<PAGE>

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                 --------------

                                  FORM 10-KSB/A
                               (Amendment No. 2)

(MARK ONE)

          [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
                              EXCHANGE ACT OF 1934

                  FOR THE ANNUAL PERIOD ENDED DECEMBER 31, 2004

        [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
                              EXCHANGE ACT OF 1934

              FOR THE TRANSITION PERIOD FROM _________ TO _________

                           COMMISSION FILE NO. 0-29015

                     AMERICAN ORIENTAL BIOENGINEERING, INC.
                                 --------------
                 (Name of Small Business Issuer in Its Charter)

NEVADA                                                                84-0605867
(State or other jurisdiction of             (I.R.S. Employer Identification No.)
incorporation or organization)

           NO. 308 XUEFU ROAD, NANGANG DISTRICT, HARBIN, CHINA, 150086
                    (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

                                86-451-8666-6601
                (ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:   None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                    COMMON STOCK, PAR VALUE $0.001 PER SHARE
                   PREFERRED STOCK, PAR VALUE $0.001 PER SHARE

                                (TITLE OF CLASS)

         Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports); and (2)
has been subject to such filing requirements for the past 90 days.

         Yes [X]       No [ ]

         Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definite proxy or
information statements incorporated by reference in Part III of this form 10-KSB
or any amendment to this Form 10-KSB. [ ]

The issuer's revenues for the fiscal year ended December 31, 2004 were
$31,966,927.

The aggregate market value of the registrant's common stock held by
non-affiliates as of March 30, 2004 was $28,201,096.

         State the number of shares outstanding of each of the issuer's classes
of equity securities, as of the latest practicable date:

Title of Each Class of Equity                 Number of Shares Outstanding as of
Securities                                    December 31, 2004
---------------------------------             ----------------------------------
Common Stock, $0.001 par value                39,746,827
Preferred Stock, $0.001 par value              1,000,000

Transitional Small Business Disclosure Format (check one):

         Yes [ ]       No [X]
<PAGE>

EXPLANATORY NOTE REGARDING THIS AMENDMENT


American Oriental Bioengineering, Inc. is filing this report on Form 10-KSB/A
solely to amend the diluted earnings per share amount in the financial
statements contained in its annual report for the period ended December 31,
2004, due to a mistake in the weighted average number of shares calculation. The
result of the miscalculation was an understatement in the diluted earnings per
share. This amended filing reflects the correct value of the diluted earnings
per share of $0.23 (changed from $0.20). The date of filing the original Form
10-KSB for the period ended December 31,2004, was April 8, 2005, and the first
amendment to the report was filed April 18, 2005.



<PAGE>

         SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) of the Securities
and Exchange Act, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned thereunto duly authorized.

         Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.


Date:  May 5, 2005                    By:  /s/ Shujun Liu
                                           ------------------------------------
                                           Shujun Liu
                                           Chief Executive Officer and Director

         Pursuant to the requirements of the Securities and Exchange Act of
1934, this Report has been signed below by the following person on behalf of the
Registrant and in the capacities and on the dates indicated.

<TABLE>
SIGNATURE                    TITLE                                                    DATE
---------                    -----                                                    ----
<S>                          <C>                                                      <C>
/s/ Shujun Liu               Chairman and Chief Executive Officer                     May 5, 2005
                             (Principal Executive Officer) and Director

/s/ Yahchun Li               Acting Chief Financial Officer                           May 5, 2005
                             (Principal Financial and Accounting Officer)
                             and Director

/s/ Jun Min                  Director and Vice President                              May 5, 2005

/s/ Binsheng Li              Director and Chief Accounting and Finance Officer        May 5, 2005
</TABLE>

                                       36


<PAGE>






                     AMERICAN ORIENTAL BIOENGINEERING, INC.
                                AND SUBSIDIARIES
                        CONSOLIDATED FINANCIAL STATEMENTS
                               FOR THE YEARS ENDED
                           DECEMBER 31, 2004 AND 2003








<PAGE>









             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES




                                    CONTENTS
                                    --------


PAGE  F-1         REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

PAGE  F-2         CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2004 AND 2003

PAGE  F-3         CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER
                  31, 2004 AND 2003

PAGE  F-4         CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR
                  THE YEARS ENDED DECEMBER 31, 2004 AND 2003

PAGE  F-5-6       CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED
                  DECEMBER 31, 2004 AND 2003

PAGES F-7-30      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31,
                  2004 AND 2003




<PAGE>



             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
             -------------------------------------------------------



To the Board of Directors and Shareholders of:
American Oriental Bioengineering, Inc. and Subsidiaries:

We have audited the accompanying consolidated balance sheets of American
Oriental Bioengineering, Inc. and Subsidiaries (the "Company") as of December
31, 2004 and 2003 and the related consolidated statements of income, changes in
shareholders' equity and cash flows for the years then ended. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
American Oriental Bioengineering, Inc. and Subsidiaries as of December 31, 2004
and 2003 and the consolidated results of their operations and their cash flows
for the years then ended in conformity with accounting principles generally
accepted in the United States of America.




/s/ Weinberg & Company, P.A.

Boca Raton, Florida
March 25, 2005





                                       F-1


<PAGE>
<TABLE>

                         AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                                       CONSOLIDATED BALANCE SHEETS
                                    AS OF DECEMBER 31, 2004 AND 2003


                                                 ASSETS
                                                                               2004             2003
                                                                            -----------     -----------
<S>                                                                         <C>             <C>
CURRENT ASSETS
  Cash and cash equivalents                                                 $11,404,149     $ 5,366,857
  Accounts receivable                                                         4,736,901       3,256,807
  Inventories                                                                 5,673,059       2,546,810
  Advances to suppliers                                                         518,589         868,458
  Other receivables                                                             156,062              --
  Due from employees                                                            182,099          55,116
  Deferred merger costs                                                              --          33,334
  Deferred consulting expenses                                                1,686,652       1,569,442
                                                                            -----------     -----------
          Total Current Assets                                               24,357,511      13,696,824

PLANT AND EQUIPMENT, NET                                                      8,068,776       6,463,761
DEFERRED TAX ASSETS                                                             159,958          96,620
LICENSE, NET                                                                    542,168         632,531
CONSTRUCTION IN PROGRESS                                                      1,836,714              --
LAND USE RIGHTS, NET                                                          7,871,497         801,061
                                                                            -----------     -----------
    TOTAL ASSETS                                                            $42,836,624     $21,690,797
                                                                            ===========     ===========

                                  LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES
Accounts payable                                                            $   755,266     $    11,352
Short-term bank loans                                                         5,060,241       1,445,783
Customer deposits                                                               160,504          76,593
Taxes payable                                                                 1,096,545         310,480
Other payables and accrued expenses                                           1,064,411       1,242,474
Due to shareholders                                                           1,404,522          43,243
Current portion of obligations under capital leases                              12,952           6,780
                                                                            -----------     -----------
          Total current liabilities                                           9,554,441       3,136,705

LONG-TERM PORTION OF OBLIGATIONS UNDER CAPITAL LEASES                            34,548          25,449
DEFERRED TAX LIABILITIES                                                        107,201          18,181
                                                                            -----------     -----------
TOTAL LIABILITIES                                                             9,696,190       3,180,335
                                                                            -----------     -----------

SHAREHOLDERS' EQUITY
Preferred stock, $0.001 par value; 2,000,000 shares authorized;
  1,000,000 shares issued and outstanding in 2004 and 2003                        1,000           1,000
Common stock, $0.001 par value; 60,000,000 shares authorized;
  39,746,827 and 32,725,827 shares issued and outstanding, respectively          39,747          32,726
Additional paid-in capital                                                   16,900,303      10,048,734
Retained earnings (the restricted portion of retained earnings is
  $1,294,689 and $946,865 in 2004 and 2003, respectively)                    16,199,384       8,428,002
                                                                            -----------     -----------
          Total Shareholders' Equity                                         33,140,434      18,510,462
                                                                            -----------     -----------
   TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY                               $42,836,624      21,690,797
                                                                            ===========     ===========


                    See accompanying notes to the consolidated financial statements.

                                                   F-2
</TABLE>


<PAGE>
<TABLE>

             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF INCOME
                 FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003

<CAPTION>

                                                      2004              2003
                                                  -------------     -------------
<S>                                               <C>               <C>
REVENUES                                          $ 31,966,927      $ 20,862,709

COST OF GOODS SOLD                                 (11,267,647)       (7,513,012)
                                                  -------------     -------------

GROSS PROFIT                                        20,699,280        13,349,697

Selling and marketing expenses                       2,387,805         1,582,190

Advertising                                          2,926,629         2,687,688

General and administrative expenses                  4,582,388         2,841,666

Depreciation and amortization                          757,720           573,874
                                                  -------------     -------------

INCOME FROM OPERATIONS                              10,044,738         5,664,279

INTEREST EXPENSE, NET                                 (100,765)          (63,407)

OTHER INCOME, NET                                       44,035           139,610
                                                  -------------     -------------
INCOME BEFORE INCOME TAXES                           9,988,008         5,740,482

INCOME TAXES                                         2,216,626         1,138,636
                                                  -------------     -------------

NET INCOME                                        $  7,771,382      $  4,601,846
                                                  =============     =============

NET INCOME PER SHARE
         BASIC                                    $       0.23      $       0.15
         DILUTED                                  $       0.23      $       0.15

WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING
         BASIC                                      33,595,685        31,062,573
         DILUTED                                    33,953,507        31,296,193



        See accompanying notes to the consolidated financial statements.

                                       F-3
</TABLE>
<PAGE>
<TABLE>


                                      AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                                    CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
                                          FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003
<CAPTION>


                                     Preferred Stock              Common Stock         Additional
                                               Stated                        Par         Paid-In      Retained
                                 Shares        Value         Shares         Value        Capital      Earnings        Total
                               -----------   -----------   -----------   -----------   -----------   -----------   -----------
<S>                <C>
BALANCE AT JANUARY 1, 2003              --   $         0    11,341,017   $    11,341   $ 4,597,263   $ 3,826,156   $ 8,434,760

 Stock issued for assets
     acquisition                 1,000,000         1,000    20,284,810        20,285     3,264,571            --     3,285,856

 Common stock issued for
     consulting services                --            --       800,000           800     1,575,200            --     1,576,000

 Common stock issued for
     consulting services                --            --       300,000           300        56,700            --        57,000

 Warrants issued in
     investment agreement               --            --            --            --       555,000            --       555,000

 Net income                             --            --            --            --            --     4,601,846     4,601,846
                               -----------   -----------   -----------   -----------   -----------   -----------   -----------
BALANCE AT DECEMBER 31, 2003     1,000,000   $     1,000    32,725,827   $    32,726   $10,048,734   $ 8,428,002   $18,510 462
                               -----------   -----------   -----------   -----------   -----------   -----------   -----------

 Stock option granted
     to executives                      --            --            --            --        64,000            --        64,000

 Common stock issued for
     consulting services                --            --       700,000           700     1,189,300            --     1,190,000

 Common stock and warrants
     issued in private
     placement, net                     --            --     6,000,000         6,000     5,432,614            --     5,438,614

 Common stock issued for
     consulting services                --            --       321,000           321       165,655            --       165,976

 Net income                             --            --            --            --            --     7,771,382     7,771,382
                               -----------   -----------   -----------   -----------   -----------   -----------   -----------
BALANCE AT DECEMBER 31, 2004     1,000,000   $     1,000    39,746,827   $    39,747   $16,900,303   $16,199,384   $33,140,434
                               ===========   ===========   ===========   ===========   ===========   ===========   ===========


                                 See accompanying notes to the consolidated financial statements.

                                                                F-4
</TABLE>


<PAGE>
<TABLE>

                                AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                                         CONSOLIDATED STATEMENTS OF CASH FLOWS
                                     FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003

<CAPTION>

                                                                                            2004               2003
                                                                                        -------------     -------------
<S>                                                                                     <C>               <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income                                                                            $  7,771,382      $  4,601,846
  Adjustments to reconcile net income to net cash provided by operating activities:
  Depreciation and amortization                                                              757,720           573,874
  Amortization of deferred merger costs and deferred consulting expenses                   1,106,124         1,067,515
  Deferred taxes                                                                              25,682            (9,667)
  Common stock issued for consulting services                                                165,976                --
  Stock option compensation expense                                                           64,000                --

Changes in operating assets and liabilities, net of the effects of the acquisition:
(Increase) Decrease In:
  Accounts receivable                                                                       (807,686)       (1,784,113)
  Inventories                                                                             (1,606,851)       (2,051,061)
  Advances to suppliers                                                                      381,724          (724,874)
  Other receivables                                                                         (105,455)               --

Increase (Decrease) In:
  Accounts payable                                                                        (1,289,640)          (18,422)
  Customer deposits                                                                           81,786           (77,237)
  Tax payable                                                                                786,065           261,317
  Other payables and accrued expenses                                                      1,064,414           690,006
                                                                                        -------------     -------------
  Net cash provided by operating activities                                                8,395,241         2,529,184
                                                                                        -------------     -------------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Due from employees                                                                        (126,983)          329,465
  Purchases of construction in progress                                                   (1,826,089)               --
  Purchases of plant and equipment                                                           (64,557)         (151,361)
  Purchases of subsidiary, net of cash acquired                                           (7,070,883)               --
                                                                                        -------------     -------------
  Net cash (used in) provided by investing activities                                     (9,088,512)          178,104
                                                                                        -------------     -------------

CASH FLOWS FROM FINANCING ACTIVITIES
  Proceeds from short-term bank loans                                                      1,445,783                --
  Repayments of short-term bank loans                                                     (1,445,783)               --
  Proceeds from private placement                                                          5,438,614                --
  Repayments of capital lease                                                                (27,161)          (18,171)
  Cash received from (repayment to) shareholders                                           1,319,110          (138,983)
                                                                                        -------------     -------------
  Net cash provided by (used in) financing activities                                      6,730,563          (157,154)
                                                                                        -------------     -------------

NET INCREASE IN CASH AND CASH EQUIVALENTS                                                  6,037,292         2,550,134

  Cash and cash equivalents, beginning of year                                             5,366,857         2,816,723
                                                                                        -------------     -------------

CASH AND CASH EQUIVALENTS, END OF YEAR                                                  $ 11,404,149      $  5,366,857
                                                                                        =============     =============



                            See accompanying notes to the consolidated financial statements.

                                                          F-5
</TABLE>

<PAGE>
<TABLE>


                           AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                                    CONSOLIDATED STATEMENTS OF CASH FLOWS
                                FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003
<CAPTION>


SUPPLEMENTARY CASH FLOW INFORMATION                                                   2004            2003
                                                                                    ----------     ----------
<S>                                                                                 <C>            <C>
  1. Interest paid                                                                  $  130,601     $   92,987
                                                                                    ==========     ==========

  2. Income taxes paid                                                              $1,404,878     $1,113,959
                                                                                    ==========     ==========

  3. On October 12, 2004, the Company completed the acquisition of Heilongjiang
     Songhuajiang Pharmaceuticals Co., Ltd. for $7,228,916. The following
     represents the assets purchased and liabilities assumed at the acquisition
     date:
             Land use rights                                                        $7,137,137
             Construction in progress                                                   10,627
             Fixed assets                                                            2,098,683
             Cash and cash equivalents                                                 158,033
             Accounts receivable                                                       672,408
             Inventories                                                             1,519,398
             Other receivables and prepayments                                          82,462
                                                                                    ----------
       Total assets purchased                                                       11,678,748
                                                                                    ----------

             Short term bank loans                                                   3,656,627
             Accounts payable and accrued expenses                                     791,080
             Customer deposits                                                           2,125
                                                                                    ----------
       Total liabilities assumed                                                     4,449,832
                                                                                    ----------
    Net assets acquired                                                              7,228,916
                                                                                    ----------

    Total consideration paid                                                        $7,228,916
                                                                                    ==========

  4. Issued 321,000 shares of common stock valued at $165,975 for consulting
     services in 2004.

  5. Issued 700,000 shares of common stock valued at $1,190,000 for deferred
     consulting services in 2004.

  6. Issued 1,000,000 shares of preferred stock and 20,284,810 shares of common
     stock in 2003 valued at $3,285,856 for the acquisition of the protein
     peptide project.

</TABLE>



        See accompanying notes to the consolidated financial statements.

                                      F-6

<PAGE>


             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


1.       ORGANIZATION AND PRINCIPAL ACTIVITIES

         In an agreement dated December 18, 2001, Internet Golf Association
         agreed to acquire Harbin Three Bioengineering Limited, a limited
         liability company formed in the People's Republic of China ("PRC").
         Under the terms of the agreement, Internet Golf Association had
         reversed split its common stock 100 to 1, reduced the authorized shares
         to 20,000,000 shares and changed its name to American Oriental
         Bioengineering, Inc. (the "Company"). The Company also acquired Bestkey
         International, Ltd., a British Virgin Island Corporation. This
         transaction was treated as a reverse merger for accounting purposes.

         On December 18, 2001, the Company acquired 100% of the equity interest
         of Harbin Three Happiness Bioengineering Co., Ltd. ("Harbin
         Bioengineering"), a company organized under the laws of China, through
         the exchange of 8,538,943 shares of the Company's restricted common
         stock. The transaction was a triangular merger with Bestkey
         International, Ltd, a British Virgin Island corporation, and was
         treated as a reverse merger for accounting purposes. That merger
         transaction was completed on June 26, 2002. Bestkey International, Ltd
         is an inactive company.

         On April 16, 2004 American Oriental Bioengineering (Hong Kong) Limited
         was set up as a wholly-owned subsidiary.

         The Company signed a purchase agreement relating to the acquisition of
         Heilongjiang Songhuajiang Pharmaceutical Co., Ltd. ("HSPL") on
         September 8, 2004 and on October 12, 2004 the transaction was
         completed. The Company acquired 100% of the equity interest of HSPL for
         $7,228,916 in cash. That transaction was a triangular merger with
         Goware Holding International, Ltd., a British Virgin Island
         corporation. Goware Holding International, Ltd. is an inactive company.

         The principal activities of the Company are research, manufacture and
         sale of prescription and non-prescription health care products and
         Chinese medical products. The principal activities of American Oriental
         Bioengineering (Hong Kong) Limited are marketing and trading of health
         care products in Hong Kong and currently it has 4 full time employees.

2.       BASIS OF CONSOLIDATION

         The consolidated financial statements include the accounts of the
         Company, Bestkey International, Ltd., Harbin Three Happiness
         Bioengineering Limited, American Oriental Bioengineering (Hong Kong)
         Limited, Goware Holding International, Ltd., and Heilongjiang
         Songhuajiang Pharmaceutical Company, Limited. All material
         inter-company accounts and transactions have been eliminated in
         consolidation.

         Certain amounts in the prior year have been reclassified to conform to
         current year's presentation.



                                      F-7

<PAGE>

             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         (a)      ECONOMIC AND POLITICAL RISKS

         The Company's operations are conducted in the PRC. Accordingly, the
         Company's business, financial condition and results of operations may
         be influenced by the political, economic and legal environment in the
         PRC, and by the general state of the PRC economy.

         The Company's operations in the PRC are subject to special
         considerations and significant risks not typically associated with
         companies in North America and Western Europe. These include risks
         associated with, among others, the political, economic and legal
         environment and foreign currency exchange. The Company's results may be
         adversely affected by changes in the political and social conditions in
         the PRC, and by changes in governmental policies with respect to laws
         and regulations, anti-inflationary measures, currency conversion,
         remittances abroad, and rates and methods of taxation, among other
         things.

         (b)      LAND USE RIGHTS

         According to the law of China, the government owns all the land in
         China. Companies or individuals are authorized to possess and use the
         land only through land use rights granted by the Chinese government.
         Land use rights are being amortized using the straight-line method over
         the lease term of 40 to 50 years.

         (c)      PLANT AND EQUIPMENT

         Plant and equipment are carried at cost less accumulated depreciation.
         Depreciation is provided over their estimated useful lives, using the
         straight-line method. Estimated useful lives of the plant and equipment
         are as follows:

                   Buildings                                     40 years
                   Machinery and equipment                       10 years
                   Leasehold improvements                        10 years
                   Motor vehicles                                 5 years
                   Office equipment and furniture                 5 years
                   Other equipment                                5 years

         The cost and related accumulated depreciation of assets sold or
         otherwise retired are eliminated from the accounts and any gain or loss
         is included in the statement of income. The cost of maintenance and
         repairs is charged to income as incurred, whereas significant renewals
         and betterments are capitalized.


                                      F-8
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

         (d)      ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS

         The long-lived assets held and used by the Company are reviewed for
         impairment whenever events or changes in circumstances indicate that
         the carrying amount of assets may not be recoverable. It is reasonably
         possible that these assets could become impaired as a result of
         technology or other industry changes. Determination of recoverability
         of assets to be held and used is by comparing the carrying amount of an
         asset to future net undiscounted cash flows to be generated by the
         assets. If such assets are considered to be impaired, the impairment to
         be recognized is measured by the amount by which the carrying amount of
         the assets exceeds the fair value of the assets. Assets to be disposed
         of are reported at the lower of the carrying amount or fair value less
         costs to sell. There were no impairments of long-lived assets in 2004
         and 2003.

         (e)      CONSTRUCTION IN PROGRESS

         Construction in progress represents direct costs of construction or
         acquisition and design fees incurred. Capitalization of these costs
         ceases and the construction in progress is transferred to plant and
         equipment when substantially all the activities necessary to prepare
         the assets for their intended use are completed. No depreciation is
         provided until it is completed and ready for its intended use.

         (f)      INVENTORIES

         Inventories consisting of raw materials, work-in-progress and finished
         goods are stated at the lower of weighted average cost or market value.
         Finished goods are comprised of direct materials, direct labor and an
         appropriate proportion of overhead.

         (g)      ACCOUNTS RECEIVABLE

         Trade receivables are recognized and carried at the original invoice
         amount less allowance for any uncollectible amounts. An estimate for
         doubtful accounts is made when collection of the full amount is no
         longer probable. Bad debts are written off as incurred. There were no
         bad debts in 2004 and 2003.

         (h)      ADVANCES TO SUPPLIERS

         Advances to suppliers represent the cash paid in advance for purchasing
         raw materials.



                                      F-9
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

         (i)      RESEARCH AND DEVELOPMENT

         Research and development costs are expensed as incurred. Engineers and
         technical staff are involved in the production of our products as well
         as on-going research, with no segregation of the portion of their
         salaries relating to research and development from the portion of their
         salaries relating to production. The total salaries are included in
         cost of sales. Other research is performed on a future profit sharing
         basis conducted by universities and research institutions.

         (j)      CASH AND CASH EQUIVALENTS

         The Company considers all highly liquid investments purchased with
         original maturities of three months or less to be cash equivalents. The
         Company does not maintain any bank accounts in the United States of
         America.

         (k)      DEFERRED CONSULTING EXPENSES

         The deferred consulting expenses are amortized over their service term
         of one to three years.

         (l)      LICENSE

         License represents the ownership of new drugs and is amortized over the
         estimated useful life of twelve years

         (m)      FAIR VALUE OF FINANCIAL INSTRUMENTS

         The Company's financial instruments include cash and cash equivalents,
         accounts receivable, advances to suppliers, other receivables, accounts
         payable, short-term bank loans, customer deposits, taxes payable, other
         payables and accrued expenses and due to shareholders. Management has
         estimated that the carrying amount approximates their fair value due to
         their short-term nature.




                                      F-10
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

         (n)      REVENUE RECOGNITION

         Revenue represents the invoiced value of goods sold recognized upon the
         delivery of goods to customers. Revenue is recognized when all of the
         following criteria are met:

         -Persuasive evidence of an arrangement exists,
         -Delivery has occurred or services have been rendered,
         -The seller's price to the buyer is fixed or determinable, and
         -Collectibility is reasonably assured.

         (o)      SHIPPING AND HANDLING

         All shipping and handling are expensed as incurred and outbound freight
         is not billed to customers. Shipping and handling expenses included in
         selling and marketing expenses were $615,808 and $493,744 for the years
         ended December 31, 2004 and 2003, respectively.

         (p)      ADVERTISING COSTS

         The Company expenses advertising costs as incurred or the first time
         advertising takes place. Point of sale materials are accounted for as
         inventory and charged to expense as utilized.

         (q)      FOREIGN CURRENCY TRANSLATION

         The accompanying financial statements are presented in United States
         dollars. The functional currency of the Company is the Renminbi (RMB).
         The financial statements are translated into United States dollars from
         RMB at the single rate of exchange of US$1.00:RMB8.30.

         The RMB is not freely convertible into foreign currency and all foreign
         exchange transactions must take place through authorized institutions.
         No representation is made that the RMB amounts could have been, or
         could be, converted into US dollar at the rates used in translation.

         (r)      RETIREMENT BENEFITS

         Retirement benefits in the form of contributions under defined
         contribution retirement plans to the relevant authorities are charged
         to the consolidated statements of income as incurred. The retirement
         benefit expenses for 2004 and 2003 are $22,551 and $44,456,
         respectively and are included in general and administrative expenses.



                                      F-11

<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

         (s)      USE OF ESTIMATES

         The preparation of the financial statements in conformity with
         generally accepted accounting principles in the United States of
         America requires management to make estimates and assumptions that
         affect the reported amounts of assets and liabilities and disclosure of
         contingent assets and liabilities at the date of the financial
         statements and the reported amounts of revenues and expenses during the
         reporting periods. Management makes these estimates using the best
         information available at the time the estimates are made; however
         actual results could differ materially from those estimates.

         (t)      INCOME TAXES

         The Company accounts for income tax using an asset and liability
         approach and allows for recognition of deferred tax benefits in future
         years. Under the asset and liability approach, deferred taxes are
         provided for the net tax effects of temporary differences between the
         carrying amounts of assets and liabilities for financial reporting
         purposes and the amounts used for income tax purposes. A valuation
         allowance is provided for deferred tax assets if it is more likely than
         not these items will either expire before the Company is able to
         realize their benefits, or that future realization is uncertain.

         In accordance with the relevant tax laws and regulations of PRC, the
         corporation income tax rate is 33%.

         (u)      STOCK-BASED COMPENSATION

         SFAS No. 123, "Accounting for Stock-Based Compensation" encourages the
         use of the fair value based method of accounting for stock-based
         employee compensation. Alternatively, SFAS No. 123 allows entities to
         continue to apply the intrinsic value method prescribed by Accounting
         Principles Board ("APB") Opinion 25, "Accounting for Stock Issued to
         Employees," and related interpretations and provide pro forma
         disclosures of net income (loss) and earnings (loss) per share, as if
         the fair value-based method of accounting had been applied to employee
         awards. The Company has elected to continue to apply the provisions of
         APB Opinion 25 and provide the disclosures required by SFAS No. 123 and
         SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
         Disclosure."



                                      F-12
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

         (u)      STOCK-BASED COMPENSATION (CONTINUED)

         Stock-based compensation for service, for other than employees is
         accounted for in accordance with the provision of SFAS 123, Accounting
         For Stock - Based Compensation. Accordingly, all transactions in which
         goods or services are the consideration received for the issuance of
         equity instruments are accounted for based on the fair value of the
         consideration received or the fair value of the equity instruments
         issued, whichever is more reliably measurable. The fair value is then
         generally amortized over the term of the services. If the service
         period is not defined as an earlier or shorter period, the service
         period is presumed to be the vesting period.

         The following table illustrates the effect on net income attributable
         to common stockholders per share if the fair value based method had
         been applied to all awards:

<TABLE>
                                                                                DECEMBER 31,
                                                                              2004          2003
                                                                           -----------   -----------
<S>            <C>
               Net income, as reported                                     $7,771,382    $4,601,846
               Add:
               Stock-based employee compensation expense included
                 in the reported income, net of related tax effects            32,000       32,000

               Less:
               Total stock-based employee compensation expense
               determined under fair value based methods for all
               awards, net of related tax effects                             (70,345)      (51,199)
                                                                           -----------   -----------

               Pro forma net income                                        $7,733,037    $4,582,647
                                                                           ===========   ===========

               Basic earnings per share
               As reported                                                 $     0.23    $     0.15
               Pro forma                                                   $     0.23    $     0.15
               Diluted earnings per share
               As reported                                                 $     0.23    $     0.15
               Pro forma                                                   $     0.23    $     0.15
</TABLE>


                                      F-13
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

         The fair value of options granted under the Company's stock option
         plans were estimated on the date of grant using the Black-Scholes
         pricing model with the following assumptions:

         Weighted average of expected risk-free interest rates 3.00% Expected
         years to exercise date 4 Expected stock volatility 81.49% Expected
         dividend yield 0%

         (v)      SEGMENTS

         The Company operates in one business segment, the development,
         production and sale of bioengineered and traditional Chinese medical
         products.

         (w)      EARNINGS PER SHARE

         Basic earnings per share is computed by dividing income available to
         common shareholders by the weighted-average number of common shares
         outstanding during the period. Diluted earnings per share is computed
         similar to basic earnings per share except that the denominator is
         increased to include the number of additional common shares that would
         have been outstanding if the potential common shares had been issued
         and if the additional common shares were dilutive. Outstanding warrants
         at December 31, 2003 to purchase 1,100,000 shares of common stock were
         not included in the computation of diluted earnings per share because
         the exercise prices were greater than the average market price of the
         company's common stock.

         Following is a reconciliation of the denominator and numerator used in
         the computation of basic and diluted earnings per share for years ended
         December 31, 2004 and 2003:

             Denominator:                             2004             2003
                                                  -------------    -------------
             Basic weighted average shares of
               common stock outstanding           $  33,595,685    $  31,062,573
             Assumed exercise of warrants and
               options, net                             357,822          233,620
                                                  -------------    -------------
             Diluted weighted average shares
               of common stock outstanding           33,953,507       31,296,193
                                                  -------------    -------------



                                      F-14
<PAGE>

             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)


             Numerator:
             Net income                           $   7,771,382    $   4,601,846
                                                  -------------    -------------
             Diluted net income                   $   7,771,382    $   4,601,846

             Earnings per share:
             Basic                                $        0.23    $        0.15
             Diluted                              $        0.23    $        0.15

         (x)      RESERVE FUND

         In accordance with the Chinese Companies Law, the Company's subsidiary,
         Harbin Bioengineering operated in the PRC, and is required to transfer
         15% of its Chinese profit after taxation, as determined in accordance
         with Chinese accounting standards and regulations, to the surplus
         reserve fund. Subject to certain restrictions set out in the Chinese
         Companies Law, the surplus reserve fund may be distributed to
         stockholders in the form of share bonus issues and/or cash dividends.
         Retained earnings in the amount of $1,294,689 and $946,865 are
         restricted as of December 31, 2004 and 2003, respectively.

         (y)      RECENT ACCOUNTING PRONOUNCEMENTS

         In May 2003, the FASB issued SFAS No. 150, "Accounting For Certain
         Financial Instruments with Characteristics of both Liabilities and
         Equity". SFAS No. 150 changes the accounting for certain financial
         instruments with characteristics of both liabilities and equity that,
         under previous pronouncements, issuers could account for as equity. The
         new accounting guidance contained in SFAS No. 150 requires that those
         instruments be classified as liabilities in the balance sheet.

         SFAS No. 150 affects the issuer's accounting for three types of
         freestanding financial instruments. One type is mandatorily redeemable
         shares, which the issuing company is obligated to buy back in exchange
         for cash or other assets. A second type includes put options and
         forward purchase contracts, which involves instruments that do or may
         require the issuer to buy back some of its shares in exchange for cash
         or other assets. The third type of instruments that are liabilities
         under this Statement is obligations that can be settled with shares,
         the monetary value of which is fixed, tied solely or predominantly to a
         variable such as a market index, or varies inversely with the value of
         the issuers' shares. SFAS No. 150 does not apply to features embedded
         in a financial instrument that is not a derivative in its entirety.



                                      F-15
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

         Most of the provisions of Statement 150 are consistent with the
         existing definition of liabilities in FASB Concepts Statement No. 6,
         "Elements of Financial Statements". The remaining provisions of this
         Statement are consistent with the FASB's proposal to revise that
         definition to encompass certain obligations that a reporting entity can
         or must settle by issuing its own shares.

         This Statement shall be effective for financial instruments entered
         into or modified after May 31, 2003 and otherwise shall be effective at
         the beginning of the first interim period beginning after June 15,
         2003, except for mandatorily redeemable financial instruments of a
         non-public entity, as to which the effective date is for fiscal periods
         beginning after December 15, 2004.

         In November 2004, the FASB issued SFAS No. 151, "Inventory Costs". This
         Statement amends the guidance in ARB No. 43, Chapter 4, "Inventory
         Pricing" to clarify the accounting for abnormal amounts of idle
         facility expense, freight, handling costs and wasted material
         (spoilage) In addition, this Statement requires that allocation of
         fixed production overhead to the costs of conversion be based on the
         normal capacity of the production facilities. The provisions of this
         Statement will be effective for the Company beginning in 2005.

         In December 2004, the FASB issued SFAS No. 153, "Exchanges of
         Non-Monetary Assets, an Amendment of Accounting Principles Board
         ("APB") No. 29". This statement amends APB Opinion No. 29, "Accounting
         for Non-monetary Transactions". Earlier guidance had been based on the
         principle that exchanges of non-monetary assets should be based on the
         fair value of the assets exchanged and APB No. 29 included certain
         exceptions to this principle. However, FASB 153 eliminated the specific
         exceptions for non-monetary exchanges with a general exception rule for
         all exchanges of non-monetary assets that do not have commercial and
         economic substance. A non-monetary exchange has commercial substance
         only if the future cash flows of the entity are expected to change
         significantly as a result of the exchange. This statement is effective
         for non-monetary exchanges occurring in fiscal periods beginning after
         June 15, 2005.

         In December 2004, the FASB issued a revised SFAS No. 123, Accounting
         for Stock-Based Compensation, which supersedes APB opinion No. 25,
         Accounting for Stock Issued to Employees, and its related
         implementation guidance. This statement requires a public entity to
         recognize and measure the cost of employee services it receives in
         exchange for an award of equity instruments based on the grant-date
         fair value of the award (with limited



                                      F-16
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

         exceptions). These costs will be recognized over the period during
         which an employee is required to provide service in exchange for the
         award - the requisite service period (usually the vesting period). This
         statement also establishes the standards for the accounting treatment
         of these share-based payment transactions in which an entity exchanges
         its equity instruments for goods or services. It addresses transactions
         in which an entity incurs liabilities in exchange for goods or services
         that are based on the fair value of the entity's equity instruments or
         that may be settled by the issuance of those equity instruments. This
         statement shall be effective the first interim or annual reporting
         period that begins after December 15, 2005 for small business public
         entities and nonpublic companies.

         The implementations of the above pronouncements are not expected to
         have a material effect on the Company's consolidated financial
         statements.

4.       BUSINESS COMBINATION

         The Company signed the Purchase Agreement relating to the acquisition
         of Heilongjiang Songhuajiang Pharmaceutical Co., Ltd. ("HSPL") on
         September 8, 2004, and the acquisition was completed on October 12,
         2004. The Company acquired 100% of the equity interest of HSPL for
         $7,228,916 cash. The transaction was a triangular merger with Goware
         Holding International, Ltd, a British Virgin Island corporation. The
         acquisition date for accounting purpose was September 30, 2004. The
         operations of HSPL from October 1, 2004 to December 31, 2004 are
         included in the consolidated income statement.

         The following summarizes the acquisition:

                    Total cash consideration                       $  7,228,916
                    Fair value of assets acquired                   (11,991,341)
                    Fair value of liabilities assumed                 4,449,832
                                                                   -------------
                    Negative goodwill                              $   (312,593)
                                                                   =============


                    Negative goodwill proportionally applied
                      to land use rights                           $    241,562
                    Negative goodwill proportionally applied
                      to plant and equipment                             71,031
                                                                   -------------
                    Total                                          $    312,593
                                                                   =============

                                      F-17
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


4.       BUSINESS COMBINATION (CONTINUED)

         The following is the pro forma net income, basic net income per share
         and diluted net income per share of the Company for the year ended
         December 31, 2004 assuming the acquisition was completed on January 1,
         2004:

                    Net income                                     $  8,218,306

                    Basic net income per share                     $       0.24
                    Diluted net income per share                   $       0.24


5.       INVENTORIES

         Inventories consist of the following as of December 31, 2004 and 2003:

                                                       2004            2003
                                                   -------------   -------------

              Raw materials                        $   4,503,845   $   2,342,372
              Work in progress                           511,761              --
              Finished goods                             657,453         204,438
                                                   -------------   -------------
                                                   $   5,673,059   $   2,546,810
                                                   =============   =============

6.       DUE FROM EMPLOYEES

         All amounts due from employees are unsecured, interest free, and have
         no fixed repayment terms.

7.       LICENSE

                                                       2004             2003
                                                   -------------   -------------

         Cost                                      $  1,084,337    $  1,084,337
         Less: Accumulated amortization                (542,169)       (451,807)
                                                   -------------   -------------
         License, net                              $    542,168    $    632,530
                                                   =============   =============

         Amortization expense for the years ended 2004 and 2003 was $90,362 and
         $90,362, respectively.



                                      F-18
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


7.       LICENSE (CONTINUED)

         Amortization expense for the next five years and thereafter is as
         follows:

         2005                                                    $       90,362
         2006                                                             90,362
         2007                                                             90,362
         2008                                                             90,362
         2009                                                             90,362
         Thereafter                                                       90,358
                                                                 ---------------
         Total                                                   $       542,168
                                                                 ===============

8.       LAND USE RIGHTS

                                                       2004            2003
                                                   -------------   -------------

         Cost                                      $  8,032,752    $    903,452
         Less: Accumulated amortization                (161,255)       (102,391)
                                                   -------------   -------------
         Land use rights, net                      $  7,871,497    $    801,061
                                                   =============   =============

         On December 26, 1997, the Company leased land use rights from Chinese
         Military Team 81156. The lease term is for 40 years. The Company
         prepaid the total lease payments amounting to $903,452. At December 31,
         2004 and 2003, the net book value of the lease prepayments is $778,474
         and $801,061, respectively. The land use rights acquired in the HSPL
         acquisition of $7,129,300 on October 12, 2004 is being amortized over
         50 years, the life of land use rights.

         Amortization expense for years ended 2004 and 2003 was $58,864 and
         $22,587, respectively.

         Amortization expense for the next five years and thereafter is as
         follows:

             2005                                                $       165,172
             2006                                                        165,172
             2007                                                        165,172
             2008                                                        165,172
             2009                                                        165,172
             Thereafter                                                7,045,637
                                                                 ---------------
             Total                                               $     7,871,497
                                                                 ===============



                                      F-19
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


9.       PLANT AND EQUIPMENT

         Plant and equipment consist of the following as of December 31:

                                                       2004            2003
                                                   -------------   -------------
              At cost:
                Buildings                          $  5,591,534    $  4,853,465
                Machinery and equipment               7,527,745       2,876,838
                Leasehold improvements                   71,406          71,406
                Motor vehicles                          392,084         307,483
                Office equipment and furniture          264,451         121,046
                Other equipment                          85,020          97,385
                                                   -------------   -------------
                                                   $ 13,932,240    $  8,327,623
                                                   -------------   -------------
              Less : Accumulated depreciation
                Buildings                            (1,096,180)       (864,754)
                Machinery and equipment              (4,150,720)       (605,446)
                Leasehold improvements                  (40,610)        (33,470)
                Motor vehicles                         (249,534)       (195,984)
                Office equipment and furniture         (243,667)        (94,827)
                Other equipment                         (82,753)        (69,381)
                                                   -------------   -------------
                                                     (5,863,464)     (1,863,862)
                                                   -------------   -------------

              Plant and equipment, net             $  8,068,776    $  6,463,761
                                                   =============   =============

         Depreciation expense for years ended 2004 and 2003 was $572,218 and
         $460,565, respectively.

         A motor vehicle amounting to $34,046 was registered in the name of a
         director as at December 31, 2004. The transfer of the title is still in
         progress.

         A motor vehicle amounting to $68,386 was encumbered by a finance lease
         at December 31, 2004.

10.      INCOME TAXES

         (a)      CORPORATE INCOME TAX ("CIT")

         In accordance with the relevant tax laws and regulations of PRC, the
         corporate income tax rate is 15% and 33%. The corporate income tax rate
         for Harbin Bioengineering was 15% for 2004 because the Company is
         considered as a high technology company by the Chinese government. When
         the Chinese government considers that Harbin Bioengineering is no
         longer a high technology company, they will be taxed at 33% corporate
         income tax rate. No determination can be made at this point how long
         Harbin Bioengineering will be taxed at the 15% corporate income tax
         rate.



                                      F-20
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


10.      INCOME TAXES (CONTINUED)

         The Company's tax expense differs from the "expected" tax expense for
         the years ended December 31, 2004 and 2003 (computed by applying the
         CIT rate of 15 percent of profit of Harbin Bioengineering, and 33
         percent of net profit of HSPL):

                                                       2004            2003
                                                   -------------   -------------

             Computed "expected" expense           $   2,216,626   $   1,138,636
             Permanent difference                             --              --
                                                   -------------   -------------
             Income tax expense                    $   2,216,626   $   1,138,636
                                                   =============   =============

         The provisions for income taxes for each of the two years ended
         December 31 are summarized as follows:

                                                       2004            2003
                                                   -------------   -------------

             Current                               $   2,190,944   $   1,113,959
             Deferred                                     25,682          24,677
                                                   -------------   -------------
                                                   $   2,216,626   $   1,138,636
                                                   =============   =============

        The tax effects of temporary differences that give rise to the Company's
        deferred tax assets and liabilities as of December 31, 2004 and 2003:

                                                       2004            2003
                                                   -------------   -------------
             Deferred tax assets:
             Write off of prepayment               $      52,548   $      52,150
             Amortization                                 29,050              --
             Depreciation                                 20,746              --
             Expenses not yet deductible for
               tax purposes                               57,614          44,470
                                                   -------------   -------------
             Deferred tax assets                   $     159,958   $      96,620
                                                   -------------   -------------

             Deferred tax liabilities:
             Welfare expense                              66,547              --
             Depreciation                                 40,654              --
             Revenue not yet taxable for tax purposes         --          18,181
                                                   -------------   -------------
             Deferred tax liabilities                    107,201          18,181
                                                   -------------   -------------
             Net deferred tax assets               $      52,757   $      78,439
                                                   =============   =============



                                      F-21
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


10.      INCOME TAXES (CONTINUED)

         (b)      VALUE ADDED TAX ("VAT")

         In accordance with the relevant taxation laws in the PRC, the VAT rate
         for export sales is 0% and domestic sales is 17%. VAT is levied at 17%
         on the invoiced value of sales and is payable by the purchaser. The
         Company is required to remit the VAT it collects to the tax authority,
         but may deduct there from the VAT it has paid on eligible purchases.

         The VAT payable balance of $471,595 and $140,120 at December 31, 2004
         and 2003, respectively are included in other payables and accrued
         expenses in the accompanying consolidated balance sheets.

11.      SHORT-TERM BANK LOANS

         Short-term bank loans are summarized as follows:

                                                       2004            2003
                                                   -------------   -------------
         Bank of China, Harbin Nangang Branch,
           interest at 6.435% per annum
             Due August 18, 2004                              --         481,928
             Due November 17, 2004                            --         963,855
             Due August 18, 2005                         481,928              --
             Due November 17, 2005                       963,855              --
                                                   -------------   -------------
                                                   $   1,445,783   $   1,445,783
         Industrial and Commercial Bank of China,
           Dongzhi Branch, interest at 7.254%
             per annum
           Due December 31, 2005                       3,614,458              --
                                                   -------------   -------------
                                                   $   5,060,241   $   1,445,783
                                                   =============   =============

         All of the short-term bank loans due in 2004 were renewed in 2004.
         Interest expense, which is paid quarterly, was $130,601 and $92,987 in
         2004 and 2003, respectively and is included in interest expenses, net.

         The short-term bank loans from Bank of China in the amount of $481,928
         and $963,855 were secured by a guarantee by Harbin Three Happiness
         Group, a company affiliated with the Company through common ownership.



                                      F-22
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


12.      DUE TO SHAREHOLDERS

         Due to shareholders are unsecured, interest free, and have no fixed
         repayment term.

13.      COMMITMENTS AND CONTINGENCIES

         The Company entered into an unconditional purchase commitment during
         2004 to purchase equipment. The future obligations of the Company under
         this commitment are as follows:

             2005                                                $       536,739
             Thereafter                                                       --
                                                                 ---------------
             Total                                               $       536,739
                                                                 ===============

The Company conducted a private placement of shares of common stock and warrants
in November 2004, while they had two outstanding resale registration statements
on a certain equity line filed on December 30, 2003 and December 31, 2003, which
never became effective and which were subsequently withdrawn on January 12, 2004
("Resale Registrations"). It may be determined that such private placement may
have constituted a general solicitation under Section 5 of the Securities Act of
1933 due to the outstanding Resale Registrations during the private placement
period. As a result, the Company may be obligated to make a rescission offer to
the private placement investors, and while the Company believes that the chances
of the acceptance of a rescission offer is low, the Company could be required to
make payments to the investors for rescissions. Also see Note 14(D).

14.      SHAREHOLDERS' EQUITY

         A.       PREFERRED STOCK

         The Company authorized 2,000,000 shares $.001 par value Class A
         Preferred Stock. The Class A Preferred Stock provides the holder(s)
         with aggregate voting rights constituting 25% of total voting rights in
         the Company as well as a liquidation preference. In February 2003, the
         Company issued 1,000,000 shares of Class A preferred stock for the
         acquisition of the protein peptide project. The preferred shares have
         preference over common stock in terms of any liquidation or
         distribution of assets or retained earnings. No liquidation
         distribution can be made until the holders of the preferred stock
         receive the original value of their investment of $1,000 plus any
         accrued and unpaid dividends. There is no dividend provided for the
         outstanding preferred stock. The Company valued the 1,000,000 shares of
         the Class A preferred stock at $1,000 based on:

                  1.       The Company has not registered any of the Class A
                           preferred stock with the Securities and Exchange
                           Commission and therefore there is no market for the
                           stock. The shares are also not convertible into the
                           Company's common stock.

                  2.       The par value of the stock, which was $ 0.001 per
                           share, was used as the basis for the Company to value
                           the organizing effort of Mr. Shujun Liu in
                           coordinating and providing the soybean protein
                           peptide project.

                  3.       With reference to the voting power represented by the
                           Class A preferred stock, by the time the 1,000,000
                           shares of Class A preferred stock were issued to Mr.
                           Shujun Liu, he owned more than 50% of the outstanding
                           common stock of the Company and was the single
                           largest shareholder. This implied that the 25% voting
                           power represented by the Class A preferred stock did
                           not create any additional value to Mr. Shujun Liu.


                                      F-23
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


14.      SHAREHOLDERS' EQUITY (CONTINUED)

         B.       WARRANTS

         The Company issued common stock purchase warrants to various
         consultants, strategic partners and investors.

         On July 18, 2003, the Company entered into a $3 million investment
         agreement ("Investment Agreement") with BH Capital Investment, LP and
         Excalibur Limited Partnership ("Investors") to purchase Company's
         common stock. The Company granted to Investors 450,000 warrants to
         purchase Company's common stock at $0.30 per share and agreed to issue
         warrants to purchase Company's common stock of equal value to 15% of
         the investment sum pursuant to the investment agreement at 120% of the
         closing bid price of the Company's stock (the "15% Warrants"), which
         were not issued in 2003 but contingent to the completion of investment.
         Also, Company issued 300,000 warrants to purchase Company's common
         stock at $0.30 per share to FirsTrust Group, Inc. ("FirsTrust") or its
         designees for commitment and advisory fees. The warrants are
         immediately exercisable and expire 5 years from the grant date. The
         warrants were valued using the Black-Scholes pricing model using the
         flowing assumptions: no expected dividend yield; volatility rate of
         252%; risk free interest rate of 2.89% and expected life of 5 years,
         resulting in a total fair value of $555,000. The amount was expensed
         for the year ended December 31, 2003 and also resulted in an increase
         to additional paid-in capital by $555,000.

         On December 5, 2003, the Company and the Investors amended the
         Investment Agreement to waive the 15% Warrants and replaced by 180,000
         warrants to purchase Company's common stock at $2.50 per share. On June
         3, 2004, the Company has signed Amendment No. 2 to the Investment
         Agreement and the Investors agreed to waive all the registration rights
         relating to the warrants issued to the Investor in connection with
         execution of the Investment Agreement.

         On June, 30, 2004, the Company paid $ 25,000 to purchase back from
         unrelated third parties 450,000 warrants to purchase Company's common
         stock at $0.30 per share and 180,000 warrants to purchase Company's
         common stock at $2.50 per share that were originally issued to the
         Investors and 276,000 warrants to purchase Company's common stock at
         $0.30 per share that were originally issued to FirsTrust. The Company
         was returned the original warrant documents and the Company cancelled
         the warrants subsequently.

         On December 14, 2004, the Company paid $4,000 to purchase back from
         unrelated third parties 13,000 shares of warrants to purchase Company's
         common stock at $0.30 per share that were originally issued to
         FirsTrust. The Company was returned the original warrant documents and
         the Company cancelled the warrants subsequently.



                                      F-24
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


14.      SHAREHOLDERS' EQUITY (CONTINUED)

         B.       WARRANTS (CONTINUED)

         As of December 31, 2004, 11,000 warrants to purchase the Company's
         common stock at $0.30 per share that were originally issued to
         FirsTrust on July 18, 2003 in connection with the Investment Agreement,
         were still outstanding. The warrants were valued using the
         Black-Scholes pricing model resulting in a total charge to general and
         administrative expenses of $20,350 for the year ended December 31,
         2003. The warrants were valued using the Black-Scholes pricing model
         using the flowing assumptions:

               Weighted average of expected risk free rate: 2.89%

               Expected years to exercise date                    : 5 year
               Expected stock volatility                          : 252%
               Expected dividend yield                            : 0%

         On November 23, 2004, the Company completed a private placement of $6
         million of its securities to "accredited investors" pursuant to
         Regulation D under the Securities Act of 1933, as amended. Pursuant to
         the Subscription Agreement, the Company issued 7,500,000 warrants to
         purchase Company's common stock, exercisable within 3 years from the
         date of completion of a registration statement at $0.85 per share, and
         3,000,000 warrants to purchase Company's common stock, exercisable
         within 3 years from the date of completion of a registration statement
         at $1.60 per share. The proceeds from the private placement
         attributable to the warrants have been included with the total net
         proceeds in additional paid-in capital. The following table summarizes
         information about all common stock purchase warrants outstanding as of
         December 31, 2004. All warrants were exercisable as of December 31,
         2004.

         The following table summarize the outstanding warrants as of December
         31, 2004:

<TABLE>
Range of Exercise          Number of Warrants            Weighted Average
      Prices                  Outstanding                 Exercise Price              Expiration Dates
-------------------     -------------------------      ----------------------     ------------------------
<S>   <C>
      $0.30                      11,000                        $0.30                   July 17, 2008
      $0.85                    7,500,000                       $0.85                   April 7, 2008
      $1.60                    3,000,000                       $1.60                   April 7, 2008
                        -------------------------
                               10,511,000
                        =========================
</TABLE>

*   Estimated expiration only because the expiration date of the warrants will
    be 3 years after the completion of registration. Also see Note 14 (D).

                                      F-25
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


14.      SHAREHOLDERS' EQUITY (CONTINUED)

         B.       WARRANTS (CONTINUED)

         The following table summarizes the warrant activities of the Company
         for the years ended December 31, 2004 and 2003:

<TABLE>
                                                                              Weighted Average
                                                   Warrants Granted            Exercise Price
                                                  ----------------------    ----------------------
<S>                            <C>
           Outstanding January 1, 2003                               --                        --
                Granted                                        930,000                     $0.73
                Exercised                                            --                        --
                Cancelled                                            --                        --
                                                  ----------------------    ----------------------
           Outstanding December 31, 2003                       930,000                     $0.73
                Granted                                     10,500,000                     $1.06
                Exercised                                            --                        --
                Cancelled                                     (919,000)                    $0.73
                                                  ----------------------    ----------------------
           Outstanding at December 31, 2004                 10,511,000                     $1.06
                                                  ======================    ======================
           Exercisable at December 31, 2004                 10,511,000                     $1.06
                                                  ======================    ======================
</TABLE>

         C.       STOCK OPTIONS

         In March 2004, the Company's board of directors formally adopted a
         stock option plan (the "Plan"), which was considered by the directors
         in late 2003. That Plan provides for the grant of options to employees,
         officers, directors and consultants. Options may be either "incentive
         stock options" within the meaning of Section 422 of the United States
         Internal Revenue Code of 1986, as amended, or non-qualified options.
         The Plan is presently administered directly by the Company's board of
         directors. Subject to the provisions of the Plan, the Company's board
         of directors determines who receives stock options, the number of
         shares of common stock that may be covered by the option grants, the
         time and manner of the exercise of the options and exercise prices, as
         well as any other pertinent terms of the options. The Company entered
         into employment agreements with four of the Company's top executives,
         officers and directors in March 2004 effective October 1, 2003. Under
         the four employment agreements, the Company shall pay an aggregate of
         $32,000 of value of stock options per quarter to four of the Company's
         officers and directors under the agreements. The stock options issued
         are exercisable within 5 years from date of grant and with an exercise
         price of $2.00.

         In June 2004, employment agreements for certain executive employees of
         the Company were amended to include a provision that if the Company's
         closing stock price was less than $2.00


                                      F-26
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


14.      SHAREHOLDERS' EQUITY (CONTINUED)

         on the last day of the quarter, the employees would not be entitled to
         their quarterly stock options. At the quarters ended December 31,
         September 30 and June 30, 2004, the closing stock prices were $1.53,
         $1.35 and $1.75, respectively. According to the employment agreements
         as amended, no options were granted to the employees for those three
         respective quarters.

         To summarize, the Company granted stock options to purchase 23,704 and
         19,393 shares of common stock under the four employment agreements in
         2004 and 2003, respectively.

         The following table summarizes the stock option activity:

<TABLE>
                                                                                    Weighted Average
                                                            Options Granted          Exercise Price
                                                           ------------------     ----------------------
<S>                             <C>
            Outstanding January 1, 2003                                   --                         --
                  Granted                                             19,393  $                     2.0
                  Exercised                                               --                         --
                  Cancelled                                               --                         --
                                                           ------------------     ----------------------
            Outstanding December 31, 2003                             19,393  $                     2.0
                  Granted.                                            23,704                        2.0
                  Exercised                                               --                         --
                  Cancelled                                               --                         --
                                                           ------------------     ----------------------
            Outstanding at December 31, 2004                          43,097  $                     2.0
                                                           ==================     ======================
            Exercisable at December 31, 2004                          43,097  $                     2.0
                                                           ==================     ======================

         The following table summarizes information about stock options
         outstanding as of December 31, 2004:

                                         Options Outstanding                               Options Exercisable
--------------------- ---------------------------------------------------------- ----------------------------------------
                                                             Weighted Average
                                      Weighted Average           Remaining                                   Weighted
    Range of           Number of       Exercise Price        Contractual Life          Number of             Average
 Exercise Prices        Shares                                  (in years)              Shares            Exercise Price
------------------    ------------    ------------------    --------------------    ----------------      ---------------
        $2.0            43,097             $2.0                   4.0                     43,097            $2.0
                      ------------                                                     -------------
                        43,097                                                            43,097
                      ============                                                     =============
</TABLE>

         The weighted average fair value per share of the 43,097 options issued
         under the Plan is $2.82 per share.


                                      F-27
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


14.      SHAREHOLDERS' EQUITY (CONTINUED)

         D.       ISSUANCE OF RESTRICTED COMMON STOCK

         RESTRICTED COMMON STOCKS ISSUED TO FOCUS PARTNERS, LLC

         During 2002, the Company appointed Focus Partners, LLC to provide
         investor relations services to the Company. In the contract, the
         Company agreed to issue them restricted common stock for their
         services. Their services were terminated in early 2003 because of a
         dispute on the quality of the services. The Company did not pay and
         Focus Partners, LLC had not requested the Company to pay the common
         stock and therefore the Company considered the chance of issuing the
         stock remote in 2003. In early 2004, the Company reached a settlement
         with Focus Partners, LLC and agreed to issue 309,000 shares of
         restricted stock to Focus Partners, LLC. On April 7, 2004 and December
         18, 2004, the Company issued 206,000 shares and 103,000 shares of
         restricted stock of the Company to Focus Partners, LLC, respectively.
         The 309,000 shares of restricted stock issued to Focus Partners, LLC
         were valued based on the settlement date resulting in a total value of
         $145,815.

         COMMON STOCK ISSUED FOR CONSULTING SERVICES

         On July 9, 2004, the Company filed a Form S-8 Registration Statement
         under the Securities Act of 1933 to register a total of 700,000 shares
         of common stock of the Company as compensation that related to the nine
         consulting agreements entered into between the Company and nine
         unrelated individuals effective July 1, 2004. These individuals were
         engaged to provide various kinds of services to the Company, including
         set up of regional offices, marketing and sales channelling,
         negotiation with government regulatory agencies, reviewing and
         improving the internal control system and implementation of the
         Company's website. These consulting agreements had terms ranging from 1
         year to 3 years. The common stock issued as the consideration of these
         consulting agreements were valued based on the closing market price of
         the Company's common stock ($1.70 per share) at the date of agreements
         and the consideration of all 9 consulting agreements were valued at
         $1,190,000 in the aggregate. The Company amortizes the expense over the
         term of the consulting agreements. For the year ended December 31,
         2004, $261,800 was amortized to general and administrative expense and
         $928,200 was deferred consulting expenses at December 31, 2004.

         Stern & Co. was contracted by the Company as its investor relations
         company from June 1, 2004 to May 31, 2005. However, the Company
         terminated the services of Stern & Co. early, and as a compensation for
         the early termination, the Company negotiated and settled with Stern &
         Co. by issuing 12,000 shares of restricted common stock of the Company
         on December 6, 2004. The common stock was valued at $1.68 per share
         according to the closing stock price on the date the stock was issued
         for a value of $20,160.



                                      F-28
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


14.      SHAREHOLDERS' EQUITY (CONTINUED)

         D.       ISSUANCE OF RESTRICTED COMMON STOCK (CONTINUED)

         COMMON STOCK ISSUED FOR CONSULTING SERVICES (CONTINUED)

         On October 20, 2003, the Company filed a Form S-8 Registration
         Statement under the Securities Act of 1933 to register a total of
         800,000 shares of common stock of the Company as compensation that
         related to the four consulting agreements entered between the Company
         and four unrelated individuals effective October 1, 2003. These
         individuals were engaged to provide various kinds of services to the
         Company, including set up of marketing, channelling, commercial
         researches and internal control processes implementation. These
         consulting agreements had terms ranging from 1 year to 3 years. The
         common stock issued as the consideration of these consulting agreements
         were valued based on the closing market price of the Company's common
         stock ($1.97 per share) at the date of agreements and the consideration
         of all four consulting agreements were valued at $1,576,000 in the
         aggregate. The Company amortizes the expense over the term of the
         consulting agreements. For the years ended December 31, 2004 and 2003,
         $535,182 and $282,366 were amortized to general and administrative
         expense, respectively and $758,452 and $1,293,634 were deferred
         consulting expenses at December 31, 2004 and 2003, respectively.

         ISSUANCE OF RESTRICTED COMMON STOCK IN $6.0 MILLION PRIVATE PLACEMENT

         The Company completed a private placement of its securities to
         "accredited investors" pursuant to Regulation D under the Securities
         Act of 1933, as amended on November 23, 2004. The Company entered into
         a stock subscription agreement ("Subscription Agreement"), with
         eighty-five (85) accredited investors ("Subscribers"). Pursuant to the
         Subscription Agreement, the Subscribers purchased six million
         (6,000,000) shares of the Company's common stock at a per share
         purchase price of $1.00 in a private placement, resulting in $6,000,000
         of gross proceeds to the Company. The offering consisted of investment
         units, each comprised of one share of the Company's common stock sold
         at a purchase price per share of $1.00, a 3-year Class A stock purchase
         warrant to purchase 1 share of common stock exercisable at $0.85, and a
         3-year Class B stock purchase warrant to purchase 1/2 share of common
         stock exercisable at $1.60. The Company paid fees and commissions in
         the aggregate amount of $561,386 in connection with this offering.

         Upon the execution of the Subscription Agreement, the Company issued to
         the Subscribers (i) ten (10) Class A warrants and (ii) five (5) Class B
         warrants for every ten (10) Shares purchased by them under the
         Subscription Agreement. The warrants will expire three (3) years from
         the effectiveness of the registration statement and contain a cashless
         exercise provision.



                                      F-29
<PAGE>
             AMERICAN ORIENTAL BIOENGINEERING, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        AS OF DECEMBER 31, 2004 AND 2003


14.      SHAREHOLDERS' EQUITY (CONTINUED)

         D.       ISSUANCE OF RESTRICTED COMMON STOCK (CONTINUED)

         ISSUANCE OF RESTRICTED COMMON STOCK IN $6.0 MILLION PRIVATE PLACEMENT
         (CONTINUED)

         Westminster Securities Corporation of New York served as placement
         agent in connection with this offering. As compensation for its
         services, Westminster received Class A stock purchase warrants
         exercisable for a total of 1.5 million shares of AOBO's common stock,
         subject to adjustment provisions set forth in such warrants, and
         otherwise on the same terms and conditions as the Class A stock
         purchase warrants issued to the investors in the offering.

         The securities sold in this offering have not been registered under the
         Securities Act of 1933, and may not be offered or sold in the United
         States absent registration or an applicable exemption from registration
         requirements. The Company agreed to register the resale of the shares
         of common stock and the shares issuable upon exercise of the warrants,
         all shares issued to the investors in this private placement, on the
         terms and conditions set forth in Company's subscription agreements
         with the investors. Subsequent to the completion of signing of the
         Subscription Agreements with respect to the private placement, the
         Company filed a Form SB-2 registration statement under the Securities
         Act of 1933 to register 16,500,000 shares of the common stock on behalf
         of the subscribers, which represents:

         1.       6,000,000 shares issued pursuant to a private placement;
         2.       7,500,000 shares issuable upon exercise of Class A warrants
                  issued in the private placement;
         3.       3,000,000 shares issuable upon the exercise of Class B
                  warrants issued in the private placement.

         The Company is currently in default of a provision in the private
         placement agreement. The agreement requires that a registration
         statement be declared effective by the Securities and Exchange
         Commission within 120 days after the closing of the private placement
         (March 20, 2005) to register 16,500,000 share of common stock. The
         registration statement was not declared effective by the required date.
         The Company is required to pay to the subscribers a penalty of one and
         one-half percent (1.5%) of their investment per month pro rated on a
         daily basis for the first sixty (60) days, and thereafter for each
         thirty (30) days at a rate of two percentage (2%) of their investment
         pro rated on a daily basis.

                                      F-30