidated
financial statements. InterOil Corporation maintains systems of internal accounting and
administrative controls. These systems are designed to provide reasonable
assurance that the financial information is relevant, reliable and accurate
and that the Companys assets are properly accounted for and adequately
safeguarded. The Audit Committee of the Board of Directors, composed of independent
non-management directors, meets regularly with management, as well as the
external auditors, to discuss auditing, internal controls, accounting policy
and financial reporting matters. The Committee reviews the annual
consolidated financial statements with both management and the independent
auditors and reports its findings to the Board of Directors before such
statements are approved by the Board. The consolidated financial statements have been audited by KPMG, the
independent auditors, in accordance with Canadian generally accepted auditing
standards on behalf of the shareholders. KPMG has full and free access to
the Audit Committee. -s- Phil Mulacek
    
    -s- Tom DonovanPhil Mulacek
    
    Tom DonovanChief Executive Officer
    
    Chief Financial Officer




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##### 



InterOil CorporationConsolidated Balance Sheets
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 December 31
    
    
    December 31
    
    
    December 312004
    
    
    2003
    
    
    2002$
    
    
    $
    
    
    $AssetsCurrent assets:Cash and cash equivalents (note 2)
    
    
    19,735,912
    
    
    
    9,313,682
    
    
    
    3,288,539Temporary investments (note 9)
    
    
    24,407,709
    
    
    
    24,723,572
    
    
    
    7,105,701Trade receivables (note 3)
    
    
    58,698,069
    
    
    
    
    
    
    
    Commodity hedge contracts (note 9)
    
    
    503,500
    
    
    
    
    
    
    
    Other assets
    
    
    806,123
    
    
    
    486,584
    
    
    
    503,859Inventories (note 6)
    
    
    27,916,902
    
    
    
    
    
    
    
    Prepaid expenses
    
    
    190,135
    
    
    
    488,532
    
    
    
    80,359Total current assets
    
    
    132,258,350
    
    
    
    35,012,370
    
    
    
    10,978,458Deferred financing costs (note 11)
    
    
    760,488
    
    
    
    
    
    
    
    Plant and equipment (note 7)
    
    
    244,914,355
    
    
    
    202,309,465
    
    
    
    121,217,700Oil and gas properties (note 8)
    
    
    6,605,360
    
    
    
    23,018,015
    
    
    
    2,878,703Future income tax benefit (note 13)
    
    
    1,303,631
    
    
    
    
    
    
    
    Total assets
    
    
    385,842,184
    
    
    
    260,339,850
    
    
    
    135,074,861Liabilities and shareholders equityCurrent liabilities:Accounts
payable and accrued liabilities
    
    
    26,328,544
    
    
    
    5,835,583
    
    
    
    6,744,515Income tax payable
    
    
    2,881,398
    
    
    
    
    
    
    
    Short term loan facility  crude feedstock (note 18)
    
    
    76,520,541
    
    
    
    
    
    
    
    Deferred acquisition cost (note 10)
    
    
    12,123,106
    
    
    
    
    
    
    
    Due to related parties (note 5)
    
    
    1,056,251
    
    
    
    1,478,751
    
    
    
    2,784,560Foreign currency forward contracts (note 9)
    
    
    
    
    
    
    
    
    
    
    678,648Current portion of secured loan (note 11)
    
    
    9,000,000
    
    
    
    9,000,000
    
    
    
    Current portion of indirect participation interest (note 14)
    
    
    13,749,852
    
    
    
    
    
    
    
    Total current liabilities
    
    
    141,659,692
    
    
    
    16,314,334
    
    
    
    10,207,723Accrued financing costs (note 11)
    
    
    863,329
    
    
    
    
    
    
    
    Secured loan (note 11)
    
    
    76,000,000
    
    
    
    74,000,000
    
    
    
    31,000,000Indirect participation interest (note 14)
    
    
    10,608,830
    
    
    
    16,600,000
    
    
    
    Total liabilities
    
    
    229,131,851
    
    
    
    106,914,334
    
    
    
    41,207,723Non-controlling interest (note 15)
    
    
    6,404,262
    
    
    
    6,467,496
    
    
    
    6,490,398Shareholders equity:Share capital (note 16)
    
    
    216,813,654
    
    
    
    157,449,200
    
    
    
    94,120,609Authorised  unlimited
Issued and outstanding 28,310,884
(Dec 31, 2003 - 24,815,961)
(Dec 31, 2002 - 20,585,943)Contributed surplus
    
    
    1,841,776
    
    
    
    540,222
    
    
    
    769,964Warrants (note 12)
    
    
    2,258,227
    
    
    
    
    
    
    
    Foreign currency translation adjustment
    
    
    463,200
    
    
    
    
    
    
    
    Deferred hedge gain (note 9)
    
    
    537,358
    
    
    
    
    
    
    
    Deficit accumulated during the development stage
    
    
    (71,608,144
    )
    
    
    (11,031,402
    )
    
    
    (7,513,833
    )Total shareholders equity
    
    
    150,306,071
    
    
    
    146,958,020
    
    
    
    87,376,740Total liabilities and shareholders equity
    
    
    385,842,184
    
    
    
    260,339,850
    
    
    
    135,074,861
 See accompanying notes to the consolidated financial statements Commitments (note 20) On behalf of the Board Phil Mulacek, Director Christian Vinson, Director




---



##### 



InterOil CorporationConsolidated Statements of Operations
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 Unauditedcumulative amountsfrom inception ofdevelopmentYear ended
    
    
    
    
    
    
    stages toDecember 31
    
    
    December 31
    
    
    December 31
    
    
    December 312004
    
    
    2003
    
    
    2002
    
    
    2004$
    
    
    $
    
    
    $
    
    
    $RevenueSales and operating revenues (note 19)
    
    
    70,644,486
    
    
    
    
    
    
    
    
    
    
    
    70,644,486Interest
    
    
    382,461
    
    
    
    246,912
    
    
    
    373,015
    
    
    
    7,349,234Other
    
    
    196,337
    
    
    
    12,368
    
    
    
    11,211
    
    
    
    230,485Equity (loss) of SP InterOil, LDC
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (281,128
    )71,223,284
    
    
    
    259,280
    
    
    
    384,226
    
    
    
    77,943,077ExpensesCost of sales and operating expenses (note 19)
    
    
    63,836,182
    
    
    
    
    
    
    
    
    
    
    
    63,836,182Inventory revaluation
    
    
    1,508,334
    
    
    
    
    
    
    
    
    
    
    
    1,508,334Administrative and general expenses
    
    
    8,470,625
    
    
    
    2,337,255
    
    
    
    2,241,911
    
    
    
    19,219,202Management fees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,365,000Management fees for prior periods waived
    
    
    
    
    
    
    (840,000
    )
    
    
    
    
    
    
    (840,000
    )Exploration costs (note 8)
    
    
    38,470,074
    
    
    
    164,992
    
    
    
    92,673
    
    
    
    39,430,660Legal and professional fees
    
    
    3,573,727
    
    
    
    1,421,390
    
    
    
    464,253
    
    
    
    7,233,954Short term borrowing costs
    
    
    4,705,190
    
    
    
    
    
    
    
    
    
    
    
    4,705,190Long term borrowing costs
    
    
    1,401,256
    
    
    
    
    
    
    
    
    
    
    
    1,401,256Foreign exchange (gain) loss
    
    
    392,805
    
    
    
    678,774
    
    
    
    (1,094,787
    )
    
    
    2,556,475122,358,193
    
    
    
    3,762,411
    
    
    
    1,704,050
    
    
    
    140,416,253Loss before income taxes and
non-controlling interest
    
    
    (51,134,909
    )
    
    
    (3,503,131
    )
    
    
    (1,319,824
    )
    
    
    (62,473,176
    )Income taxes (note 13)Current
    
    
    (2,538,410
    )
    
    
    (37,339
    )
    
    
    (1,446
    )
    
    
    (2,687,836
    )Future
    
    
    663,347
    
    
    
    
    
    
    
    
    
    
    
    663,347(1,875,063
    )
    
    
    (37,339
    )
    
    
    (1,446
    )
    
    
    (2,024,489
    )Loss before non-controlling interest
    
    
    (53,009,972
    )
    
    
    (3,540,470
    )
    
    
    (1,321,270
    )
    
    
    (64,497,665
    )Non-controlling interest
    
    
    70,091
    
    
    
    22,901
    
    
    
    5,383
    
    
    
    526,381Net loss
    
    
    (52,939,881
    )
    
    
    (3,517,569
    )
    
    
    (1,315,887
    )
    
    
    (63,971,284
    )Basic loss per share(note 23)
    
    
    (2.09
    )
    
    
    (0.16
    )
    
    
    (0.06
    )Diluted loss per share(note 23)
    
    
    (2.09
    )
    
    
    (0.16
    )
    
    
    (0.06
    )Weighted average number of
common shares outstandingBasic and diluted
    
    
    25,373,575
    
    
    
    22,649,924
    
    
    
    20,462,167
 See accompanying notes to the consolidated financial statements




---



##### 



InterOil CorporationConsolidated Statements of Cash Flows
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 Unauditedcumulative amountsfrom inception ofdevelopmentYear ended
    
    
    stages toDecember 31
    
    
    December 31
    
    
    December 31
    
    
    December 312004
    
    
    2003
    
    
    2002
    
    
    2004$
    
    
    $
    
    
    $
    
    
    $Cash flows from/(used in) operating activitiesNet loss
    
    
    (52,939,881
    )
    
    
    (3,517,569
    )
    
    
    (1,315,887
    )
    
    
    (63,971,283
    )Adjustments
for non-cash transactionsNet distributions from SP InterOil LDC
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    781,187Non-controlling interest
    
    
    (70,091
    )
    
    
    (22,901
    )
    
    
    (5,383
    )
    
    
    (526,300
    )Depreciation and amortization
    
    
    639,075
    
    
    
    73,068
    
    
    
    85,657
    
    
    
    797,800Future income tax benefit
    
    
    (663,347
    )
    
    
    
    
    
    
    
    
    
    
    (663,347
    )Gain on sale of other assets
    
    
    (94,260
    )
    
    
    
    
    
    
    
    
    
    
    (94,260
    )Amortization of discount on debt
    
    
    604,045
    
    
    
    
    
    
    
    
    
    
    
    604,045Amortization of deferred financing costs
    
    
    268,873
    
    
    
    
    
    
    
    
    
    
    
    268,873Debt conversion settlement expense  debentures
    
    
    77,589
    
    
    
    
    
    
    
    
    
    
    
    77,589Management fee waived
    
    
    
    
    
    
    (840,000
    )
    
    
    
    
    
    
    (840,000
    )Stock compensation expense
    
    
    1,209,921
    
    
    
    (39,654
    )
    
    
    612,197
    
    
    
    1,782,464Capitalized oil and gas properties expensed
    
    
    35,566,761
    
    
    
    164,992
    
    
    
    92,673
    
    
    
    35,824,426Ineffective hedge loss
    
    
    40,715
    
    
    
    
    
    
    
    678,648
    
    
    
    719,363Interest expense forfeited by debenture holders
    
    
    998,438
    
    
    
    
    
    
    
    
    
    
    
    998,438Unrealized foreign exchange loss (gain)
    
    
    392,805
    
    
    
    678,774
    
    
    
    (1,773,435
    )
    
    
    2,556,475Change in
non-cash working capitalDecrease/(increase) in trade receivables
    
    
    (50,456,671
    )
    
    
    
    
    
    
    
    
    
    
    (50,456,671
    )Decrease/(increase) in other assets and prepaid expenses
    
    
    982,014
    
    
    
    220,196
    
    
    
    709,782
    
    
    
    2,237,894Decrease/(increase) in inventories
    
    
    (22,666,150
    )
    
    
    
    
    
    
    
    
    
    
    (22,666,150
    )Increase (decrease) in accounts payable, accrued liabilities and income tax payable
    
    
    5,880,047
    
    
    
    (236,058
    )
    
    
    (1,433,211
    )
    
    
    (916,755
    )(80,230,117
    )
    
    
    (3,519,152
    )
    
    
    (2,348,959
    )
    
    
    (93,486,212
    )Cash flows used in investing activitiesCash paid on consolidation of SP InterOil LDC
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (14,858,947
    )Expenditure on oil and gas properties
    
    
    (19,154,106
    )
    
    
    (19,987,946
    )
    
    
    (875,105
    )
    
    
    (37,855,204
    )Expenditure on plant and equipment
    
    
    (38,484,704
    )
    
    
    (81,843,608
    )
    
    
    (42,372,277
    )
    
    
    (185,519,616
    )Proceeds on sale of other assets
    
    
    405,353
    
    
    
    
    
    
    
    
    
    
    
    405,353Redemption of cash on short term investments
    
    
    24,723,572
    
    
    
    (17,617,871
    )
    
    
    9,894,299
    
    
    
    Acquisition of InterOil Products Limited,
net of cash received (note 10)
    
    
    4,631,904
    
    
    
    
    
    
    
    
    
    
    
    4,631,904Change in non-cash working capitalIncrease
(decrease) in accounts payable and accrued liabilities
    
    
    4,094,594
    
    
    
    (1,351,521
    )
    
    
    4,749,199
    
    
    
    7,492,272(23,783,387
    )
    
    
    (120,800,946
    )
    
    
    (28,603,884
    )
    
    
    (225,704,238
    )Cash flows from financing activitiesProceeds from secured loan
    
    
    2,000,000
    
    
    
    52,000,000
    
    
    
    30,240,000
    
    
    
    84,240,000Proceeds from senior convertible debenture
    
    
    45,000,000
    
    
    
    
    
    
    
    
    
    
    
    45,000,000Senior convertible debenture issuance costs
    
    
    (3,259,766
    )
    
    
    
    
    
    
    
    
    
    
    (3,259,766
    )Proceeds from indirect participation interest
    
    
    16,984,852
    
    
    
    16,300,000
    
    
    
    
    
    
    
    33,284,852Proceeds from related party borrowings (note 5)
    
    
    1,775,565
    
    
    
    
    
    
    
    2,900,000
    
    
    
    4,753,841Repayment to related party (note 5)
    
    
    (2,198,065
    )
    
    
    (776,902
    )
    
    
    (878,276
    )
    
    
    (3,853,243
    )Proceeds from issue of common shares  options
    
    
    2,020,316
    
    
    
    62,822,143
    
    
    
    1,312,223
    
    
    
    126,647,846Proceeds from short term borrowing
    
    
    5,100,000
    
    
    
    
    
    
    
    
    
    
    
    5,100,000Repayments of short term borrowings
    
    
    (5,100,000
    )
    
    
    
    
    
    
    
    
    
    
    (5,100,000
    )Proceeds from (repayments of) working capital facility
    
    
    76,520,541
    
    
    
    
    
    
    
    
    
    
    
    76,520,541Cash held as security for working capital facility
    
    
    (24,407,709
    )
    
    
    
    
    
    
    
    
    
    
    (24,407,709
    )114,435,734
    
    
    
    130,345,241
    
    
    
    33,573,947
    
    
    
    338,926,362Increase in cash and cash equivalents
    
    
    10,422,230
    
    
    
    6,025,143
    
    
    
    2,621,104
    
    
    
    19,735,912Cash and cash equivalents, beginning of period
    
    
    9,313,682
    
    
    
    3,288,539
    
    
    
    667,435
    
    
    
    Cash and cash equivalents, end of period(note 2)
    
    
    19,735,912
    
    
    
    9,313,682
    
    
    
    3,288,539
    
    
    
    19,735,912
 See accompanying notes to the consolidated financial statements




---



##### 



InterOil CorporationConsolidated Statements of Shareholders Equity
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 Year endedDecember 31
    
    
    December 31
    
    
    December 312004
    
    
    2003
    
    
    2002$
    
    
    $
    
    
    $Share capitalAt beginning of period
    
    
    157,449,200
    
    
    
    94,120,609
    
    
    
    92,808,387Adjustment to reflect change in accounting for
employee stock options (note 1c)
    
    
    92,434
    
    
    
    
    
    
    
    Issue of capital stock
    
    
    59,272,020
    
    
    
    63,328,591
    
    
    
    1,312,222At end of period
    
    
    216,813,654
    
    
    
    157,449,200
    
    
    
    94,120,609Contributed surplusAt beginning of period
    
    
    540,222
    
    
    
    769,964
    
    
    
    Adjustment to reflect change in accounting for
employee stock options (note 1c)
    
    
    645,216
    
    
    
    
    
    
    
    Stock compensation
    
    
    656,338
    
    
    
    (229,742
    )
    
    
    769,964At end of period
    
    
    1,841,776
    
    
    
    540,222
    
    
    
    769,964WarrantsAt beginning of period
    
    
    
    
    
    
    
    
    
    
    Movement for period (note 12)
    
    
    2,258,227
    
    
    
    
    
    
    
    At end of period
    
    
    2,258,227
    
    
    
    
    
    
    
    Foreign currency translation adjustmentAt beginning of period
    
    
    
    
    
    
    
    
    
    
    Movement for period (note 1e)
    
    
    463,200
    
    
    
    
    
    
    
    At end of period
    
    
    463,200
    
    
    
    
    
    
    
    Deferred hedge gainAt beginning of period
    
    
    
    
    
    
    
    
    
    
    Movement for period (note 9)
    
    
    537,358
    
    
    
    
    
    
    
    At end of period
    
    
    537,358
    
    
    
    
    
    
    
    Deficit accumulated during the development stageAt beginning of period
    
    
    (11,031,402
    )
    
    
    (7,513,833
    )
    
    
    (6,197,946
    )Adjustment to reflect change in accounting for
employee stock options (note 1c)
    
    
    (737,650
    )
    
    
    
    
    
    
    Adjustment to reflect cumulative debentures conversion expense (note 12)
    
    
    (6,899,211
    )
    
    
    
    
    
    
    Net (loss) for period
    
    
    (52,939,881
    )
    
    
    (3,517,569
    )
    
    
    (1,315,887
    )At end of period
    
    
    (71,608,144
    )
    
    
    (11,031,402
    )
    
    
    (7,513,833
    )Shareholders equity at end of period
    
    
    150,306,071
    
    
    
    146,958,020
    
    
    
    87,376,740
 See accompanying notes to the consolidated financial statements




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 InterOil Corporations (the Company or InterOil) is a development stage enterprise whose
primary business interests are the development of an oil refinery (the Project), oil and gas
exploration in Papua New Guinea (PNG), and distribution of refined petroleum products in PNG. 1. Statement of significant accounting policies (a) Basis of presentation The consolidated financial statements for the year ended December 31, 2004 have been prepared in
accordance with Canadian generally accepted accounting principles on a going concern basis which
presumes the realization of assets and discharge of liabilities in the normal course of business
in the future. The consolidated financial statements of the Company include the financial statements of SP
InterOil, LDC (SPI) (99.9%), SPI Exploration and Production Corporation (100%), SPI
Distribution Limited (100%), InterOil Australia Pty Ltd (100%) and their subsidiaries. All
significant intercompany balances and transactions have been eliminated upon consolidation. (b) Segment reporting The Company operates its business in Papua New Guinea in the following segments:  Upstreamincludes the
exploration for and production of crude oil and natural gas.Midstreamincludes refinery operations. The refinery processes crude oil into naphtha, gasoline,
diesel, LPG, jet/kerosene and low sulphur way residue. The midstream operations sell to the PNG
domestic market as well as to export customers.Downstreamincludes the distribution of refined products and lubricants, including gasoline,
diesel and fuel oils in PNG.
 The above functions have been defined as the operating segments of the Company because they are
the segments (a) that engage in business activities from which revenues are earned and expenses
are incurred or where business activities are being developed; (b) whose operating results are
regularly reviewed by the Companys chief operating decision-maker to make decisions about
resources to be allocated to the segment and assess its performance; and (c) for which discrete
financial information is available. Corporate includes assets and liabilities that do not
specifically relate to business segments e.g. primarily cash. Results in this segment primarily
include financing costs and interest income. Segment accounting policies are the same as those described in this summary of significant
accounting policies. Upstream, midstream and downstream include costs allocated from the
corporate activities. The allocation is based on a fee for service. (c) Stock-based compensation Prior to January 1, 2004, the Company applied the fair value based method only to employee stock
appreciation rights, and applied the settlement method of accounting to employee stock options.
Under the settlement method, any consideration paid by employees on the exercise of stock
options or purchase of stock was credited to share capital and no compensation expense was
recognized. The Company adopted the fair value based method to account for employee stock options, beginning
January 1, 2004. Under the fair value based method, compensation expense is measured at fair
value at the date of grant and is expensed over the awards vesting period. In accordance with
one of the transitional options permitted, the Company has retroactively applied the fair value
based method to all employee stock options granted on or after January 1, 2002, without
restatement to prior periods. The effect of retroactively adopting the fair value based method,
without restatement, is to increase the opening deficit accumulated during the development stage
by $737,650, increase contributed surplus by $645,216 and increase share capital by $92,434. (d) Inventories Crude oil and refined petroleum products are valued at the lower of cost, on a first-in,
first-out basis, or net realizable value. The cost of midstream refined petroleum product
consists of raw material, labour, direct overheads and transportation costs. Cost of downstream
refined petroleum product includes the cost of the product plus related freight, wharfage and
insurance.




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 1. Statement of significant accounting policies (contd) (e) Foreign currency For subsidiaries considered to be self-sustaining foreign operations, all assets and liabilities
denominated in foreign currency are translated to United States dollars at exchange rates in
effect at the balance date and all revenue and expense items are translated at the rates of
exchange in effect at the time of the transactions. Foreign exchange gains or losses are
reported as a separate component of shareholders equity. For subsidiaries considered to be an integrated foreign operation, monetary items denominated in
foreign currency are translated to United States dollars at exchange rates in effect at balance
date and non-monetary items are translated at rates of exchange in effect when the assets were
acquired or obligations incurred. Revenue and expense items are translated at the rates of
exchange in effect at the time of the transactions. Foreign exchange gains or losses are
included in income. (f) Deferred financing costs Deferred financing costs represent the unamortized financing costs paid to secure long term
borrowings. Amortization is provided on a straight-line basis, over the term of the related
debt and is included in expenses for the period. (g) Receivables The collectability of debts is assessed at reporting date and specific provision is made for any
doubtful accounts. The Company sells certain trade receivables with recourse to BNP Paribas under its working
capital facility. The receivables are retained on the balance sheet as the Company retains the
risks and rewards associated with carrying the receivables. The working capital facility
balance is increased for the amount of cash received on the transaction. (h) Revenue recognition The following particular accounting policies, which significantly affect the measurement of
profit and of financial position, have been applied. Revenue from midstream operations:
Revenue from sales of products is recognized when products are shipped and the customer takes
ownership and assumes risk of loss, collection of the relevant receivable is probable,
persuasive evidence of an arrangement exists and the sales price is fixed or determinable.
Sales between business segments of the Company are eliminated from sales and operating revenues
and cost of sales and between the asset for the refinery as all revenues and expenses relating
to the refinery have been capitalized for the period to December 31, 2004. Revenue from downstream operations:
Sales of goods are recognized when the Company has delivered products to the customer, the
customer takes ownership and assumes risk of loss, collection of the receivable is probable,
persuasive evidence of an arrangement exists and the sale price is fixed or determinable. It is
not the Companys policy to sell products with a right of return. Interest income
Interest income is recognized on a time-proportionate basis using the effective interest method.




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 1. Statement of significant accounting policies (contd) (i) Derivative financial instruments Derivative financial instruments are utilized by the Company in the management of its naphtha
sales price exposures and its crude purchase cost exposures. The Companys policy is not to
utilize derivative financial instruments for trading or speculative purposes. On the date a derivative contract is entered into the Company designates the derivative as a
hedge of a forecasted transaction. The Company documents all relationships between hedging
instruments and hedged items, as well as its risk management objective and strategy for
undertaking various hedge transactions, the nature of the risk being hedged, how the hedging
instruments effectiveness in offsetting the hedged risk will be assessed and a description of
the method for measuring ineffectiveness. This process includes linking all derivatives to
specific assets and liabilities on the balance sheet or to specific firm commitments or
anticipated transactions. The Company also assesses whether the derivatives that are used in
hedging transactions are highly effective in offsetting changes in fair value or cash flows of
hedged items at inception and on an ongoing basis. Changes in the fair value of a derivative that is highly effective and that is designated and
qualifies as a cash-flow hedge are recorded in a separate component of equity to the extent that
the derivative is effective as a hedge, until earnings are affected by the variability in cash
flows of the designated hedged item. The ineffective portion of the change in fair value of a
derivative instrument that qualifies as a hedge is reported in earnings. The Company discontinues hedge accounting prospectively when it is determined that the
derivative is no longer effective in offsetting changes in cash flows of the hedged item, the
derivative expires or is sold, terminated, or exercised, the derivative is no longer designated
as a hedging instrument, because it is unlikely that a forecasted transaction will occur, a
hedged firm commitment no longer meets the definition of a firm commitment, or management
determines that designation of the derivative as a hedging instrument is no longer appropriate. In all situations in which hedge accounting is discontinued, the Company continues to carry the
derivative at its fair value on the balance sheet and recognizes any subsequent changes in its
fair value in earnings. The adjustment of the carrying amount of the hedged asset or liability
is accounted for in the same manner as other components of the carrying amount of that asset or
liability. When hedge accounting is discontinued because it is probable that a forecasted
transaction will not occur, the Company recognizes immediately in earnings gains and losses that
were accumulated in a separate component of equity. The Company enters into naphtha swaps in order to reduce the impact of fluctuating naphtha
prices on its revenue. These swap agreements require the periodic exchange of payments without
the exchange of the notional product amount on which the payments are based. The Company designates its naphtha price swap agreements as hedges of the
underlying sale. Naphtha sales revenue is adjusted to include the payments made or received
under the naphtha price swaps. The Company enters into crude swaps in order to reduce the impact of fluctuating crude prices on
its cost of sales. These swap agreements require the period exchange of payments without the
exchange of the notional product amount on which the payments are based. The Company designates
its crude price swap agreements as hedges of the underlying purchase. Cost of sales is adjusted
to include the payments made or received under the crude purchase cost swaps. (j) Income taxes The Company uses the asset and liability method of accounting for income taxes. Under the asset
and liability method, future tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Future tax assets and
liabilities are measured using enacted or substantively enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to be recovered or
settled. The effect on future tax assets and liabilities of a change in tax rates is recognized
in income in the period that includes the date of enactment or substantive enactment. A
valuation allowance is provided against any portion of a future tax asset which will more likely
not be recovered. (k) Oil and gas properties The Company uses the successful-efforts method to account for its oil and gas exploration and
development activities. Under this method costs are accumulated on a field-by-field basis with
certain exploratory expenditures and exploratory dry holes being expensed as incurred. The
Company continues to carry as an asset the cost of drilling exploratory wells if the required
capital expenditure is made and drilling of additional exploratory wells is underway or firmly
planned for the near future or when exploration and evaluation activities have not yet reached a
stage to allow reasonable assessment regarding the existence of




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##### 



InterOil Corporation
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 1. Statement of significant accounting policies (contd) (k) Oil and gas properties (contd) economical reserves. Capitalized costs for producing wells will be subject to depletion on the
units-of-production method. Geological and geophysical costs are expensed as incurred. (l) Plant and equipment Refinery assets
The Companys most significant item of plant and equipment is the oil refinery in PNG. The
Company is considered to be in the construction and pre-operating stage of development of the
oil refinery. Project costs, net of any recoveries, incurred during this pre-operating stage
are being capitalized as part of plant and equipment. Administrative and general costs are
expensed as incurred. The refinery assets are recorded at cost. Development costs and the costs
of acquiring or constructing support facilities and equipment are capitalized. Interest costs
relating to the construction and pre-operating stage of the development project prior to
commencement of commercial operations are capitalized as part of the cost of such plant and
equipment. Refinery related assets will be depreciated on a straight line basis over their
useful lives, at 4% per annum. The refinery is being built on land leased from the Independent
State of Papua New Guinea. The lease expires on July 26, 2097 and does not outline any terms
for restoration and closure costs. Repairs and maintenance costs, other than major turnaround costs, are charged to earnings as
incurred. Major turnaround costs will be deferred to other assets when incurred and amortized
over the estimated period of time to the next scheduled turnaround. No major turnaround costs
had been incurred at December 31, 2004. Other assets
Property, plant and equipment is recorded at cost. Depreciation of assets begins when the asset
is in place and ready for its intended use. Assets under construction are not depreciated.
Depreciation of plant and equipment is calculated using the straight line method, based on the
estimated service life of the asset. The depreciation rates used on plant and equipment range
from 15% to 40%. Maintenance and repair costs are expensed as incurred. Improvements that
increase the capacity or prolong the service life of an asset are capitalized. Leased assets
Operating lease payments are representative of the pattern of benefit derived from the leased
asset and accordingly are included in expenses in the periods in which they are incurred. Asset retirement obligations
Estimated costs of future dismantlement, site restoration and abandonment of properties are
provided based upon current regulations and economic circumstances at year end. Management
estimates there are no legal obligations associated with the retirement of the refinery or with
its normal operations relating to future restoration and closure costs. The refinery is being
built on land leased from the Independent State of Papua New Guinea. The lease expires on July
26, 2097 and does not outline any terms for restoration and closure costs. As a result, no
provision has been raised. Disposal of property, plant and equipment
At the time of disposition of plant and equipment, accounts are relieved of the asset values and
accumulated depreciation and any resulting gain or loss is included in income. Environmental remediation
Remediation costs are accrued based on estimates of known environmental remediation exposure.
Ongoing environmental compliance costs, including maintenance and monitoring costs, are expensed
as incurred. Provisions are determined on an assessment of current costs, current legal
requirements and current technology. Changes in estimates are dealt with on a prospective basis.
No provision has been recorded at December 31, 2004, 2003 and 2002. (m) Employee entitlements The amounts expected to be paid to employees for their pro-rata entitlement to long service and
annual leave and leave fares are accrued having regard to anticipated periods of service,
remuneration levels and statutory obligations.




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 1. Statement of significant accounting policies (contd) (n) Use of estimates 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 at the date of the financial statements and the reported
amounts of revenue and expense during the year. Actual results could differ from those
estimates. (o) Per share amounts Basic per share amounts are computed by dividing net earnings by the weighted average shares
outstanding during the reporting period. Diluted per share amounts are computed similar to basic
per share amounts except that the weighted average shares outstanding are increased to include
additional shares from the assumed exercise of stock options, conversion options and warrants,
if dilutive. The number of additional shares is calculated by assuming that outstanding stock
options were exercised and the proceeds from such exercises were used to acquire shares of
common stock at the average price during the reporting period. (p) Vulnerability to concentration risk Credit risk
The majority of the Companys export sales are made to one customer. The Companys domestic
sales for the period ended December 31, 2004 were not dependent on a single customer or
geographic region of PNG. No export or domestic sales from the refinery have been recognized in the Consolidated Statement
of Operations for the year ended December 31, 2004. Product risk
The composition of the crude feedstock will vary the refinery output of products. The 2004
output achieved through the commissioning process includes naphtha (35.8%), diesel (32.5%) and
low sulphur waxy residue (16.2%). The product yields obtained during commissioning will vary
going forward as the refinery operations are optimized. Supply risk
During 2004, the Company sourced the majority of its crude supply from two sources. Geographic risk
The operations of InterOil are concentrated in Papua New Guinea. (q) Temporary investments Temporary investments are carried at the lower of cost and recoverable amount. If the carrying
amount of the asset exceeds its recoverable amount, the asset is written down to the lower
amount. The write-down is expensed in the reporting period in which it occurs. (r) Presentation Certain prior years amounts have been reclassified to conform with current presentation.




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 2. Cash and cash equivalents The Company considers deposits in bank and short-term investments with original maturities of three
months or less as cash and cash equivalents. Cash and cash equivalents are carried at cost.
Accrued interest is included with other receivables. The components of cash and cash equivalents are as follows: 2004
    
    
    2003
    
    
    2002$
    
    
    $
    
    
    $Cash on deposit
    
    
    15,313,941
    
    
    
    6,208,785
    
    
    
    3,206,084Bank term deposits- Papua New Guinea kina deposits (K 13,891,853 )
    
    
    4,417,609
    
    
    
    97,417
    
    
    
    79,324- Australian dollar deposits (AUD 5,595)
    
    
    4,362
    
    
    
    
    
    
    
    3,131Papua New Guinea kina treasury bills
    
    
    
    
    
    
    3,007,480
    
    
    
    19,735,912
    
    
    
    9,313,682
    
    
    
    3,288,539
 Increase in cash for the year ended December 31, 2004 is the result of the acquisition of
InterOil Products Limited, which holds cash, and proceeds from the debenture issuance and
options exercised. In addition, $13,749,852 was received near year end for a new indirect
participation interest. Included in the Papua New Guinea bank term deposits is $102,096 (2003  $97,417, 2002  $nil)
which is restricted and unavailable to the Company while Petroleum Prospecting Licenses 236, 237
and 238 are being utilized by the Company. 3. Trade receivables At December 31, 2004, the Company had a discounting facility with BNP Paribas on specific monetary
receivables (note 18). As at December 31, 2004, $13,034,904 in outstanding accounts receivable
had been sold with recourse under the facility. The Company has retained the responsibility for
administering and collecting accounts receivable sold and therefore has included the sold
receivables in the trade receivables balance at December 31, 2004. The increase in trade receivables over prior year is a result of the fact that the Company has sold
refined product produced by the refinery during its commissioning operations. The increase in trade
receivables also relates to the operations of InterOil Products Limited, a subsidiary acquired
during the year (note 10). At December 31, 2004 $46,911,393 of the trade receivables secures the BNP Paribas working capital
facility disclosed in note 18.




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 4. Supplemental cash flow information Dec-31
    
    
    Dec-31
    
    
    Dec-312004
    
    
    2003
    
    
    2002$
    
    
    $
    
    
    $Cash paid during the yearInterest
    
    
    1,444,006
    
    
    
    4,138,290
    
    
    
    1,948,043Income taxes
    
    
    1,914,459
    
    
    
    64,891
    
    
    
    2,855Interest received
    
    
    671,479
    
    
    
    149,631
    
    
    
    840,337Non-cash investing and financing activities: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 1c)
    
    
    645,216
    
    
    
    
    
    
    
    Increase in due to related parties resulting from transfer of other
assets
    
    
    
    
    
    
    311,093
    
    
    
    Increase in share capital from:oil and gas property expenditure paid for with stock
    
    
    
    
    
    
    316,359
    
    
    
    change in accounting policy for stock based compensation (note 1c)
    
    
    92,434transfer 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
    
    
    9,226,260
    
    
    
    
    
    
    
    inducement paid on conversion of debentures
    
    
    6,976,800
    
    
    
    
    
    
    
    prepaid transaction costs being attributed to share capital
transaction
    
    
    300,000Movement in accumulated deficit as a result of the inducement paid
on conversion of the debentures
    
    
    6,899,211
    
    
    
    
    
    
    
    
 All non-cash investing and financing activities disclosed in note 4 relate to the corporate
segment except for those involving the other payables capitalized as part of plant and equipment
(midstream), the recording of deferred hedge gain (midstream), and the oil and gas property
expenditure paid for with stock (upstream). 5. Related parties Amounts due to related parties of $1,056,251 (2003  $1,478,751, 2002  $2,784,560) represents
monies owed to Petroleum Independent and Exploration Corporation (PIE) which acts as a sponsor of
the Companys oil refinery project. PIE is controlled by an officer and director of InterOil.
During the year, $422,500 of the loan to PIE was repaid . The loan has interest charged at a rate
of 5.75% (2003  5.75%, 2002  5.75%) per annum. During the year ended December 31, 2004, PIE
also advanced InterOil Corporation $1,775,565, which was repaid prior to December 31, 2004. The
advance had interest charged at a rate of 6% per annum. During the year the Company incurred total
interest to PIE amounting to $246,745 (2003  $105,374, 2002  $127,639). SPI does not have a Board of Directors. Instead, its articles of association provide for the
business and affairs of SPI to be managed by a general manager appointed by the shareholders of SPI
and it is the US sponsor under the Overseas Private Investment Corporation (OPIC), an agency of the
US Government, loan. PIE has been appointed as the general manager of SPI. Under the laws of the
Commonwealth of The Bahamas, the general manager exercises all powers which would typically be
exercised by a Board of Directors, being those which are not required by laws or by SPIs
constituting documents to be exercised by the members (shareholders) of SPI. During the year,
$150,410 (2003  $150,000, 2002  $150,000) was expensed for the sponsors (PIE) legal, accounting
and reporting costs. This amount was included in accounts payable and accrued liabilities at
December 31, 2004. During 2003, PIE also waived $840,000 of management fees due to it for prior
periods and this was reflected in the Consolidated Statement of Operations. Breckland Limited provides technical and advisory services to the Company and/or subsidiaries on
normal commercial terms. This party is related by virtue of common directorships. Amounts paid or
payable to Breckland during the year amounted to $120,426 (2003  $131,250, 2002  $204,522).




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##### 



InterOil Corporation
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 5. Related parties (contd) The services of certain executive officers and senior management of the Company are provided under
a management services agreement with Direct Employment Services Corp. (DESC). DESC is a U.S.
private Company administered by executive officers of the Company and which was established for the
purposes of providing non-profit management services to the Company. During 2004 DESC was paid
$708,104 (2003  $535,855, 2002  $435,661). Amounts due to Directors at December 31, 2004 totaled $61,000 for Directors fees (2003  $30,500,
2002  $26,000) and $320,000 for Directors bonuses (2003  nil, 2002  nil) and are included in
accounts payable and accrued liabilities. 6. Inventories Dec-31
    
    
    Dec-31
    
    
    Dec-312004
    
    
    2003
    
    
    2002$
    
    
    $
    
    
    $Midstream (crude oil feedstock)
    
    
    3,971,982
    
    
    
    
    
    
    
    Midstream (refined petroleum product)
    
    
    16,396,975
    
    
    
    
    
    
    
    Downstream (refined petroleum product)
    
    
    7,547,945
    
    
    
    
    
    
    
    27,916,902
    
    
    
    
    
    
    
    
 Midstream inventories have increased between December 31, 2003 and December 31, 2004 as a result of
the refinery entering its commissioning stage. Further, downstream inventories have increased as a
result of the acquisition of InterOil Products Limited. At December 31, 2004 $20,368,957 of the midstream inventory balance secures the BNP Paribas working
capital facility disclosed in note 18.




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 7. Plant and equipment Year ended December 31, 2004Upstream
    
    
    Midstream
    
    
    Downstream
    
    
    Corporate and consolidations
    
    
    TotalsPlant and equipment
    
    
    5,659,248
    
    
    
    237,102,876
    
    
    
    12,331,522
    
    
    
    263,217
    
    
    
    255,356,863Deferred project costs
    
    
    
    
    
    
    
    
    
    
    406,077
    
    
    
    
    
    
    
    406,077Consolidation entries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,002,214
    )
    
    
    (2,002,214
    )Accumulated depreciation
and amortization
    
    
    (19,792
    )
    
    
    (419,629
    )
    
    
    (8,230,060
    )
    
    
    (176,890
    )
    
    
    (8,846,371
    )Net book value
    
    
    5,639,456
    
    
    
    236,683,247
    
    
    
    4,507,539
    
    
    
    (1,915,887
    )
    
    
    244,914,355Capital expenditure for year
    
    
    1,131
    
    
    
    40,532,990
    
    
    
    1,320,644
    
    
    
    83,920
    
    
    
    41,938,685
 Year ended December 31, 2003Upstream
    
    
    Midstream
    
    
    Downstream
    
    
    Corporate and consolidations
    
    
    TotalsPlant and equipment
    
    
    5,658,117
    
    
    
    43,218,420
    
    
    
    
    
    
    
    179,472
    
    
    
    49,056,009Deferred project costs
    
    
    
    
    
    
    153,298,736
    
    
    
    321,817
    
    
    
    
    
    
    
    153,620,553Consolidation entries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (165,647
    )
    
    
    (165,647
    )Accumulated depreciation
and amortization
    
    
    (7,282
    )
    
    
    (107,643
    )
    
    
    
    
    
    
    (86,525
    )
    
    
    (201,450
    )Net book value
    
    
    5,650,835
    
    
    
    196,409,513
    
    
    
    321,817
    
    
    
    (72,700
    )
    
    
    202,309,465Capital expenditure for year
    
    
    5,658,117
    
    
    
    81,226,712
    
    
    
    100,333
    
    
    
    53,791
    
    
    
    87,038,953
 Year ended December 31, 2002Upstream
    
    
    Midstream
    
    
    Downstream
    
    
    Corporate and consolidations
    
    
    TotalsPlant and equipment
    
    
    
    
    
    
    47,959,600
    
    
    
    
    
    
    
    132,615
    
    
    
    48,092,215Deferred project costs
    
    
    
    
    
    
    73,076,344
    
    
    
    221,484
    
    
    
    
    
    
    
    73,297,828Consolidation entries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (128,296
    )
    
    
    (128,296
    )Accumulated depreciation
and amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (44,047
    )
    
    
    (44,047
    )Net book value
    
    
    
    
    
    
    121,035,944
    
    
    
    221,484
    
    
    
    (39,728
    )
    
    
    121,217,700Capital expenditure for year
    
    
    
    
    
    
    39,069,313
    
    
    
    45,398
    
    
    
    46,128
    
    
    
    39,160,839




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 8. Oil and gas properties Costs of oil and gas properties, including major development projects, excluded from costs subject
to depletion and depreciation were as follows: Dec 31, 2004
    
    
    Dec 31, 2003
    
    
    Dec 31, 2002$
    
    
    $
    
    
    $Petroleum Prospecting Licence 238, at costEquipment and inventories
    
    
    5,353,471
    
    
    
    6,992,867
    
    
    
    Drilling programs
    
    
    1,251,889
    
    
    
    14,199,188
    
    
    
    1,193,910Other exploration properties, at cost
    
    
    
    
    
    
    1,825,960
    
    
    
    1,684,7936,605,360
    
    
    
    23,018,015
    
    
    
    2,878,703
 The following table discloses a breakdown of the exploration expenses presented in the statements
of operations for the years ended: Dec 31, 2004
    
    
    Dec 31, 2003
    
    
    Dec 31, 2002$
    
    
    $
    
    
    $Exploration costs expensed as incurred
    
    
    2,903,313
    
    
    
    
    
    
    
    Capitalized oil and gas properties expensedCosts incurred in prior years
    
    
    16,576,982
    
    
    
    70,016
    
    
    
    84,362Costs incurred in current years
    
    
    18,989,779
    
    
    
    94,976
    
    
    
    8,31138,470,074
    
    
    
    164,992
    
    
    
    92,673
 Capitalized oil and gas properties expensed during the period include costs relating to the Moose
and Sterling Mustang wells. These wells were suspended during the year. Due to the uncertainty of
reentering these wells and without any proven reserves established, the cost of drilling these
exploratory wells to date has been expensed. 9. Financial instruments With the exception of cash and cash equivalents and short term investments, all financial assets
are non interest bearing. Cash and cash equivalents earned average interest rates of 1.6% per
annum (2003  1.5%, 2002  3.5%). Temporary investments
    
    Dec-31, 2004
    
    
    Dec-31, 2003
    
    
    Dec-31, 2002Cash deposit on working capital facility (1.98%)
    
    
    24,407,709
    
    
    
    
    
    
    
    Managed trust (1.5%)
    
    
    
    
    
    
    24,626,154
    
    
    
    Pledged deposit (1.6%)
    
    
    
    
    
    
    97,418
    
    
    
    7,105,701Total
    
    
    24,407,709
    
    
    
    24,723,572
    
    
    
    7,105,701
 Credit risk is minimized as all cash amounts and certificate of deposit are held with large banks
which have acceptable credit ratings determined by a recognized rating agency. The carrying values
of cash and cash equivalents, trade receivables, all other assets, accounts payable and accrued
liabilities, short and long term debt and amounts due to related parties approximate fair values
due to the short term maturities of these instruments. Cash held as deposit on the working capital facility supports the Companys working
capital facility with BNP Paribas. The balance is initially based on 20% of the
outstanding balance of the facility subject to fluctuations or variations in inventories and
accounts receivables. Foreign currency hedge contracts
The Company had no outstanding foreign currency forward contracts at December 31, 2004 and 2003.
At December 31, 2002, the Company had contracts valued at $62,000,000 to acquire Australian dollar
amounts payable pursuant to the refinery construction. These hedging contracts have all matured
during 2003. At December 31, 2002, the Company had an unrealized loss of $4,001,462 resulting




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 from hedge contracts. An unrealized exchange loss of $678,648 was recognized on the balance sheet
for contracts in excess of specific commitments at December 31, 2002. 9. Financial instruments (contd) To define a maximum potential amount payable on the outstanding hedge contracts, the Company
acquired Australia dollar put options during the year ended December 31, 2003 for total premiums of
$218,430 (2002  $85,000). The maturity dates and nominal amounts of the put options coincided with
the exercise dates and nominal amounts of the outstanding hedge contracts. There were no
outstanding put options at December 31, 2003 or December 31, 2004. At December 31, 2002, as a requirement of the hedging contracts a collateral arrangement was
entered into whereby an amount of $7,105,701 was held on deposit and had been pledged in favor of
the provider of the hedge and recorded as cash. Funds required to be held on deposit as collateral
reduced over time as project expenditure was undertaken and the foreign currency forward contracts
were closed out. These amounts had reduced to nil as at December 31, 2003 and December 31, 2004. Commodity hedge contracts
InterOil uses derivative commodity instruments to manage exposure to price volatility on a portion
of its refined product. As at December 31, 2004, InterOil had entered into naphtha and crude swap
agreements to hedge a portion of the anticipated January and February 2005, sales of naphtha and
the purchase of associated crude feedstock. The unrealized gain on hedge contracts deemed to be
effective at December 31, 2004 amounted $537,358 (2003  $nil, 2002  $nil) and is recognized in
the financial statements under deferred hedge gain. A summary of the outstanding hedge contracts
is as follows: Notional VolumesDerivative
    
    
    Type
    
    
    
    (bbls)
    
    
    
    Expiry
    
    
    
    Price USD per Barrel
    
    
    
    $ ReceivableNaphtha fixed price
    
    
    Sell
    
    
    
    50,000
    
    
    
    Jan-05
    
    
    $
    43.90
    
    
    
    $
    280,000Naphtha fixed price
    
    
    Sell
    
    
    
    50,000
    
    
    
    Feb-05
    
    
    $
    41.00
    
    
    
    $
    112,500Crude fixed price
    
    
    Buy
    
    
    
    50,000
    
    
    
    Feb-05
    
    
    $
    38.90
    
    
    
    $
    111,000Total
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    503,500
 10. Acquisition of subsidiary On April 28, 2004, InterOil, through its wholly owned subsidiary, SPI Distribution Limited acquired
100% of the outstanding common shares of BP Papua New Guinea Limited which was subsequently renamed
InterOil Products Limited (IPL). IPL is a distributor of refined petroleum products in Papua New
Guinea. The results of IPLs operations have been included in the consolidated financial statements since
April 28, 2004, the date control of IPLs shares was transferred to InterOil. Under the purchase
agreement, InterOil Corporation was entitled to the profit of IPL from March 1, 2004. The profit
earned after tax between March 1, 2004 and April 28, 2004 of $1,243,746 was recognized as a
reduction in the acquisition cost. The adjusted purchase price is $13,226,854, including a service agreement for $1,000,000 related to
the purchase. A deposit of $1,000,000 of the purchase price has been paid. The remaining purchase
price of $12,226,854, which is included in current liabilities at December 31, 2004, was discounted
to $11,895,349 at the time of acquisition. The discount is being amortised over the period to the
payment date of March 1, 2005 and the amortised amount is included in short term borrowing costs.
At December 31, 2004 the discounted amount of the debt was $12,123,106.




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements

(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 10. Acquisition of subsidiary (contd) The following table summarizes the estimated fair value of the assets acquired and liabilities
assumed at the date of acquisition. The net assets acquired is equal to the adjusted purchase price, less the discount on the balance
owing for the purchase at the time of acquisition. $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
 The net cash received from the purchase of IPL of $4,631,904 is comprised of $5,859,517 held by IPL
at the time of acquisition less $1,000,000 paid relating to the acquisition price and $227,613 paid
in transaction costs and in stamp duty. 11. Secured loan On June 12, 2001, the Company entered into a loan agreement with (OPIC) to secure a project
financing facility of $85,000,000. The facility is fully drawn down at December 31, 2004. The
loan is secured over the assets of the refinery project which have a carrying value of $236,683,247
at December 31, 2004 (2003  $196,409,513, 2002  $121,035,944). The loan expires June 30, 2014 with half yearly repayments of $4,500,000 commencing June 30, 2005.
The agreement contains certain financial covenants which include the maintenance of minimum levels
of tangible net worth and limitations on the incurrence of additional indebtedness. The interest
rate is equal to the treasury cost applicable to each promissory note outstanding plus the OPIC
spread. The OPIC spread was 3% per annum during 2004. From practical completion, achieved on
January 31, 2005, the OPIC margin will increase to 3.5%. Deferred financing costs of $760,488 are being amortized over the period of the loan (10 years)
until June 2014. The accrued financing costs of $863,329 include discounting of the liability for
a 12 month period. The total liability is $950,000 and will be due for payment in June 2006. 12. Debentures and warrants On August 28, 2004 and September 4, 2004 InterOil issued a total of $45.0 million in senior
convertible debentures. The debentures were to mature on August 28, 2009 and bore interest at a
rate of 8.875% per annum, payable quarterly. The debentures were converted into 2,232,143 common
shares of the Company at a fixed conversion price of US$20.16 per share on December 31, 2004 at the
investors option. The Company also issued 180,000 additional shares to debenture holders in
connection with their conversion of the debt to equity. As a result of the issuance of the 180,000
additional shares, share capital increased by $6,976,800 which represents the fair market value of
the shares on the date they were issued. In connection with these additional shares $77,589 was
recognized as a debt conversion expense and $6,899,211 was recorded to accumulated deficit during
the year ended December 31, 2004. In connection with the issuance of the senior convertible debentures, InterOil issued to the
investors five-year warrants to purchase 359,415 common shares at an exercise price equal to
US$21.91. All warrants were outstanding at December 31, 2004 and were not impacted by the debt
conversion. The warrants are exercisable between August 27, 2004 and August 27, 2009. The
warrants are recorded at the fair value calculated at inception as a separate component of equity.
The fair value was calculated using a Black-Scholes




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements

(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 pricing model with the following assumptions: risk-free interest rate of 2.5%, dividend yield of
nil, volatility factor of the expected market price of the Companys common stock of 45%, and a
weighted average expected life of the warrants of five years. 13. Income taxes The combined income tax expense in the consolidated statements of operations reflects an
effective tax rate which differs from the expected statutory rate (combined federal and provincial
rates). Differences for the years ended December 31 were accounted for as follows: 2004
    
    2003
    
    2002$
    
    $
    
    $(Loss) before income taxes and non controlling interest
    
    
    (51,134,909
    )
    
    
    (3,503,131
    )
    
    
    (1,319,824
    )Statutory income tax rate
    
    
    35.12
    %
    
    
    35.12
    %
    
    
    38.62
    %Computed tax (benefit)
    
    
    (17,958,580
    )
    
    
    (1,230,300
    )
    
    
    (509,716
    )Effect on income tax of:Losses in foreign jurisdictions not deductible
    
    
    2,273,530
    
    
    
    (56,527
    )
    
    
    (183,802
    )Non-deductible stock compensation expense
    
    
    424,924
    
    
    
    (13,926
    )
    
    
    236,431Gains and losses on foreign exchange
    
    
    58,659
    
    
    
    302,499
    
    
    
    Tax rate differential in foreign jurisdictions
    
    
    (341,613
    )
    
    
    143,502
    
    
    
    188,788Over provision for tax in prior years
    
    
    (42,874
    )
    
    
    
    
    
    
    (332
    )Tax losses for which no future tax benefit has been brought to
account
    
    
    2,696,330
    
    
    
    836,142
    
    
    
    346,526Temporary differences for which no future tax benefit has been
brought to account
    
    
    14,552,726
    
    
    
    
    
    
    
    158,204Temporary differences brought to account on acquisition of
subsidiary
    
    
    (488,027
    )
    
    
    
    
    
    
    Other  net
    
    
    699,988
    
    
    
    55,949
    
    
    
    (234,653
    )1,875,063
    
    
    
    37,339
    
    
    
    1,446
 The future income tax asset at December 31 comprised the tax effect of the following: 2004
    
    2003
    
    2002$
    
    $
    
    $Future tax assets:Temporary differencesProperty, plant and equipment
    
    
    2,263,654
    
    
    
    
    
    
    
    Exploration expenditure
    
    
    11,541,022
    
    
    
    
    
    
    
    Other  net
    
    
    127,240
    
    
    
    (1,194,314
    )
    
    
    671,32313,931,916
    
    
    
    (1,194,314
    )
    
    
    671,323Loss carry forwards
    
    
    4,850,380
    
    
    
    2,558,406
    
    
    
    1,366,19018,782,296
    
    
    
    1,364,092
    
    
    
    2,037,513Less valuation allowance
    
    
    (17,478,665
    )
    
    
    (1,364,092
    )
    
    
    (2,037,513
    )Net future tax asset
    
    
    1,303,631
    
    
    
    
    
    
    
    
 All future tax assets recorded in the consolidated balance sheet relate to Papua New Guinea.
The amounts are non current at December 31, 2004. The valuation allowance for deferred tax assets increased by $16,164,716 in the year ended December
31, 2004, decreased by $673,421 in the year ended December 31, 2003 and increased by $622,646 in
the year ended December 31, 2002. In assessing the realizability of deferred tax assets, management considers whether it is more
likely than not that some portion or all of the deferred tax assets will not be realized. The
ultimate realization of deferred tax assets is dependent upon the generation of future




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements

(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 taxable income during the periods in which those temporary differences become deductible.
Management considers the actual levels of past taxable income, scheduled reversal of deferred tax
liabilities, projected future taxable income, projected tax rates and tax planning strategies in
making this assessment. Management has determined that a 100% valuation allowance of the net
operating loss carry-forwards is appropriate as of December 31, 2004 in respect of losses generated
from the refinery pre-commissioning activities. 14. Indirect participation interest On May 17, 2004, PNG Energy Investors converted their $7,650,000 indirect participation interest
(IPI) to 683,140 common shares of InterOil Corporation. In March 2004, the Company received an additional $3,235,000 from PNG Drilling Ventures Limited
(PNGDV) relating to PNGDVs indirect interest in the Companys phase one exploration program
within the area governed by Petroleum Prospecting Licences 236, 237 and 238. This additional
receipt brought the total invested by PNGDV in the indirect participation interest to $12,185,000.
This interest is subject to the terms of the agreement dated July 21, 2003 between the Corporation
and PNG Drilling Ventures Limited, under which all or part of the indirect participation interest,
up to a maximum of $11,620,000 may be converted to common shares in the Company at a price no less
than C$20.85 per common share. Alternatively, an amount up to $1,969,000 of the indirect
participation interest may be converted to debt due in December 2005 and December 2006. Should
neither of these conversion rights be exercised,the indirect participation in the drilling program
will be maintained and distributions will be paid in accordance with the agreements. In January
2004, $75,500 of the PNGDV interest was converted to 5,000 common shares of InterOil Corporation
and a further $1,500,670 of the interest was converted to 84,545 common shares on September 30,
2004 in accordance with the indirect participation interest agreement. The balance of PNGDVs
indirect participation interest at December 31, 2004 is $10,608,830 (December 31, 2003 
$8,950,000). Prior to December 31, 2004, the Company received deposits of $13,749,852 toward an additional
indirect participation interest. 15. Non-controlling interest On September 11, 1998 Enron Papua New Guinea Ltd (Enron), SPIs former joint venture partner,
exercised its option (pursuant to a January 1997 joint venture agreement with SPI) to terminate the
joint venture agreement. Consequently, SPI purchased Enrons voting, non-participating shares in
E.P. InterOil Limited (EPI), a wholly owned subsidiary of SPI, for a nominal amount. The capital
structure of the joint venture was composed of voting, non-participating shares and non-voting,
participating shares. Enron no longer actively participates in the development of the refinery
project but continues to be a non-voting participating shareholder in EPI. SPI now holds all voting
non-participating shares issued from EPI and has sole responsibility for managing the refinery
project. Enron does not hold any transfer or conversion rights into shares of InterOil Corporation. At December 31, 2004, a subsidiary, SPI, holds 98.74% (2003  98.66%, 2002  98.55%) of the
non-voting participating shares issued from EPI. 16. Share capital The authorized share capital of the Company consists of an unlimited number of common shares with
no par value.
Each common share entitles the holder to one vote. Number of Shares
    
    
    $Balance, January 1, 2002
    
    
    20,186,870
    
    
    
    92,808,387Shares issued for cash
    
    
    399,073
    
    
    
    1,312,222Balance, December 31, 2002
    
    
    20,585,943
    
    
    
    94,120,609Shares issued for cash
    
    
    3,817,500
    
    
    
    61,060,640Shares issued for debt
    
    
    31,240
    
    
    
    316,359Shares issued on exercise of options
    
    
    381,278
    
    
    
    1,951,592Balance, December 31, 2003
    
    
    24,815,961
    
    
    
    157,449,200Shares issued for debt
    
    
    3,184,828
    
    
    
    56,698,121Shares issued on exercise of options
    
    
    310,095
    
    
    
    2,666,333Balance, December 31, 2004
    
    
    28,310,884
    
    
    
    216,813,654




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements

(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 17. Stock options At December 31, 2004, 1,692,390 common shares were reserved for issuance under the Company stock
option plan.
Options are issued at no less than market price to directors, staff and contractors. Options are
exercisable on a 1:1 basis.
Options vest at various dates in accordance with the applicable option agreement, have an exercise
period of three to five years assuming continuous employment by the InterOil Group and may be
exercised at any time after vesting within the exercise period. Upon resignation or retirement,
vested options must be exercised within 30 days for employees and 90 days for directors. 2004
    
    2003
    
    2002Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    Weightedaverage
    
    
    
    
    
    
    average
    
    
    
    
    
    
    averageStock options
    
    Number of
    
    
    exercise price
    
    
    Number of
    
    
    exercise price
    
    
    Number of
    
    
    exercise priceoutstanding
    
    options
    
    
    $
    
    
    options
    
    
    $
    
    
    options
    
    
    $Outstanding at beginning of year
    
    
    1,363,265
    
    
    
    7.55
    
    
    
    1,510,085
    
    
    
    5.48
    
    
    
    1,165,600
    
    
    
    4.00Granted
    
    
    224,460
    
    
    
    26.30
    
    
    
    257,802
    
    
    
    14.09
    
    
    
    762,585
    
    
    
    6.53Exercised
    
    
    (310,095
    )
    
    
    6.52
    
    
    
    (381,278
    )
    
    
    4.62
    
    
    
    (393,000
    )
    
    
    3.26Expired
    
    
    (115,308
    )
    
    
    23.04
    
    
    
    (23,344
    )
    
    
    5.75
    
    
    
    (25,100
    )
    
    
    5.68Outstanding
at end of year
    
    
    1,162,322
    
    
    
    9.91
    
    
    
    1,363,265
    
    
    
    7.55
    
    
    
    1,510,085
    
    
    
    5.48
 2004
    
    Options issued and outstanding
    
    Options exercisableRange of exercise
    
    
    
    
    
    Weighted average
    
    
    Weighted average
    
    
    
    
    
    
    Weighted averageprices
    
    
    
    
    
    exercise price
    
    
    remaining terms
    
    
    
    
    
    
    exercise price$
    
    Number of options
    
    
    $
    
    
    (years)
    
    
    Number of options
    
    
    $2.75 to 5.00
    
    
    504,463
    
    
    
    4.37
    
    
    
    0.61
    
    
    
    494,463
    
    
    
    4.365.01 to 8.00
    
    
    211,834
    
    
    
    6.31
    
    
    
    1.91
    
    
    
    151,834
    
    
    
    6.068.01 to 12.00
    
    
    231,200
    
    
    
    11.18
    
    
    
    0.98
    
    
    
    83,200
    
    
    
    11.3012.01 to 24.00
    
    
    143,100
    
    
    
    23.05
    
    
    
    3.54
    
    
    
    134,000
    
    
    
    23.1224.00 to 31.00
    
    
    71,725
    
    
    
    29.25
    
    
    
    2.73
    
    
    
    7,125
    
    
    
    26.501,162,322
    
    
    
    9.91
    
    
    
    2.07
    
    
    
    870,622
    
    
    
    8.39
 The fair value of the 224,460 (2003  257,802, 2002  762,585 ) options granted subsequent to
January 1, 2004 has been estimated at the date of grant in the amount of $1,122,938 (2003 
$1,087,131, 2002  $976,900) using a Black-Scholes option pricing model with the following
assumptions: risk-free interest rate of 2.5%, dividend yield of nil, volatility factor of the
expected market price of the Companys common stock of 45%, and a weighted average expected life
of the options of 3.8 years. An amount of $1,209,921 has been recognized in 2004 as a compensation
expense. In 2003, $530,794 (2002  $206,936) was recognized as a proforma compensation expense
disclosure. The estimated fair value of the options is expensed over the options vesting period,
which is identified in the individuals option agreement. 18. Working capital facility During the year ended December 31, 2004, InterOil obtained a working capital credit facility
with BNP Paribas (Singapore branch) with a maximum availability of $100,000,000. This financing
facility supports the ongoing procurement of crude oil for the refinery and includes related
hedging transactions. The facility comprises a base facility to accommodate the issuance of
letters of credit followed by secured loans in the form of short term advances. In addition to the
base facility, the agreement offers both a cash secured short term facility and a discounting
facility on specific monetary receivables. The facility is secured by sales contracts, purchase
contracts, certain cash accounts associated with the refinery, all crude and refined products of
the refinery and trade receivables. The facility bears interest at LIBOR + 2.5% on the short term advances. During the year the
weighted average interest rate was 4.36%.




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements

(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 At December 31, 2004, $9,479,459 of the total facility remained available for use. At December 31, 2004, the Company had one letter of credit outstanding for $14,000,000. Cash
totaling $24,407,709 was being maintained as a security margin for the facility, as separately
disclosed in note 9. In addition, inventory of $20,368,957 and receivables of $46,911,393 secured
the facility. 19. Operations Sales and operating revenues include the tradeout of a crude cargo which resulted in sales income
of $26,309,547 and cost of goods sold of $27,685,347. The tradeout related to refinery
commissioning issues and is not considered to be part of normal trading operations which were
capitalized up to December 31, 2004. Downstream sales of $44,334,939 and cost of good sold of
$36,150,835 are also included. 20. Commitments Payment due by periodLess than
    
    
    
    
    
    
    
    
    
    
    
    
    
    More thanContractual obligations
    
    
    Total
    
    
    
    1 year
    
    
    
    1  3 years
    
    
    
    3 - 5 years
    
    
    
    5 yearsLong-Term Debt Obligations
    
    
    $
    85,000,000
    
    
    
    $
    9,000,000
    
    
    
    $
    18,000,000
    
    
    
    $
    18,000,000
    
    
    
    $
    40,000,000Indirect Participation
Interests(1)
    
    
    $
    6,885,000
    
    
    
    $
    3,442,500
    
    
    
    $
    3,442,500
    
    
    
    nil
    
    
    nilAcquisition of BP assets
in PNG(2)
    
    
    $
    12,226,854
    
    
    
    $
    12,226,854
    
    
    
    nil
    
    
    nil
    
    
    nilBP Services Agreement(3)
    
    
    $
    1,000,000
    
    
    
    $
    1,000,000
    
    
    
    nil
    
    
    nil
    
    
    nilPurchase Obligations(4)
    
    
    $
    5,000,000
    
    
    
    $
    1,000,000
    
    
    
    $
    2,000,000
    
    
    
    $
    2,000,000
    
    
    
    nilOperating Leases
    
    
    $
    300,000
    
    
    
    $
    300,000
    
    
    
    nil
    
    
    nil
    
    
    nilPetroleum Prospecting and
Retention License(5)
    
    
    $
    8,233,937
    
    
    
    nil
    
    
    $
    8,233,937
    
    
    
    nil
    
    
    nilTotal
    
    
    $
    118,645,791
    
    
    
    $
    26,969,354
    
    
    
    $
    31,676,437
    
    
    
    $
    20,000,000
    
    
    
    $
    40,000,000
 Notes  (1)
    The 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, 2004 Consolidated Balance Sheet due to conversion
requirements into the Companys paid common shares.(2)
    The aggregate purchase price was $13,226,854. A down payment of $1,000,000 of the
purchase price was paid in 2004.(3)
    Management service agreement with BP.(4)
    Arises from management fees payable under the 5 year refinery facilities and management
contract.(5)
    Amount necessary for the next 2 years under the work program to maintain our
exploration licenses. The committed amount can be spent in any proportion over the two
years.




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements

(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 21. Segment reporting
 Year ended December 31, 2004Upstream
    
    Midstream
    
    Downstream
    
    Corporate
    
    Consol
    
    TotalOperating resultsExternal sales
    
    
    
    
    
    
    26,309,547
    
    
    
    62,410,291
    
    
    
    
    
    
    
    (18,075,352
    )
    
    
    70,644,486Intersegment revenue
    
    
    
    
    
    
    
    
    
    
    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
    )
    
    
    14,701,313Geological and geophysical expenses
    
    
    2,903,313
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,903,313Depreciation and amortization
    
    
    12,510
    
    
    
    311,986
    
    
    
    224,214
    
    
    
    90,365
    
    
    
    
    
    
    
    639,075Exploration impairment
    
    
    35,566,761
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    35,566,761Interest expense
    
    
    4,932
    
    
    
    843,888
    
    
    
    455,368
    
    
    
    1,899,027
    
    
    
    
    
    
    
    3,203,215Loss 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 expenses
    
    
    
    
    
    
    
    
    
    
    (2,250,960
    )
    
    
    24,740
    
    
    
    351,157
    
    
    
    (1,875,063
    )Non controlling interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    70,091
    
    
    
    
    
    
    
    70,091Total net income/(loss)
    
    
    (40,136,707
    )
    
    
    (5,664,769
    )
    
    
    3,663,218
    
    
    
    (8,067,679
    )
    
    
    (2,733,944
    )
    
    
    (52,939,881
    )
 Year ended December 31, 2003Upstream
    
    Midstream
    
    Downstream
    
    Corporate
    
    Consol
    
    TotalOperating results
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    External sales
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Intersegment revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    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
    )
    
    
    3,418,977Depreciation and amortization
    
    
    10,282
    
    
    
    8,254
    
    
    
    
    
    
    
    54,532
    
    
    
    
    
    
    
    73,068Exploration expenses
    
    
    164,992
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    164,992Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    105,374
    
    
    
    
    
    
    
    105,374Loss from ordinary activities before income taxes
    
    
    (695,545
    )
    
    
    (230,321
    )
    
    
    (24,939
    )
    
    
    (2,562,382
    )
    
    
    10,055
    
    
    
    (3,503,131
    )Income tax expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (37,339
    )
    
    
    
    
    
    
    (37,339
    )Non controlling interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    22,901
    
    
    
    
    
    
    
    22,901Total net income/(loss)
    
    
    (695,545
    )
    
    
    (230,321
    )
    
    
    (24,939
    )
    
    
    (2,576,820
    )
    
    
    10,055
    
    
    
    (3,517,569
    )
 Year ended December 31, 2002Upstream
    
    Midstream
    
    Downstream
    
    Corporate
    
    Consol
    
    TotalOperating results
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    External sales
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Intersegment revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    645,434
    
    
    
    (645,434
    )
    
    
    Interest revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    373,015
    
    
    
    
    
    
    
    373,015Other unallocated revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,211
    
    
    
    
    
    
    
    11,211Total segment revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,029,660
    
    
    
    (645,434
    )
    
    
    384,226Cost of sales and operating expensesOffice and Admin and other expenses
    
    
    (215,836
    )
    
    
    (123,626
    )
    
    
    3,258
    
    
    
    1,847,812
    
    
    
    14,112
    
    
    
    1,525,720Depreciation and amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    85,657
    
    
    
    
    
    
    
    85,657Exploration write off
    
    
    92,673
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    92,673Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Loss from ordinary activities before income taxes
    
    
    123,163
    
    
    
    123,626
    
    
    
    (3,258
    )
    
    
    (903,809
    )
    
    
    (659,546
    )
    
    
    (1,319,824
    )Income tax expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,446
    )
    
    
    
    
    
    
    (1,446
    )Non controlling interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,383
    
    
    
    
    
    
    
    5,383Total net income/(loss)
    
    
    123,163
    
    
    
    123,626
    
    
    
    (3,258
    )
    
    
    (899,872
    )
    
    
    (659,546
    )
    
    
    (1,315,887
    )




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements

(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 The following tables present the Companys total assets by segment: Year ended December 31, 2004Upstream
    
    Midstream
    
    Downstream
    
    Corporate and consolidations
    
    Totals21,570,221
    
    
    
    269,301,052
    
    
    
    34,436,144
    
    
    
    60,534,767
    
    
    
    385,842,184
 Year ended December 31, 2003Upstream
    
    Midstream
    
    Downstream
    
    Corporate and consolidations
    
    Totals60,129,239
    
    
    
    181,660,129
    
    
    
    321,817
    
    
    
    18,228,665
    
    
    
    260,339,850
 Year ended December 31, 2002Upstream
    
    Midstream
    
    Downstream
    
    Corporate and consolidations
    
    Totals3,047,177
    
    
    
    136,253,078
    
    
    
    221,485
    
    
    
    (4,446,879
    )
    
    
    135,074,861
 Interest capitalized during the year to midstream plant and equipment was $5,949,270 (2003 -
$4,025,004 , 2002  $1,820,404) Refer to note 7 for plant and equipment presented by business segment. 22. Subsequent events On January 28, 2005 InterOil Corporation obtained a $20,000,000 Term Loan Facility from Clarion
Finanz AG of which a tranche of $10,000,000 was received on January 31, 2005 and the balance of
$10,000,000 was received on February 25, 2005. The loan has an interest rate equal to 5% per annum
payable quarterly in arrears, and includes a 1% arrangement fee of the face amount. The term of
the loan is fifteen months from the disbursement dates, and is repayable at any time prior to
expiry with no penalty. The certificate for practical completion of the refinery project in PNG was received on January 31,
2005. InterOil applied for delisting from the Australian Stock Exchange on February 18, 2005. InterOil executed investment agreements in respect of its ongoing exploration program in Papua New
Guinea on February 28, 2005. Under these agreements, certain institutional and accredited
investors have agreed to invest $125,000,000 for an aggregate 25% indirect participation interest
in the exploration program. InterOil made the final payment for the acquisition of BP Papua New Guinea on March 1, 2005,
excluding a services agreement fee of $1,000,000 which is due on April 1, 2005. 23. Loss per share Warrants, indirect participation conversion options and stock options totaling 2,155,042 common
shares at prices ranging from $2.75 to $30.40 per share were outstanding in 2004 (2003  2,769,940
common shares at prices ranging from $2.75 to $30.40 per share, 2002  1,515,085 common shares at
prices ranging from $2.75 to $12.00 per share) but were not included in the computation of diluted
loss per share because they caused the loss per share to be antidilutive. 24. United States generally accepted accounting principles disclosures The audited consolidated financial statements of the Company for the twelve month periods ended
December 31, 2004, 2003 and 2002 have been prepared in accordance with generally accepted
accounting principles in Canada (Canadian GAAP) which, in most respects, conforms with generally
accepted accounting principles in the United States (U.S. GAAP). The reconciliations and other




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements

(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 information presented in this note are solely in relation to the consolidated financial statements.
The significant differences between Canadian GAAP and U.S. GAAP as they relate to the Company are
presented throughout this note. Additionally, where there is no significant conflict with Canadian
GAAP requirements some of the additional U.S. GAAP disclosure requirements have been incorporated
throughout the Canadian GAAP financial statements. The following table presents the consolidated statements of operations under U.S. GAAP compared to
Canadian GAAP: Canadian GAAP
    
    U.S. GAAP
    
    Canadian GAAP
    
    U.S. GAAP
    
    Canadian GAAP
    
    U.S. GAAPDec 31, 2004
    
    Dec 31, 2003
    
    Dec 31, 2002$
    
    $
    
    $
    
    $
    
    $
    
    $RevenueSales and operating revenues(1)
    
    
    70,644,486
    
    
    
    121,974,268
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Interest
    
    
    382,461
    
    
    
    382,461
    
    
    
    246,912
    
    
    
    246,912
    
    
    
    373,015
    
    
    
    373,015Other
    
    
    196,337
    
    
    
    196,337
    
    
    
    12,368
    
    
    
    12,368
    
    
    
    11,211
    
    
    
    11,21171,223,284
    
    
    
    122,553,066
    
    
    
    259,280
    
    
    
    259,280
    
    
    
    384,226
    
    
    
    384,226ExpensesCost of sales and operating expenses(1)
    
    
    63,836,182
    
    
    
    128,362,792
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Administrative and general expenses(1)
    
    
    7,831,550
    
    
    
    8,577,513
    
    
    
    2,264,187
    
    
    
    2,264,187
    
    
    
    2,156,254
    
    
    
    2,156,254Inventory revaluation
    
    
    1,508,334
    
    
    
    1,508,334Depreciation and amortization (1)
    
    
    639,075
    
    
    
    1,462,953
    
    
    
    73,068
    
    
    
    73,068
    
    
    
    85,657
    
    
    
    85,657Management fees for prior periods waived
    
    
    
    
    
    
    
    
    
    
    (840,000
    )
    
    
    (840,000
    )
    
    
    
    
    
    
    Debt conversion expense(5)
    
    
    
    
    
    
    6,976,800
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exploration costs
    
    
    38,470,074
    
    
    
    38,470,074
    
    
    
    164,992
    
    
    
    164,992
    
    
    
    92,673
    
    
    
    92,673Legal and professional fees
    
    
    3,573,727
    
    
    
    3,655,631
    
    
    
    1,421,390
    
    
    
    1,421,390
    
    
    
    464,253
    
    
    
    464,253Short term borrowing costs
    
    
    4,705,190
    
    
    
    4,705,190
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Long term borrowing costs
    
    
    1,401,256
    
    
    
    1,401,256
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Foreign exchange (gain) loss(2)
    
    
    392,805
    
    
    
    392,805
    
    
    
    678,774
    
    
    
    (7,392,002
    )
    
    
    (1,094,787
    )
    
    
    (8,829,287
    )Non-controlling interest
    
    
    (70,091
    )
    
    
    (265,624
    )
    
    
    (22,901
    )
    
    
    94,341
    
    
    
    (5,383
    )
    
    
    108,617122,288,102
    
    
    
    195,247,724
    
    
    
    3,739,510
    
    
    
    (4,214,024
    )
    
    
    1,698,667
    
    
    
    (5,921,833
    )Income/(loss) before income taxes
    
    
    (51,064,818
    )
    
    
    (72,694,658
    )
    
    
    (3,480,230
    )
    
    
    4,473,304
    
    
    
    (1,314,441
    )
    
    
    6,306,059Income tax expense(3)
    
    
    (1,875,063
    )
    
    
    (1,875,063
    )
    
    
    (37,339
    )
    
    
    (37,339
    )
    
    
    (1,446
    )
    
    
    (1,446
    )Income/(loss) before cumulative effect of
accounting change
    
    
    (52,939,881
    )
    
    
    (74,569,721
    )
    
    
    (3,517,569
    )
    
    
    4,435,965
    
    
    
    (1,315,887
    )
    
    
    6,304,613Cumulative effect of accounting change(4)
    
    
    
    
    
    
    (737,650
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income/(loss)
    
    
    (52,939,881
    )
    
    
    (75,307,371
    )
    
    
    (3,517,569
    )
    
    
    4,435,965
    
    
    
    (1,315,887
    )
    
    
    6,304,613




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements

(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 Statement of comprehensive income (loss),
net of tax Twelve months endedDecember 31,2004
    
    2003
    
    2002$
    
    $
    
    $Net income/(loss) in accordance with U.S. GAAP
    
    
    (75,307,371
    )
    
    
    4,435,965
    
    
    
    6,304,613Foreign currency translation reserve
    
    
    463,200
    
    
    
    
    
    
    
    Deferred hedge gain
    
    
    537,358
    
    
    
    
    
    
    
    Other comprehensive income
    
    
    1,000,558
    
    
    
    
    
    
    
    Comprehensive income/(loss)
    
    
    (74,306,813
    )
    
    
    4,435,965
    
    
    
    6,304,613
 Foreign
    
    
    
    
    
    
    Accumulatedcurrency
    
    
    
    
    
    
    otherStatement of accumulated other
    
    translation
    
    
    Deferred
    
    
    comprehensivecomprehensive income, net of tax (AOCI)
    
    reserve
    
    
    hedge gain
    
    
    incomeAOCI balance as of December 31, 2001
    
    
    
    
    
    
    
    
    
    
    Current period change
    
    
    
    
    
    
    
    
    
    
    AOCI balance as at 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
    
    
    
    1,000,558
 Per share amounts Basic per share amounts computed by dividing net income available to shareholders by the weighted
average number of shares outstanding for the reporting period. Diluted per share amounts reflects
the potential dilution that could occur if options or contracts to issue shares were exercised or
converted into shares. For the calculation of diluted per share amounts, the basic weighted average number of shares is
increased by the dilutive effect of stock options determined using the treasury method. No
potential shares in options on issue were antidilutive for the year ended December 31, 2004.
Antidilutive shares on issue for the year ended December 31, 2003 were 35,822 and December 31, 2002
were 152,917.




---



##### 



InterOil Corporation
Notes to Consolidated Financial Statements

(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 Year ended December 31,Weighted average number of
shares on which earnings pershare calculations are based
in accordance with U.S. GAAP
    
    2004
    
    2003
    
    2002Basic
    
    
    25,373,575
    
    
    
    22,649,924
    
    
    
    20,462,167Effect of dilutive options
    
    
    
    
    
    
    1,542,214
    
    
    
    338,551Diluted
    
    
    25,373,575
    
    
    
    24,192,138
    
    
    
    20,800,718Net income/(loss) per share
in accordance with U.S. GAAPBasic
    
    
    (2.97
    )
    
    
    0.20
    
    
    
    0.31Diluted
    
    
    (2.97
    )
    
    
    0.18
    
    
    
    0.30
 The following table presents the consolidated balance sheets under U.S. GAAP compared to Canadian
GAAP: As of
    
    As ofDecember 31, 2004
    
    December 31, 2003Canadian
    
    
    
    
    
    CanadianGAAP
    
    U.S. GAAP
    
    GAAP
    
    U.S. GAAPCurrent assets
    
    
    132,258,350
    
    
    
    132,258,350
    
    
    
    35,012,370
    
    
    
    35,012,370Oil and gas properties
    
    
    6,605,360
    
    
    
    6,605,360
    
    
    
    23,018,015
    
    
    
    23,018,015Capital assets (1)
    
    
    244,508,278
    
    
    
    232,641,229
    
    
    
    48,854,559
    
    
    
    48,854,559Deferred project costs (2)
    
    
    406,077
    
    
    
    406,077
    
    
    
    153,454,906
    
    
    
    156,514,019Deferred charges
    
    
    760,488
    
    
    
    760,488
    
    
    
    
    
    
    
    Future income tax benefit (3)
    
    
    1,303,631
    
    
    
    1,303,631
    
    
    
    
    
    
    
    Total assets
    
    
    385,842,184
    
    
    
    373,975,135
    
    
    
    260,339,850
    
    
    
    263,398,963Current liabilities
    
    
    141,659,692
    
    
    
    141,659,692
    
    
    
    16,314,334
    
    
    
    16,314,334Deferred financing costs
    
    
    863,329
    
    
    
    863,329
    
    
    
    
    
    
    
    Long term debt
    
    
    86,608,830
    
    
    
    86,608,830
    
    
    
    90,600,000
    
    
    
    90,600,000Non-controlling interest
    
    
    6,404,262
    
    
    
    6,063,971
    
    
    
    6,467,496
    
    
    
    6,322,739Shareholders equity (1) (2) (4)
    
    
    150,306,071
    
    
    
    138,779,313
    
    
    
    146,958,020
    
    
    
    150,161,890Total liabilities &
shareholders equity
    
    
    385,842,184
    
    
    
    373,975,135
    
    
    
    260,339,850
    
    
    
    263,398,963
  (1)
    Operations:The 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 21 in the consolidated financial statements, operations commenced after
December 31, 2004 under Canadian GAAP. Therefore, the Company continued to capitalize
December 2004s results to the refinery project.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. The useful life
for the refinery under U.S. GAAP is the same as that disclosed under Canadian GAAP in note
1(l) in the consolidated financial statements.The Company was a development stage enterprise in prior years in respect of the refinery
construction. Classification as a development stage enterprise under U.S. GAAP ceased in
conjunction with operations commencement at December 1, 2004.The Company made sales from the refinery of $30,539,560 (59.5%) to one customer during the
year.(2)
    Derivative instruments and hedging:The 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.




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##### 



InterOil Corporation
Notes to Consolidated Financial Statements

(Expressed in United States dollars)
    
    (INTEROIL LOGO)
  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 years ended
December 31, 2003 and 2002 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. The hedge accounting for the new hedges is disclosed in
notes 1(i) and 8 in the consolidated financial statements of the Company for the year ended
December 31, 2004.(3)
    Income tax effect of adjustments:The income tax effect of U.S. GAAP adjustments was a tax
benefit of $7,665,071 for the year ended December 31, 2004 for which a corresponding increase
in the valuation allowance was recorded. No income tax expense was recorded in the years
ended December 31, 2003 and 2002 due to the tax relief available in PNG through five years
after the refinery commences operations.(4)
    Stock based compensation:FASB 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 years ended December 31, 2003 and 2002, 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 and 2002 would have been the pro forma amounts indicated as follows: Year ended December 31,2003
    
    2002Net income in accordance with U.S. GAAP
    
    
    4,435,965
    
    
    
    6,304,613Pro forma stock based compensation
    
    
    (530,794
    )
    
    
    (206,856
    )Pro forma net income
    
    
    3,905,171
    
    
    
    6,097,757Earnings per share as reportedBasic
    
    
    0.20
    
    
    
    0.31Diluted
    
    
    0.18
    
    
    
    0.30Pro forma earnings per shareBasic
    
    
    0.17
    
    
    
    0.30Diluted
    
    
    0.16
    
    
    
    0.29
 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
16 to the consolidated financial statements.




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##### 



InterOil Corporation
Notes to Consolidated Financial Statements

(Expressed in United States dollars)
    
    (INTEROIL LOGO)
  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 1(c) 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.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, 2004, 2003 and 2002.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 expense:As disclosed in note 12 in the consolidated financial statements, 100% of the convertible
debentures were converted before 31 December 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. Acquisition of InterOil Products Limited (IPL)
The following summary audited pro forma condensed consolidated financial information for the twelve
month periods ended December 31, 2004 and 2003 shows the estimated pro forma impact on the
Companys consolidated financial statements of the acquisition of IPL as of April 28, 2004. Refer
to note 9 in the consolidated financial statements.




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##### 



InterOil Corporation
Notes to Consolidated Financial Statements

(Expressed in United States dollars)
    
    (INTEROIL LOGO)
 This pro forma information is based on managements current estimates of, and good faith
assumptions regarding, the adjustments arising from the transactions described above. The pro
forma adjustments are based on currently available information and actual adjustments could differ
materially from the current estimates. The pro forma information does not purport to represent what the financial position and results of
operations actually would have been had the acquisition of IPL been consummated on the dates
indicated or to project the financial position of any future date of operations for any future
period. The following pro forma statements of earnings for the years ended December 31, 2004 and 2003 give
effect to the acquisition of IPL as if it had occurred on January 1, 2003. InterOil
    
    
    IPL(1)
    
    
    Pro forma(audited)
    
    
    (unaudited)
    
    
    (unaudited)Twelve months ended December 31, 2004Sales and operating revenue  Canadian GAAP
    
    
    70,644,486
    
    
    
    27,317,000
    
    
    
    97,961,486Sales and operating revenue  U.S. GAAP
    
    
    121,974,268
    
    
    
    27,317,000
    
    
    
    149,291,268Net loss  Canadian GAAP
    
    
    (52,939,881
    )
    
    
    2,350,000
    
    
    
    (50,589,881
    )Net loss  U.S. GAAP
    
    
    (75,307,371
    )
    
    
    2,350,000
    
    
    
    (72,957,371
    )Basic loss per share (cents per share)Canadian GAAP (2)
    
    
    (2.08
    )
    
    
    
    
    
    
    (1.99
    )U.S. GAAP(3)
    
    
    (2.97
    )
    
    
    
    
    
    
    (2.87
    )Diluted loss per share (cents per share)Canadian GAAP (2)
    
    
    (2.08
    )
    
    
    
    
    
    
    (1.99
    )U.S. GAAP(3)
    
    
    (2.97
    )
    
    
    
    
    
    
    (2.87
    )Twelve months ended December 31, 2003Sales and operating revenue  Canadian and
U.S. GAAP
    
    
    
    
    
    
    69,897,000
    
    
    
    69,897,000Net income/(loss)  Canadian GAAP
    
    
    (3,517,569
    )
    
    
    6,474,000
    
    
    
    2,956,431Net income  U.S. GAAP
    
    
    4,435,965
    
    
    
    6,474,000
    
    
    
    10,909,965Basic income/(loss) per share (cents per share)Canadian GAAP (2)
    
    
    (0.15
    )
    
    
    
    
    
    
    0.14U.S. GAAP(3)
    
    
    0.20
    
    
    
    
    
    
    
    0.49Diluted income/(loss) per share (cents per share)Canadian GAAP (2)
    
    
    (0.15
    )
    
    
    
    
    
    
    0.13U.S. GAAP(3)
    
    
    0.18
    
    
    
    
    
    
    
    0.45
  (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.