Auditors Report

To the Shareholders of Talisman Energy Inc.

We have audited the Consolidated Balance Sheets of Talisman Energy Inc. as at December 31, 2003 and 2002 and the Consolidated Statements of Income, Retained Earnings and Cash Flows for each of the years in the three year period ended December 31, 2003. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with Canadian and US generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.

In our opinion, these Consolidated Financial Statements present fairly, in all material respects, the financial position of the Company as at December 31, 2003 and 2002 and the results of its operations and its cash flows for each of the years in the three year period ended December 31, 2003 in accordance with Canadian generally accepted accounting principles. We also report that, in our opinion, these principles have been applied, except for the change in the method of accounting for goodwill as explained in note 1(o) to the Consolidated Financial Statements, on a basis consistent with that of the preceding year.

Calgary, Canada
      Ernst & Young LLPFebruary 27, 2004
      Chartered Accountants






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Consolidated Balance Sheets

(December 31)



|(millions of Canadian dollars)                   |                | 2003   |  | 2002   | 
|------------------------------------------------ | -------------- | ------ |  | ------ | 
|                                                 |                |        |  |        | 
|Assets                                           |                |        |  |        | 
|Current                                          |                |        |  |        | 
|Cash and cash equivalents                        |                | 98     |  | 27     | 
|Accounts receivable                              |                | 760    |  | 719    | 
|Inventories (note 3)                             |                | 100    |  | 147    | 
|Prepaid expenses                                 |                | 17     |  | 24     | 
|                                                 |                |        |  |        | 
|                                                 |                | 975    |  | 917    | 
|                                                 |                |        |  |        | 
|Accrued employee pension benefit asset (note 16) |                | 63     |  | 67     | 
|Other assets                                     |                | 76     |  | 99     | 
|Goodwill (note 2)                                |                | 473    |  | 469    | 
|Property, plant and equipment (note 4)           |                | 9,778  |  | 10,042 | 
|                                                 |                |        |  |        | 
|                                                 |                | 10,390 |  | 10,677 | 
|                                                 |                |        |  |        | 
|Total assets                                     |                | 11,365 |  | 11,594 | 
|                                                 |                |        |  |        | 
|                                                 |                |        |  |        | 
|Liabilities                                      |                |        |  |        | 
|Current                                          |                |        |  |        | 
|Accounts payable and accrued liabilities         |                | 1,064  |  | 803    | 
|Income and other taxes payable                   |                | 154    |  | 186    | 
|                                                 |                |        |  |        | 
|                                                 |                | 1,218  |  | 989    | 
|                                                 |                |        |  |        | 
|Deferred credits                                 |                | 57     |  | 57     | 
|Provision for future site restoration (note 10)  |                | 840    |  | 813    | 
|Long-term debt (note 5)                          |                | 2,203  |  | 2,997  | 
|Future income taxes (note 13)                    |                | 2,088  |  | 2,236  | 
|                                                 |                |        |  |        | 
|                                                 |                | 5,188  |  | 6,103  | 
|                                                 |                |        |  |        | 
|Contingencies and commitments (note 10)          |                |        |  |        | 
|Shareholders equity                             |                |        |  |        | 
|Preferred securities (note 6)                    |                | 431    |  | 431    | 
|Common shares (note 7)                           |                | 2,725  |  | 2,785  | 
|Contributed surplus                              |                | 73     |  | 75     | 
|Cumulative foreign currency translation (note 8) |                | (114)  |  | 140    | 
|Retained earnings                                |                | 1,844  |  | 1,071  | 
|                                                 |                |        |  |        | 
|                                                 |                | 4,959  |  | 4,502  | 
|                                                 |                |        |  |        | 
|Total liabilities and shareholders equity       |                | 11,365 |  | 11,594 | 
|                                                 |                |        |  |        | 
|                                                 |                |        |  |        | 
|See accompanying notes.                          |                |        |  |        | 
|                                                 |                |        |  |        | 
|On behalf of the board:                          |                |        |  |        | 
|                                                 |                |        |  |        | 
|                                                 |                |        |  |        | 
|                                                 |                |        |  |        | 
|                                                 |                |        |  |        | 
|                                                 |                |        |  |        | 
|                                                 |                |        |  |        | 
|                                                 |                |        |  |        | 
|                                                 |                |        |  |        | 
|                                                 |                |       
|Douglas D.Baldwin                                | Dale G. Parker |        |  |        | 
|Chairman of the Board                            | Director       |        |  |        | 







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Consolidated Statements of Income

(Years ended December 31)

]





(millions of Canadian dollars)
   2003
   
   2002
   
   2001RevenueGross sales
   5,295
   
   5,299
   
   5,047Less royalties
   894
   
   927
   
   989Net sales
   4,401
   
   4,372
   
   4,058Other (note 11)
   76
   
   80
   
   82Total revenue
   4,477
   
   4,452
   
   4,140ExpensesOperating
   1,099
   
   1,115
   
   946General and administrative
   152
   
   138
   
   108Depreciation, depletion and amortization
   1,443
   
   1,495
   
   1,313Dry hole
   251
   
   174
   
   113Exploration
   213
   
   185
   
   147Interest on long-term debt
   137
   
   164
   
   139Stock-based compensation (note 7)
   185
   
   
   
   Other (note 12)
   16
   
   113
   
   78Total expenses
   3,496
   
   3,384
   
   2,844Gain on sale of Sudan operations (note 17)
   296
   
   
   
   Income before taxes
   1,277
   
   1,068
   
   1,296Taxes (note 13)Current income tax
   229
   
   258
   
   342Future income tax (recovery)
   (51)
   
   162
   
   72Petroleum revenue tax
   92
   
   124
   
   149270
   
   544
   
   563Net income
   1,007
   
   524
   
   733Preferred security charges, net of tax
   22
   
   24
   
   24Net income available to common shareholders
   985
   
   500
   
   709Per common share (Canadian dollars) (note 15)Net income
   7.65
   
   3.73
   
   5.25Diluted net income
   7.57
   
   3.67
   
   5.16Average number of common shares outstanding (millions)
   129
   
   134
   
   135Diluted number of common shares outstanding (millions)
   130
   
   136
   
   137See accompanying notes.Consolidated Statements of Retained Earnings(Years ended December 31)(millions of Canadian dollars)
   2003
   
   2002
   
   2001Retained earnings, beginning of year
   1,071
   
   787
   
   257Net income
   1,007
   
   524
   
   733Common share dividend
(90)
   
   (80)
   
   (81)Purchase of common shares
   (122)
   
   (136)
   
   (98)Preferred security charges, net of tax
   (22)
   
   (24)
   
   (24)Retained earnings, end of year
   1,844
   
   1,071
   
   787See accompanying notes.




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Consolidated Statements of Cash Flows

(Years ended December 31)

|(millions of Canadian dollars)                             | 2003    |  | 2002     |  | 2001    | 
|---------------------------------------------------------- | ------- |  | -------- |  | ------- | 
|                                                           |         |  |          |  |         | 
|Operating                                                  |         |  |          |  |         | 
|Net income                                                 | 1,007   |  | 524      |  | 733     | 
|Items not involving current cash flow (note 14)            | 1,509   |  | 1,936    |  | 1,614   | 
|Exploration                                                | 213     |  | 185      |  | 147     | 
|                                                           |         |  |          |  |         | 
|Cash flow                                                  | 2,729   |  | 2,645    |  | 2,494   | 
|Deferred gain on unwound hedges                            | (9)     |  | (43)     |  | 52      | 
|Changes in non-cash working capital (note 14)              | (104)   |  | (163)    |  | (177)   | 
|                                                           |         |  |          | 
|Cash provided by operating activities                      | 2,616   |  | 2,439    |  | 2,369   | 
|                                                           |         |  |          |  |         | 
|Investing                                                  |         |  |          |  |         | 
|Corporate acquisitions (note 2)                            |        |  |         |  | (1,213) | 
|Proceeds on sale of Sudan operations (note 17)             | 1,012   |  |         |  |        | 
|Capital expenditures                                       |         |  |          |  |         | 
|Exploration,
    development and corporate                 | (2,218) |  | (1,874)  |  | (1,912) | 
|Acquisitions (note 2)                                      | (661)   |  | (244)    |  | (186)   | 
|Proceeds of resource property dispositions                 | 63      |  | 30       |  | 47      | 
|Investments                                                | (11)    |  | (36)     |  |        | 
|Changes in non-cash working capital                        | 82      |  | 2        |  | 52      | 
|                                                           |         |  |          |  |         | 
|Cash used in investing activities                          | (1,733) |  | (2,122)  |  | (3,212) | 
|                                                           |         |  |          | 
|Financing                                                  |         |  |          |  |         | 
|Long-term debt repaid                                      | (791)   |  | (1,397)  |  | (568)   | 
|Long-term debt issued                                      | 292     |  | 1,417    |  | 1,617   | 
|Common shares purchased (net of proceeds on shares issued) | (184)   |  | (184)    |  | (117)   | 
|Common share dividends                                     | (90)    |  | (80)     |  | (81)    | 
|Preferred security charges                                 | (38)    |  | (42)(42) | 
|Deferred credits and other                                 | 27      |  | (21)     |  | (25)    | 
|                                                           |         |  |          |  |         | 
|Cash (used in) provided by financing activities            | (784)   |  | (307)    |  | 784     | 
|                                                           |         |  |          |  |         | 
|Effect of translation on foreign currency cash             | (28)    |  |         |  |        | 
|                                                           |         |  |          |  |         | 
|Net increase (decrease) in cash                            | 71      |  | 10       |  | (59)    | 
|Cash and cash equivalents, beginning of year               | 27      |  | 17       |  | 76      | 
|                                                           |         |  |          |  |         | 
|Cash and cash equivalents, end of year                     | 98      |  | 27       |  | 17      | 
|                                                           |         |  |          |  |         | 
|                                                           |         |  |          |  |         | 
|See accompanying notes.                                    |         |  |          |  |         | 





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Notes to the Consolidated Financial Statements

(tabular amounts in millions of Canadian dollars ($ or C$) except as noted)

1.  Significant Accounting Policies

The Consolidated Financial Statements of Talisman Energy Inc. (Talisman or the Company) have been prepared by management in accordance with Canadian generally accepted accounting principles. A summary of the differences between accounting principles generally accepted in Canada and those generally accepted in the United States (US) is contained in note 19 to these statements.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates.

a) Consolidation

The Consolidated Financial Statements include the accounts of Talisman and its subsidiaries. A substantial portion of Talismans activities is conducted jointly with others and the Consolidated Financial Statements reflect only the Companys proportionate interest in such activities.

b) Inventories

Product inventories are valued at the lower of average cost and market value. Materials and supplies are valued at the lower of average cost and net realizable value.

c) Property, plant and equipment

The successful efforts method is used to account for oil and gas exploration and development costs. Under this method, acquisition costs of oil and gas properties and costs of drilling and equipping development wells are capitalized. Costs of drilling exploratory wells are initially capitalized and, if subsequently determined to be unsuccessful, are charged to dry hole expense. All other exploration costs, including geological and geophysical costs and annual lease rentals, are charged to exploration expense when incurred. Producing properties and significant unproved properties are assessed annually, or more frequent as economic events dictate, for potential impairment. Any impairment loss is the difference between the carrying value of the asset and its net recoverable amount (undiscounted).

d) Depreciation, depletion and amortization

Capitalized costs of proved oil and gas properties are depleted using the unit of production method. For purposes of these calculations, production and reserves of natural gas are converted to barrels on an energy equivalent basis.

Successful exploratory wells and development costs are depleted over proved developed reserves while acquired resource properties with proved reserves, including offshore platform costs, are depleted over proved reserves. Acquisition costs of probable reserves are not depleted or amortized while under active evaluation for commercial reserves. Costs are transferred to depletable costs as proved reserves are recognized. At the date of acquisition, an evaluation period is determined after which any remaining probable reserve costs associated with producing fields are transferred to depletable costs; costs not associated with producing fields are amortized over a period not exceeding the remaining lease term.

Costs associated with significant development projects are not depleted until commercial production commences. Unproved land acquisition costs that are individually immaterial are amortized on a straight-line basis over the average lease term until properties are determined to be productive or impaired. Gas plants, net of estimated salvage values, are depreciated on a straight-line basis over their estimated remaining useful lives, not to exceed the estimated remaining productive lives of related fields. Pipelines and corporate assets are depreciated using the straight-line method at annual rates of 7% and 4% to 33%, respectively.

e) Future site restoration

Estimated costs of future dismantlement, site restoration and abandonment of oil and gas properties, including offshore production platforms, are provided for using the unit of production method while those of gas plants and facilities are provided for using the straight-line method at rates approximating their useful lives but not exceeding the estimated remaining productive lives of related fields. The annual provision is included within depletion, depreciation and amortization expense and is based on engineering estimates and in accordance with existing legislation and industry practice. Expenditures are charged against the accumulated provision as incurred. When a property is disposed of, the associated accumulated provision is eliminated and included in determination of the gain or loss on disposal.

f) Capitalized interest

Interest costs associated with major development projects are capitalized until the necessary facilities are completed and ready for use.



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g) Royalties

Certain of the Companys foreign operations are conducted jointly with the respective national oil companies. These operations are reflected in the Consolidated Financial Statements based on Talismans working interest in such activities. All other government stakes, other than income taxes, are considered to be royalty interests. Royalties on production from these joint foreign operations represent the entitlement of the respective governments to a portion of Talismans share of crude oil, liquids and natural gas production and are recorded using rates in effect under the terms of contracts at the time of production.

h) Petroleum Revenue Tax

United Kingdom Petroleum Revenue Tax (PRT) is accounted for using the life of the field method whereby total future PRT is estimated using current reserves and anticipated costs and prices and charged to income based on net operating income as a proportion of estimated future net operating income. Changes in the estimated total future PRT are accounted for prospectively.

i) Foreign currency translation

Effective January 1, 2002, the Company adopted the US dollar as its functional currency. Prior to January 1, 2002, the functional currency of the Company was the Canadian dollar. The Companys financial results have been reported in Canadian dollars as explained below.

The Companys self-sustaining operations, which include the Canadian and UK operations, are translated into US dollars using the current rate method, whereby assets and liabilities are translated at period-end exchange rates while revenues and expenses are converted using average rates for the period. Gains and losses on translation to US dollars relating to self-sustaining operations are deferred and included in a separate component of shareholders equity described as cumulative foreign currency translation.

The remaining foreign operations are not considered self-sustaining and are translated using the temporal method. Under this method, monetary assets and liabilities denominated in foreign currencies are translated at exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities denominated in foreign currencies are translated at rates in effect on the dates the assets were acquired or liabilities were assumed. Revenues and expenses are translated at rates of exchange prevailing on the transaction dates. Gains and losses on translation are reflected in income when incurred.

The Companys financial results have been reported in Canadian dollars with amounts translated to Canadian dollars as follows: assets and liabilities at the rate of exchange in effect at the applicable balance sheet date and revenues and expenses at the average exchange rates for the periods. The Companys share capital accounts including its preferred securities, common shares and contributed surplus are translated at rates in effect at the time of issuance. Unrealized gains and losses resulting from the translation to Canadian dollars are included in the cumulative foreign currency translation account.

j) Employee benefit plans

The cost of pensions and other retirement benefits earned by employees is determined using the projected benefit method prorated on service and managements best estimate of expected plan investment performance, salary escalation and retirement ages of employees. There is uncertainty relating to the assumptions used to calculate the net benefit plan expense and accrued benefit obligation which are long term, consistent with the nature of employee future benefits.

The discount rate used to determine the accrued benefit obligation is determined by reference to market interest rates at the measurement date on high-quality debt instruments with cash flows that match the timing and amount of expected benefit payments. For purposes of calculating the expected return on plan assets, those assets are valued at fair value. The excess of the net actuarial gain or loss over 10% of the greater of the accured benefit obligation and the fair value of plan assets at the beginning of the year is amortized over the average remaining service life of active employees. The transitional asset and obligations are being amortized over the average remaining service period of active employees expected to receive benefits under the benefit plans.

k) Derivative financial instruments and commodity contracts

The Company may enter into derivative financial instruments to hedge against adverse fluctuations in foreign exchange rates, electricity rates, interest rates and commodity prices. Payments or receipts on derivative financial instruments that are designated and effective as hedges are recognized in income concurrently with the hedged transaction and are recorded in the consolidated statements of income and cash flows in the line item associated with the hedged transaction. For example, gains and losses on commodity hedges are included in revenues.

If the derivative financial instrument that has been designated as a hedge is terminated or is no longer designated as part of the hedging relationship, the gain or loss at that date is deferred and recognized concurrently with the anticipated transaction. If it is no longer probable that the anticipated transaction will occur substantially as and when identified at the inception of the hedging relationship, the gain or loss at that date is recognized immediately. Subsequent changes in the value of the derivative financial instrument are reflected in income. Any derivative financial instrument that does not constitute a hedge is recorded at fair value with any resulting gain or loss reflected in income.

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All of the Companys derivative financial instruments outstanding during 2003 met the hedging requirements under Canadian GAAP. The hedging requirements as amended by AcG 13, consist of the designation of the instrument as a hedge, the identification of the nature of the risk exposure being hedged and that there is reasonable assurance that the instrument is expected to be an effective hedge throughout its term. In addition, in the case of anticipated transactions, it is also probable that the transaction designated as being hedged will occur. The Company assesses, both at the hedges inception and on an ongoing basis, whether the derivative financial instruments that have been designated as hedges are highly effective in offsetting changes in fair value or cash flows of the hedged items.

The Company enters into commodity contracts in the normal course of business including contracts with fixed or optional pricing terms. The contracts outstanding at December 31, 2003 are disclosed in note 9. The Companys production is expected to be sufficient to deliver all required volumes under these contracts. No amounts are recognized in the Consolidated Financial Statements related to these contracts until such time as the associated volumes are delivered.

l) Income taxes

Talisman uses the liability method to account for income taxes. Under the liability method, future income taxes are based on the differences between assets and liabilities reported for financial accounting purposes from those reported for income tax. Future income tax assets and liabilities are measured using substantively enacted tax rates. The impact of a change in tax rate is recognized in net income in the period in which the tax rate is substantively enacted.

Certain of the Companys contractual arrangements in foreign jurisdictions stipulate that income taxes are to be paid by the respective national oil company out of its entitlement share of production. Such amounts are included in income tax expense at the statutory tax rate in effect at the time of production.

m) Revenue recognition

Revenues associated with the sale of crude oil, natural gas and liquids represents the sales value of the Companys share of petroleum production during the year (the entitlement method). Differences between production and amounts sold are not significant. Amounts received under take-or-pay gas sales contracts in respect of undelivered volumes are accounted for as deferred income.

n) Stock-based compensation

Talisman has stock option and cash unit plans for employees and directors, which are described in note 7. In 2003, the option plans were amended to provide holders of stock options the choice upon exercise to receive a cash payment in exchange for surrendering the option. Commencing in 2003, as a result of the amendment to the stock option plans, the Company began recording stock-based compensation expense based on the appreciated value of the outstanding stock options and cash units as determined using the period end closing share price.

A liability for the stock-based compensation is included in accounts payable and accrued liabilities.

o) Goodwill

Goodwill represents the excess purchase price over the fair value of identifiable assets and liabilities acquired in business combinations. Effective January 1, 2002, goodwill ceased to be amortized. Goodwill amortization of $10 million was expensed in 2001. Goodwill is subject to ongoing annual impairment reviews, or more frequent as economic events dictate, based on the fair value of reporting units. The fair value of each reporting unit is determined and compared to the book value of the reporting unit. If the fair value of the reporting unit is less than the book value, then a second test is performed to determine the amount of the impairment. The amount of the impairment is determined by deducting the fair value of the reporting units individual assets and liabilities from the fair value of the reporting unit to determine the implied fair value of goodwill and comparing that amount to the book value of the reporting units goodwill. Any excess of the book value of goodwill over the implied fair value of goodwill is the impairment amount. The Companys reporting units are consistent with the geographic segments included in note 18.

p) Net income and diluted net income per share

Net income per share is calculated by dividing net income after deducting preferred security charges, net of tax, by the weighted average number of common shares outstanding. Diluted net income per share is calculated giving effect to the potential dilution that could occur if convertible instruments, such as stock options, were exercised in exchange for common shares.

The Company uses the treasury method to determine the dilutive impact of convertible instruments. This method assumes that any proceeds from the exercise of a convertible instrument would be used to purchase common shares at the average market price during the period.

q) Cash and cash equivalents

Cash and cash equivalents include short-term investments with an original maturity of three months or less.



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2.  Acquisitions

The following acquisitions have been accounted for using the purchase method and the results have been included in these Consolidated Financial Statements from the date of acquisition.

Significant Corporate Acquisitions

Petromet Resources Limited

In May 2001, Talisman acquired Petromet Resources Limited (Petromet), an oil and gas exploration and development company, for $765 million and long-term debt assumed of $57 million.

Net Assets AcquiredProperty, plant and equipment
   795Goodwill
   301Net non-cash working capital
   (6)Future income tax
   (264)826Less acquisition costs
   (4)822


Lundin Oil AB

In August 2001, Talisman acquired Lundin Oil AB (Lundin), an oil and gas exploration and development company, for $431 million (net of cash on hand) and long-term debt assumed of $70 million.

Net Assets AcquiredProperty, plant and equipment
   515Goodwill
   176Net non-cash working capital

   (19)Future income tax
   (158)514Less acquisition costs
   (13)501


Other Acquisitions

During 2003, Talisman completed a number of individually insignificant oil and gas property and corporate acquisitions for a total cost of $768 million, comprised of $661 million in cash, $70 million of assumed debt and working capital deficiency and $37 million of properties exchanged. Four of the transactions account for the majority of the acquisitions and were acquired for a total cost of $626 million. These four acquisitions included oil and gas properties in North America and the North Sea and a company with midstream assets in North America.

|Net assets acquired            | North America |  | North Sea |  | Combined | 
|------------------------------ | ------------- |  | --------- |  | -------- | 
|                               |               |  |           |  |          | 
|Property, plant and equipment  | 541           |  | 112       |  | 653      | 
|Goodwill                       |              |  | 31        |  | 31       | 
|Future income tax              | (27)          |  | (31)      |  | (58)     | 
|                               |               |  |           |  |          | 
|                               | 514           |  | 112       |  | 626      | 
|                               |               |  |           |  |          | 
|                               |               |  |           |  |          | 
|Goodwill Continuity            |               |  |           |  |          | 
|                               | 2003          |  | 2002      |  | 2001     | 
|                               |               |  |           |  |          | 
|Opening balance at January 1   | 469           |  | 467       |  |         | 
|Acquired during year           | 31            |  |          |  | 477      | 
|Amortization                   |              |  |          |  | (10)     | 
|Foreign currency translation   | (27)          |  | 2         |  |         | 
|                               |               |  |           |  |          | 
|Closing balance at December 31 | 473           |  | 469       |  | 467      | 
|                               |               |  |           |  |          | 

Effective January 1, 2002 goodwill ceased to be subject to amortization.

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|3.                                                                                                                                                                                                                                                                                                           | Inventories                                           |        |     |                      |     |                    | 
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ----------------------------------------------------- | ------ | --- | -------------------- | --- | ------------------ | 
|                                                                                                                                                                                                                                                                                                             | December 31                                           |        |     | 2003                 |     | 2002               | 
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     |                      |     |                    | 
|                                                                                                                                                                                                                                                                                                             | Materials and supplies                                |        |     | 95                   |     | 143                | 
|                                                                                                                                                                                                                                                                                                             | Product                                               |        |     | 5                    |     | 4                  | 
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     |                      |     |                    | 
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     | 100                  |     | 147                | 
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     |                      |     |                    | 
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     |                      |     |                    | 
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     |                      |     |                    | 
|4.                                                                                                                                                                                                                                                                                                           | Property, Plant and Equipment                         |        |     |                      |     |                   
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     | Accumulated
    DD&A |     | Net book
    value | 
|                                                                                                                                                                                                                                                                                                             | December 31, 2003                                     | Cost   |     |                      |    
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     |                      |     |                    | 
|                                                                                                                                                                                                                                                                                                             | Oil and gas properties                                | 10,426 |     | 4,774                |     | 5,652              | 
|                                                                                                                                                                                                                                                                                                             | Gas plants, pipelines and production equipment        | 5,860  |     | 1,813                |     | 4,047              | 
|                                                                                                                                                                                                                                                                                                             | Corporate assets                                      | 242    |     | 163                  |     | 79                 | 
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     |                      |     |                    | 
|                                                                                                                                                                                                                                                                                                             |                                                       | 16,528 |     | 6,750                |     | 9,778              | 
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     |                      |     |                    | 
|                                                                                                                                                                                                                                                                                                             | December 31, 2002                                     |        |     |                      |     |                    | 
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     |                      |     |                    | 
|                                                                                                                                                                                                                                                                                                             | Oil and gas properties                                | 10,198 |     | 4,264                |     | 5,934              | 
|                                                                                                                                                                                                                                                                                                             | Gas plants, pipelines and production equipment        | 5,576  |     | 1,547                |     | 4,029              | 
|                                                                                                                                                                                                                                                                                                             | Corporate assets                                      | 213    |     | 134                  |     | 79                 | 
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     |                      |     |                    | 
|                                                                                                                                                                                                                                                                                                             |                                                       | 15,987 |     | 5,945                |     | 10,042             | 
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     |                      |     |                    | 
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     |                      |     |                    | 
|In the year ended December 31, 2003, interest costs of $24 million (2002  $25 million,
    2001  $19 million) were capitalized.
    Included in property, plant and equipment are the following costs that were not subject to depreciation,
    depletion or amortization (DD&A) as
    at December 31: |                                                      
|                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     |                      |     |                    | 
|                                                                                                                                                                                                                                                                                                             | Non-depleted capital at December 31                   |        |     | 2003                 |     | 2002               | 
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     |                      |     |                    | 
|                                                                                                                                                                                                                                                                                                             | Acquired probable reserve costs1                      |        |     |                      |     |                    | 
|                                                                                                                                                                                                                                                                                                             | North America  associated with producing fields      |        | 140 |                      | 102 |                   
|                                                                                                                                                                                                                                                                                                             | North Sea  not associated with producing fields      |        |     | 14                   |     | 13                 | 
|                                                                                                                                                                                                                                                                                                             | Southeast Asia  not associated with producing fields |        | -   |                      | 39  |                   
|                                                                                                                                                                                                                                                                                                             | Exploration costs2                                    |        |     | 283                  |     | 353                | 
|                                                                                                                                                                                                                                                                                                             | Development projects3                                 |        |     |                      |     |                    | 
|                                                                                                                                                                                                                                                                                                             | Southeast Asia                                        |        |     | 265                  |     | 437                | 
|                                                                                                                                                                                                                                                                                                             | North Sea                                             |        |     | 17                   |     | 44                 | 
|                                                                                                                                                                                                                                                                                                             | Algeria                                               |        |     | 39                   |     | 175                | 
|                                                                                                                                                                                                                                                                                                             | Trinidad                                              |        |     | 108                  |     | 30                 | 
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     |                      |     |                    | 
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     | 866                  |     | 1,193              | 
|                                                                                                                                                                                                                                                                                                             |                                                       |        |     |                      |     |                    | 

|1 | Acquisition costs of probable reserves are not depleted or amortized while under active evaluation for commercial reserves.                                        
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2 | Exploration costs consist of drilling in progress and wells awaiting determination of proved reserves, approval of development plans or commencement of production.
|3 | Development projects are not depleted pending initial production.                                                                                                  

The carrying values of property, plant and equipment, including acquired probable reserve costs, are subject to uncertainty associated with the quantity of oil and gas reserves, future production rates, commodity prices and other factors. Future events could result in material changes to the carrying values recognized in the Consolidated Financial Statements.



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5.
   Long-Term DebtDecember 31
   
   2003
   
   2002Bank Credit Facilities1Bank Credit Facilities (2002  3.32%)
   
   
   
   265Debentures and Notes (Unsecured)36.625% notes (£250 million), due 20175
   
   471
   
   5767.25% debentures (US$300 million),due 2027
   
   388
   
   4745.80% medium term notes, due 2007
   
   385
   
   3856.96% notes (US$200 million), due 2005
   
   258
   
   3167.125% debentures (US$175 million),due 2007
   
   226
   
   2765.70% medium term notes, due 2003
   
   
   
   1808.06% medium term notes, due 2009
   
   174
   
   1746.68% notes (US$100 million),due 2008
   
   129
   
   1586.89% notes (US$50 million),Series B, due 20064
   
   65
   
   799.80% debentures, Series B, due 20042
   
   75
   
   756.71% notes (US$25 million),Series A, due 20042
   
   32
   
   392,203
   
   2,997


|1 | Rates reflect the weighted-average interest rate of instruments outstanding at December 31. Rates are floating rate-based and vary with changes in short-term market interest rates.                                                     
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2 | The amounts outstanding at December 31, 2003 have been classified as long-term debt since the Company has the ability and intention to replace the current portions with long-term borrowings under the revolving bank credit facilities.
|3 | Interest on debentures and notes is payable semi-annually except for interest on the 6.625% notes (£250 million) which is payable annually.                                                                                              
|4 | Repayable in five equal annual installments commencing 2006.                                                                                                                                                                             
|5 | The £250 million Eurobond has been effectively swapped into a US$364 million indebtedness with floating interest payments based on three-month US LIBOR with an effective interest rate of 2.07% at December 31, 2003 (see note 9).      

Bank Credit Facilities

Talisman has unsecured credit facilities totaling $1,135 million, consisting of facilities of $405 million (Facility No. 1), $530 million (Facility No. 2), $150 million (Facility No. 3) and $50 million (Facility No. 4). The maturity date of Facility No. 1 is March 23, 2006, although this date may be extended from time to time upon agreement between the Company and the respective lenders. Prior to the maturity date, the Company may borrow, repay and reborrow at its discretion. The term dates of Facility Nos. 2, 3 and 4 are March 16, 2004, August 23, 2004 and November 24, 2004, respectively. Until each term date, the Company may borrow, repay and reborrow at its discretion. Annually, upon agreement between the Company and the respective lenders, each term date may be extended for an additional 364 days. Facility No. 2 expires two years after its term date and, if the term is not extended, must be repaid on the maturity date. Facility Nos. 3 and 4 expire one year after their term dates and, if the terms are not extended, must be repaid on the maturity date.

Borrowings under Facility Nos. 1 and 2 are available in the form of prime loans, Canadian or US dollar bankers acceptances, US dollar base rate loans or LIBOR-based loans. In addition, drawings to a total of $467 million may be made by letters of credit. Borrowings under Facility No. 3 are available in the form of prime loans, Canadian or US dollar bankers acceptances, US dollar base rate loans, LIBOR-based loans and letters of credit. Borrowings under Facility No. 4 are available in the form of prime loans, Canadian or US dollar guaranteed notes, US dollar base rate loans and LIBOR-based loans.

Repayment Schedule



|1 | The portion of long-term debt payable in 2004 has been classified as long-term debt since the Company has the ability and intention to replace the current portion with long-term borrowings under the revolving bank credit facilities.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





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C o n s o l i d a t e d   F i n a n c i a l   S t a t e m e n t s

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6.  Preferred Securities

During 1999, Talisman issued 12 million preferred securities (securities) as unsecured junior subordinated debentures,at US$25 per security, of which six million 9% securities are due February 15, 2048 and six million 8.9% securities are due June 15, 2048. The securities are redeemable, in whole or in part, at par by Talisman through the payment of cash or issuance of common shares at any time on or after February 15, 2004 and June 15, 2004, respectively. The Company has the option to defer the payment of the security charges for up to 20 consecutive three-month periods and satisfy such deferred security charges with either cash or the issuance of common shares. Security charges are due quarterly.

In December 2003, the Company announced its intention to exercise its right to redeem the outstanding six million 9% securities for US$150 million. The difference between the carrying amount of the redeemed securities and the cost of the redemption will be credited directly to retained earnings.

7.  Share Capital

Talismans authorized share capital consists of an unlimited number of common shares without nominal or par value and first and second preferred shares. No preferred shares have been issued.

Continuity of common shares
   2003
   
   2002
   
   2001Shares
   
   Amount
   
   Shares
   
   Amount
   
   Shares
   
   AmountBalance, beginning of year
   131,039,435
   
   2,785
   
   133,733,182
   
   2,831
   
   135,344,045
   
   2,849Issued on exercise of options
   294,893
   
   11
   
   1,154,067
   
   36
   
   1,512,898
   
   49Purchased during year
   (3,335,600)
   
   (71)
   
   (3,847,500)
   
   (82)
   
   (3,036,400)
   
   (65)Cancelled pursuant to termsof plans of arrangements
   
   
   
   
   (314)
   
   
   
   (87,361)
   
   (2)Balance, end of year
   127,998,728
   
   2,725
   
   131,039,435
   
   2,785
   
   133,733,182
   
   2,831


During the year ended December 31, 2003, Talisman repurchased 3,335,600 common shares of the Company pursuant to a normal course issuer bid for a total of $194 million (2002  $220 million; 2001  $166 million). The cost to repurchase common shares in excess of their average book value has been charged to retained earnings, contributed surplus and cumulative foreign currency translation. In 2001, Talisman cancelled 87,361 common shares of the Company pursuant to the terms of the offering agreements of certain past corporate acquisitions. As a result of the cancellation of these shares, $2 million was credited to contributed surplus. An additional 314 common shares were cancelled in 2002.

Stock Option Plans

Talisman has stock option plans that allow employees and directors to receive options to purchase common shares of the Company. Options granted under the plans are generally exercisable after three years and expire 10 years after the grant date. Option exercise prices approximate the market price for the common shares on the date the options are granted.

Effective 2003, the stock option plans were amended to provide option holders the choice upon exercise to receive a cash payment in exchange for surrendering the option. The cash payment is equal to the appreciated value of the stock option as determined based on the difference between the options exercise price and the Companys share price at the time of surrender. As a result, in accordance with the accounting policy described in note 1(n), the Companys 2003 results included a $105 million ($74 million, or $0.57/share, net of tax) stock-based compensation expense relating to the appreciated value of the Companys outstanding stock options and cash units at June 30, 2003. The total stock-based compensation expense for the year was $185 million ($130 million, net of tax) including $80 million during the second half of 2003 due to the appreciation of the Companys stock price during the period July 1 to December 31. Additional stock-based compensation expense or recoveries in future periods is dependent on the movement of the Companys share price and the number of outstanding options and cash units.



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The following table provides pro forma measures of net income and net income per common share had stock options been recognized as compensation expense based on the estimated fair value of the options on the grant date.

2003
   
   2002
   
   2001Net income as reported
   1,007
   
   524
   
   733Stock-based compensation expensed
   105
   
   
   
   Net income before stock-based compensation
   1,112
   
   524
   
   733Stock option expense based on fair market value
   21
   
   31
   
   24Pro forma net income1
   1,091
   
   493
   
   709Pro forma net income per share1Basic
   8.31
   
   3.50
   
   5.08Diluted
   8.21
   
   3.44
   
   4.99


1 Pro forma net income and net income per share had stock options been recognized as compensation expense based on the estimated fair value of the options on the grant date.

Stock options granted in 2003 had an estimated weighted-average fair value of $22.91 per option (2002  $26.19 per option; 2001  $22.80 per option). All options issued by the Company permit the holder to purchase one common share of the Company at the stated exercise price, or effective 2003, to receive a cash payment equal to the appreciated value of the stock option.

The estimated fair value of stock options issued was determined using the Black-Scholes model using the following weighted-average assumptions:

2003
   
   2002
   
   2001Risk-free interest rate (%)
   
   
   
   
   
   4.1
   
   5.1
   
   4.9Estimated hold period prior to exercise (years)
   
   
   
   
   
   5.3
   
   5.4
   
   5.3Volatility in the price of the Companys common shares (%)
   
   
   
   
   
   40
   
   41
   
   39Dividends ($/share)
   
   
   
   
   
   0.60
   
   0.60
   
   0.60




Continuity of stock options
   2003
   
   2002
   
   2001Number
   
   Average
   
   Number
   
   Average
   
   Number
   
   Averageof
   
   Exercise
   
   of
   
   Exercise
   
   
   of
   
   ExerciseOptions
   
   Price
   
   Options
   
   Price
   
   Options
   
   PriceOutstanding at January 1
   7,384,054
   
   46.53
   
   7,497,611
   
   41.49
   
   6,854,806
   
   33.84Granted
   2,394,699
   
   59.48
   
   1,100,710
   
   64.73
   
   2,301,828
   
   58.39Exercised for common shares
   294,893
   
   33.81
   
   1,154,067
   
   30.54
   
   1,512,898
   
   32.19Exercised for cash payment
   1,420,237
   
   35.51
   
   
   
   
   
   
   
   
   Forfeited
   196,540
   
   58.88
   
   59,150
   
   57.53
   
   146,125
   
   45.24Expired
   551
   
   30.53
   
   1,050
   
   57.88
   
   
   
   
   Outstanding at December 31
   7,866,532
   
   52.64
   
   7,384,054
   
   46.53
   
   7,497,611
   
   41.49Exercisable at December 31
   2,580,955
   
   37.38
   
   3,142,629
   
   34.34
   
   3,246,985
   
   35.87Options available for future grantspursuant to the Companys StockOption Plans
   4,678,518
   
   
   
   3,155,889
   
   
   
   4,196,399




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C o n s o l i d a t e d   F i n a n c i a l   S t a t e m e n t s

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The range of exercise prices of the Companys outstanding stock options is as follows:

December 31, 2003
   
   Outstanding Options
   
   Exercisable OptionsWeighted
   
   Weighted
   
   
   
   WeightedNumber
   
   Average
   
   Average
   
   Number
   
   Averageof
   
   Exercise
   
   Years to
   
   of
   
   ExerciseRange of Exercise Prices
   
   Options
   
   Price
   
   Expiry
   
   Options
   
   Price$
   24.25 to $29.99
   
   672,555
   
   25.62
   
   4
   
   672,555
   
   25.62$
   30.00 to $39.99
   
   814,305
   
   36.80
   
   5
   
   814,305
   
   36.80$
   40.00 to $49.99
   
   932,000
   
   42.25
   
   4
   
   932,000
   
   42.25$
   50.00 to $59.99
   
   4,262,362
   
   58.88
   
   8
   
   92,145
   
   58.24$
   60.00 to $68.36
   
   1,185,310
   
   64.55
   
   8
   
   69,950
   
   64.73$
   24.25 to $68.36
   
   7,866,532
   
   52.64
   
   7
   
   2,580,955
   
   37.38


At December 31, 2003, 12,545,050 common shares were reserved for issuance related to the stock option plans.

Cash Units

In addition to the Companys stock option plans, Talismans subsidiaries during 2003 issued 384,505 cash units with an average exercise price of $59.48/cash unit to certain employees. Cash units are similar to stock options except that the holder does not have a right to purchase the underlying share of the Company.

8.  Cumulative Foreign Currency Translation

In accordance with the Companys foreign exchange translation accounting policy, as disclosed in note 1(i),foreign exchange gains or losses on translation of self-sustaining operations and the translation of the Companys financial results into Canadian dollars for reporting purposes are included in shareholders equity in the cumulative foreign currency translation account.

The following components give rise to the exchange gains or (losses) included in the cumulative foreign currency translation account as at December 31:

2003
   
   2002Property, plant and equipment
   (443)
   
   220Future tax liabilities (including
    PRT)
   37
   
   (47)Provision for site restoration
   (4)
   
   (71)Long-term debt
   341
   
   13Working capital
   (20)
   
   23Goodwill
   (25)
   
   2(114)
   
   140




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9.  Financial Instruments

Financial contracts

The Company entered into natural gas and crude oil price derivative contracts to reduce the volatility of the Companys cash flows associated with anticipated natural gas and crude oil sales. The amounts shown below are the weighted-average of the contracts outstanding.

|Natural gas derivative contracts   |                            |                              |                        |      |                            
|---------------------------------- | -------------------------- | ---------------------------- | ---------------------- | ---- | ---------------------------
|Fixed price swaps (NYMEX)2004      | Two-way collars (AECO)2004 |                             
|                                  
|Volumes (mcf/d)48,400              | Volumes (mcf/d)6,900       |                              |                        |     
|Price ($/mcf)5.91                  | Ceiling ($/mcf)9.55        |                              |                        |     
|                                   |                            |                              |                        |      | Floor ($/mcf)6.81          
|                                  
|                                   |                            |                              |                        |      |                            
|Crude oil derivative contracts     |                            |                              |                        |      |                            
|Fixed price swaps                  |                            |                              | 2004                   | 2005 | Two-way collars            
|                                  
|(WTI oil index)(WTI oil index)     |                            |                              |                        |      |                            
|Volumes (bbls/d)12,000             |                            | 6,000                        | Volumes (bbls/d)25,000 |     
|Price (US$/bbl)29.20               | 26.97                      | Ceiling price (US$/bbl)28.90 |                       
|                                   |                            |                              |                        |      | Floor price (US$/bbl)25.08 
|                                  
|(Brent oil index)(Brent oil index) |                            |                              |                        |      |                            
|Volumes (bbls/d)                   |                            |                              | 11,000                 |      | Volumes (bbls/d)           
|Price (US$/bbl)                    |                            |                              | 26.08                  |      | Ceiling price (US$bbl)26.61
|                                   |                            |                              |                        |      | Floor price (US&/bbl)23.56 
|                                  
|                                   |                            |                              |                        |      |                            
|Interest rates                     |                            |                              |                        |      |                            

In December 1994, in anticipation of issuing the US$175 million 7.125% debentures, Talisman entered into interest rate swap contracts to hedge against possible adverse interest rate fluctuations. These contracts result in Talisman paying interest at a rate of 8.295% in exchange for receiving the three-month LIBOR rate on notional principal of US$100 million until May 16, 2005. Based on the LIBOR rate at December 31, 2003, these contracts result in an effective rate of interest on the debentures of 11.2%. Effective January 1, 2004 these contracts are no longer designated as hedges of the debentures. The accumulative loss on these contracts at December 31, 2003 will be deferred and amortized into income over their remaining term.

Cross currency and interest rate swaps

The Company had designated its US dollar cross currency and interest rate swap contracts outstanding during 2003 as hedges of the £250 million Eurobond. This in effect converted the Eurobond to US$364 million with a floating interest rate based on three-month US LIBOR. Effective January 1, 2004, these swap contracts are no longer designated as hedges of the Eurobond. The accumulative gain on these contracts at December 31, 2003 will be deferred and amortized into income over the original term of the swap contracts. Subsequent to year end, the Company terminated contracts totaling a nominal amount of £190 million for proceeds of $108 million. The remaining contracts expire December 5, 2009.

Carrying Amounts and Estimated Fair Values of Financial Instruments

|Asset (liability) at December 31       | 2003     |  |         |  | 2002         |  |          | 
|-------------------------------------- | -------- |  | ------- |  | ------------ |  | -------- | 
|                                       | Carrying |  | Fair    |  |              |  | Carrying | 
|                                       | Value    |  | Value   |  | Unrecognized |  | Value    | 
|Debentures and notes                   | (2,203)  |  | (2,535) |  | (332)        |  | (2,732)  | 
|Forward foreign currency swaps         |         |  |        |  |             |  |         | 
|Cross currency and interest rate swaps |         |  | 110     |  | 110          |  |         | 
|Natural gas derivatives                |         |  | (21)    |  | (21)         |  |         | 
|Crude oil derivatives                  |         |  | (81)    |  | (81)         |  |         | 
|                                       |          |  |         |  |              |  |          | 





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Borrowings under bank credit facilities are for short terms and are market rate based, thus, carrying values approximate fair value. The fair value of debentures and notes is based on market quotations, which reflect the discounted present value of the principal and interest payments using the effective yield at December 31 for instruments having the same term and risk characteristics. Fair values for derivative instruments are determined based on the estimated cash payment or receipt necessary to settle the contract at December 31. Cash payments or receipts are based on discounted cash flow analysis using current market rates and prices.

The fair values of other financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and income and other taxes payable, approximate their carrying values.

Credit Risk

A significant portion of the Companys accounts receivable is due from entities in the oil and gas industry. Concentration of credit risk is mitigated by having a broad domestic and international customer base, which includes a significant number of companies engaged in joint operations with Talisman. The Company routinely assesses the financial strength of its partners and customers, including parties involved in marketing or other commodity arrangements. The Companys largest credit exposure to a single party is approximately $60 million.

The Company is exposed to credit risk associated with possible non-performance by derivative instrument counterparties. The Company actively limits the total exposure to individual
counterparties.

10.     Contingencies and Commitments

From time to time, Talisman is the subject of litigation arising out of the Companys operations. These claims, including the lawsuit discussed below, are not currently expected to have a material impact on the Companys financial position.

Talisman is subject to a lawsuit brought by the Presbyterian Church of Sudan and others under the Alien Tort Claims Act in the United States District Court for the Southern District of New York. The lawsuit, which is seeking class action status, alleges that the Company conspired with, or aided and abetted, the Government of Sudan to commit violations of international law in connection with the Companys now disposed of indirect interest in oil operations in Sudan. In July 2003, Talisman filed a motion to dismiss the lawsuit for lack of personal jurisdiction of the Court over Talisman. In August 2003, the plaintiffs filed a motion seeking certification of the case as a class action. Talisman is in the process of challenging this certification. No decision is expected on either of these motions prior to the third quarter of 2004. Talisman believes these claims to be entirely without merit and is continuing to vigorously defend itself against this lawsuit and does not expect this to have a material adverse effect.

Talismans estimated total undiscounted future dismantlement, site restoration and abandonment liability at December 31, 2003 was $2.0 billion (2002  $1.7 billion), approximately 80% of which is denominated in UK Pounds Sterling. At December 31, 2003, Talisman had accrued $840 million (2002  $813 million) of this liability. Estimated future dismantlement, site restoration and abandonment costs and the related provision in the Consolidated Financial Statements are subject to uncertainty associated with the method, timing and extent of future dismantlement, site restoration and abandonment. For example, changes in legislation or technology may result in actual future costs that differ materially from those estimated. The Company has provided letters of credit in 2004 in the amount of $547 million of which a majority were provided as security for the costs of future dismantlement, site restoration and abandonment obligations in the North Sea ($472 million). The remaining outstanding letters of credit primarily relate to a retirement compensation arrangement and the guarantee of a minimum work commitment.

Talisman has firm commitments for gathering, processing and transportation services that require the Company to pay tariffs to third parties for processing or shipment of certain minimum quantities of crude oil and liquids and natural gas. The Company has sufficient production to meet these commitments.

Talisman leases certain of its ocean-going vessels and corporate offices, all of which are accounted for as operating leases. The term of the Ross Floating Production, Storage and Offloading vessel (FPSO) lease depends on the expected life of the Ross and Blake fields. A lease for an FPSO contracted in Malaysia expires in 2004. In addition, Talisman has ongoing operating commitments associated with the vessels.



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Estimated future minimum commitments1Subsequent2004
   
   2005
   
   2006
   
   2007
   
   2008
   
   to 2008
   
   TotalOffice leases
   19
   
   16
   
   16
   
   16
   
   16
   
   113
   
   196Vessel leases
   95
   
   
   
   
   
   
   
   
   
   
   
   95Transportation and processing commitments2
   135
   
   99
   
   82
   
   76
   
   70
   
   617
   
   1,079Minimum work commitments
   203
   
   47
   
   30
   
   21
   
   7
   
   
   
   308Abandonment obligations
   9
   
   9
   
   25
   
   80
   
   12
   
   1,883
   
   2,018Other service contracts
   19
   
   16
   
   16
   
   5
   
   4
   
   71
   
   131Total
   480
   
   187
   
   169
   
   198
   
   109
   
   2,684
   
   3,827


|1 | Future minimum payments denominated in foreign currencies have been translated into Canadian dollars based on the December 31, 2003 exchange rate.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------
|2 | Certain of the Companys transportation commitments are tied to firm gas sales contracts.                                                         

The Company has entered into sales contracts for a portion of its future North American natural gas production. The following are the average volumes under contract and the weighted-average contract price in each of the years shown.

Fixed price sales
   2004
   
   2005
   
   2006
   Three-way collars
   2004Volumes (mcf/d)
   40,250
   
   14,650
   
   14,650
   Volumes (mcf/d)
   15,300Average price ($/mcf)
   3.89
   
   3.29
   
   3.29
   Call strike ($/mcf)
   3.49Put strike ($/mcf)
   3.32Sold put strike ($/mcf)
   2.67


The three-way collars are similar to two-way commodity collars with the call and put strike prices being equivalent to the ceiling and floor prices, except that should the NIT (Nova Inventory Transfer) index fall below the sold put strike price, Talisman will receive NIT plus the difference between the put strike and sold put strike prices.

11.
   Other RevenueYears ended December 31
   2003
   
   2002
   
   2001Pipeline and custom treating tariffs
   63
   
   69
   
   63Investment income
   9
   
   8
   
   15Marketing income
   4
   
   3
   
   476
   
   80
   
   8212.
   Other Expenses (Income)Years ended December 31
   2003
   
   2002
   
   2001Net loss (gain) on asset disposals
   (14)
   
   10
   
   (11)Foreign exchange losses
   7
   
   28
   
   51Project loan facility deferred costs write-off
   
   
   
   
   17Property impairments
   30
   
   74
   
   Other expense (income)
   (7)
   
   1
   
   2116
   
   113
   
   78


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C o n s o l i d a t e d   F i n a n c i a l   S t a t e m e n t s

---

13.     Taxes

Income Taxes

The current and future income taxes for each of the three years ended December 31 are as follows:

2003
   

   2002
  2001Current income taxes (recovery)North America1
   21
   
   (20)45North Sea
   99
   
   131
   
   162Southeast Asia
   84
   
   76
   
   83Sudan
   17
   
   68
   
   50Other
   8
   
   3
   
   2229
   
   258
   
   342Future income taxes (recovery)North America1
   (49)
   
   67
   
   134North Sea
   22
   
   116
   
   (69)Southeast Asia
   (13)
   
   (3)15Algeria
   4
   
   
   
   Sudan
   9
   
   16
   
   3Other
   (24)
   
   (34)
   
   (11)(51)
   
   162
   
   72Income
    taxes
   178
   
   420
   
   4141 Current North America income taxes include the Canadian federal tax on large corporations,
    net of Alberta royalty tax credits.The components of the net future tax liability at December 31, are as follows:2003
   
   2002Future tax liabilitiesProperty, plant and equipment
   
   
   2,251
   
   2,392Pension assets
   
   
   22
   
   21Other
   
   
   216
   
   1842,489
   
   2,597Future tax assetsProvision for future site restoration
   
   
   332
   
   297Other
   
   
   69
   
   64401
   
   361Net future tax liability
   
   
   2,088
   
   2,236


Future distribution taxes associated with operations in the UK have not been recorded because, based on current plans, repatriation of funds in excess of foreign reinvestment will not result in material amounts of tax expense. Unremitted earnings in other foreign jurisdictions are not material.



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---

Income taxes vary from the amount that would be computed by applying the Canadian statutory income tax rate of 35.36% for the year ended December 31, 2003 (2002  42.08%; 2001  42.45%) as follows:

Years ended December 31
   2003
   
   2002
   
   2001Income taxes calculated at the Canadian statutory rate
   451
   
   442
   
   572Increase (decrease) in income taxes resulting from:Non-deductible royalties, mineral taxes and expenses
   158
   
   138
   
   207Resource allowances
   (122)
   
   (128)
   
   (168)Change in statutory tax rates
   (160)
   
   116
   
   (34)Non-taxable income
   (80)
   
   
   
   Deductible PRT expense
   (32)
   
   (51)
   
   (62)Lower foreign tax rates (net)
   (2)
   
   (80)
   
   (90)Provincial rebates and credits
   (12)
   
   (10)
   
   (40)Federal tax on large corporations
   10
   
   9
   
   9Other
   (33)
   
   (16)
   
   20Income taxes
   178
   
   420
   
   414


Petroleum Revenue Tax

Petroleum Revenue Tax (PRT) expense primarily relates to the UK and is comprised of current tax expense of $72 million (2002  $91 million; 2001  $102 million) and deferred tax expense of $20 million (2002  $33 million; 2001  $47 million). The measurement of PRT expense and the related provision in the Consolidated Financial Statements is subject to uncertainty associated with future recovery of oil and gas reserves, commodity prices and the timing of future events, which could result in material changes to deferred amounts.

14.     Consolidated Statements of Cash Flows

Selected cash flow information:

Years ended December 31
   2003
   
   2002
   
   2001Net income
   1,007
   
   524
   
   733Items not involving current cash flowDepreciation, depletion and amortization
   1,443
   
   1,495
   
   1,313Property impairments
   30
   
   74
   
   Dry hole
   251
   
   174
   
   113Net loss (gain) on asset disposals
   (14)
   
   10
   
   (11)Gain on sale of Sudan
   (296)
   
   
   
   Stock-based compensation
   138
   
   
   
   Future taxes and deferred PRT
   (32)
   
   195
   
   119Other
   (11)
   
   (12)801,509
   
   1,936
   
   1,614Exploration
   213
   
   185
   
   147Cash flow
   2,729
   
   2,645
   
   2,494Cash interest paid (net of capitalized interest)
   139
   
   156
   
   137Cash income taxes paid
   168
   
   274
   
   365






62        
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C o n s o l i d a t e d   F i n a n c i a l   S t a t e m e n t s

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Changes in operating non-cash working capital consisted of the following:

Years ended December 31
   2003
   
   2002
   
   2001Accounts receivable
   (32)
   
   (155)266Inventories
   32
   
   (42)10Prepaid expenses
   4
   
   5
   
   (9)Accounts payable and accrued liabilities
   (63)
   
   (16)(323)Income and other taxes payable
   (45)
   
   45
   
   (121)Net use of cash
   (104)
   
   (163)
   
   (177)15.
   Net Income and Diluted Net Income Per ShareThe following table summarizes the calculation of net income and diluted net income per share.2003
   
   2002
   
   2001Net income
   1,007
   
   524
   
   733Less preferred security charges, net of tax
   22
   
   24
   
   24Net income available to common shareholders
   985
   
   500
   
   709Weighted average number of common shares outstanding (millions)  basic
   129
   
   134
   
   135Dilution effect of stock options (millions)
   1
   
   2
   
   2Weighted average number of commons shares outstanding (millions)  diluted
   130
   
   136
   
   137Net income per share ($/share)Basic
   7.65
   
   3.73
   
   5.25Diluted
   7.57
   
   3.67
   
   5.16


Outstanding stock options are the only instruments that are currently dilutive to earnings per share. For 2003, 1,168,210 stock options that were antidilutive have been excluded from the computation of diluted earnings per share (2002  1,080,035; 2001  2,249,145).

16.     Employee Benefits

The Company sponsors both defined benefit and defined contribution pension arrangements covering substantially all employees. The Company uses actuarial reports prepared by independent actuaries for funding and accounting purposes. The Company uses a December 31 measurement date for the majority of its defined benefit pension plans. The following significant actuarial assumptions were employed to determine the periodic pension expense and the accrued benefit obligations:

2003
   
   2002
   
   2001Expected long-term rate of return on plan assets (%)
   7.5
   
   7.5
   
   7.5Discount rate (%)
   6.4
   
   6.5
   
   6.5Rate of compensation increase (%)
   4.5
   
   4.5
   
   4.5The Companys net benefit plan expense (credit) is as follows:2003
   
   2002
   
   2001Current service cost  defined benefit
   7
   
   5
   
   2Current service cost  defined contribution
   7
   
   6
   
   5Interest cost
   8
   
   7
   
   5Expected return on plan assets
   (9)
   
   (11)(10)Amortization of net transitional asset
   (1)
   
   (1)(1)Amortization of actuarial losses
   2
   
   
   
   Net benefit plan expense
   14
   
   6
   
   1




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Information about the Companys defined benefit pension plans is as follows:

2003
   
   2002Pension plans grouped
   
   Pension plans groupedby funded status
   
   by funded statusSurplus
   
   Deficit1
   
   Surplus
   
   Deficit1Accrued benefit obligationAccrued benefit obligation, beginning of year
   54
   
   63
   
   53
   
   42Current service cost
   1
   
   6
   
   1
   
   4Interest cost
   4
   
   4
   
   3
   
   3Actuarial losses
   7
   
   8
   
   1
   
   14Plan participants contributions
   
   
   1
   
   
   
   1Benefits paid
   (4)
   
   (4)
   
   (4)
   
   (1)Accrued benefit obligation, end of year
   62
   
   78
   
   54
   
   63Plan assetsFair value of plan assets, beginning of year
   114
   
   21
   
   128
   
   21Actual gain (loss) on plan assets
   14
   
   3
   
   (4)(5)Employer contributions
   
   
   8
   
   
   
   5Plan participants contributions
   
   
   1
   
   
   
   1Surplus applied to defined contribution plan
   (7)
   
   
   
   (6)
   
   Benefits paid
   (4)
   
   (4)
   
   (4)
   
   (1)Fair value of plan assets, end of year
   117
   
   29
   
   114
   
   21Funded status  surplus (deficit)
   55
   
   (49)
   
   60
   
   (42)Unamortized net actuarial loss
   19
   
   26
   
   18
   
   21Unamortized net transitional (asset) obligation
   (11)
   
   3
   
   (11)
   
   2Net accrued benefit asset (liability)
   63
   
   (20)
   
   67
   
   (19)


1 The net accrued benefit liability for pension plans with a deficit funding status is included in deferred credits on the Consolidated Balance Sheet.

At December 31, 2003, the actuarial net present value of the accrued benefit obligation for other post-retirement benefit plans was $8 million (2002  $7 million).

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C o n s o l i d a t e d   F i n a n c i a l   S t a t e m e n t s

---

The net benefit plan expense of $14 million for the year ended December 31, 2003 (2002 $6 million; 2001  $1 million) is determined by using actuarial assumptions including expected return on plan assets and includes the amortization of net actuarial losses and net transitional assets and obligations as described in note 1(j). Had the net benefit expense for the year been calculated without deferring and amortizing net actuarial losses and net transitional assets and obligations, the net benefit expense for 2003 would have been $12 million (2002  $37 million; 2001  $23 million).

At December 31, 2003, the composition of plan assets as a percentage of fair value was 70% equities and 30% bonds. The approximate target allocation percentage is 70% equities, 30% bonds and expected return on assets is 8.5% equities and 5.3% bonds.

17.     Sale of Sudan Operations

On March 12, 2003, the Company completed the sale of its 25% indirectly held interest in the Greater Nile Oil Project in Sudan. Total gross proceeds were $1.13 billion (US$771 million), including interest and cash received by Talisman during the interim period between September 1, 2002 and closing on March 12, 2003. The gain on sale is as follows:

|Gross proceeds on sale of Sudan operations (US$771 million) |       | 1,135 |      
|----------------------------------------------------------- | ----- | ----- | -----
|                                                            |       |       |      
|Less interim adjustments                                    | (123) |       |      
|                                                            |       |       |      
|                                                            |       |       | 1,012
|                                                            |       |       |      
|Property, plant and equipment                               | 687   |       |      
|Working capital and other assets                            | 72    |       |      
|Future income tax liability                                 | (59)  |       |      
|                                                            |       |       |      
|Net carrying value at March 12, 2003                        |       |       | 700  
|Closing costs                                               |       |       | 16   
|                                                            |       |       |      
|Gain on disposal                                            | 296   |       |      
|                                                            |       |       |      



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18. Segmented Information

Talismans activities are conducted in five geographic segments: North America, the North Sea, Southeast Asia, Algeria and other international locations. The Sudan operations were sold in 2003. North America includes operations in Canada and the US. The North Sea includes operations in the UK, Netherlands and Norway. The Southeast Asia segment includes operations in Indonesia, Malaysia and Vietnam. All activities relate to the exploration, development, production and transportation of oil, liquids and natural gas.

North America2
North
    Sea32003
   
   2002
   2001
   
   2003
   2002
   
   2001RevenueGross salesOil and liquids
   
   
   
   
   
   
   683
   
   706
   
   714
   
   1,556
   1,798
   
   1,466Natural gas
   
   
   
   
   
   
   1,972
   
   1,270
   1,583
   
   182
   173
   
   172Synthetic oil
   
   
   
   
   
   
   
   42
   
   42
   
   40
   
   
   
   
   
   Sulphur
   
   
   
   
   
   
   
   6
   
   (4)
   
   (5)
   
   
   
   
   
   Total gross sales
   
   
   
   
   
   
   2,703
   
   2,014
   2,332
   
   1,738
   1,971
   
   1,638Royalties
   
   
   
   
   
   
   587
   
   373
   
   558
   
   8
   
   96
   
   93Net sales
   
   
   
   
   
   
   2,116
   
   1,641
   1,774
   
   1,730
   1,875
   
   1,545Other
   
   
   
   
   
   
   
   54
   
   38
   
   34
   
   23
   
   40
   
   46Total revenue
   
   
   
   
   
   
   2,170
   
   1,679
   1,808
   
   1,753
   1,915
   
   1,591Segmented expensesOperatingOil and liquids
   
   
   
   
   
   
   131
   
   121
   
   121
   
   523
   517
   
   407Natural gas
   
   
   
   
   
   
   237
   
   212
   
   198
   
   21
   
   27
   
   18Synthetic oil
   
   
   
   
   
   
   
   22
   
   19
   
   20
   
   
   
   
   
   Pipeline
   
   
   
   
   
   
   
   5
   
   5
   
   4
   
   39
   
   44
   
   42Total operating expenses
   
   
   
   
   
   
   395
   
   357
   
   343
   
   583
   588
   
   467DD&A
   
   
   
   
   
   
   693
   
   614
   
   585
   
   619
   701
   
   558Dry hole
   
   
   
   
   
   
   135
   
   128
   
   54
   
   69
   
   9
   
   21Exploration
   
   
   
   
   
   
   
   87
   
   66
   
   69
   
   21
   
   20
   
   30Other
   
   
   
   
   
   
   
   (28)
   
   77
   
   11
   
   26
   
   55
   
   (23)Total segmented expenses
   
   
   
   1,282
   
   1,242
   1,062
   
   1,318
   1,373
   
   1,053Segmented income (loss) before taxes
   
   
   
   
   888
   
   437
   
   746
   
   435
   542
   
   538Non-segmented expensesGeneral and administrativeInterest on long-term debtGain on sale of Sudan operationStock based compensationCurrency translationTotal non-segmented expensesIncome before taxesCapital expendituresExploration
   
   
   
   
   
   
   453
   
   321
   
   314
   
   99
   134
   
   106Development
   
   
   
   
   
   
   629
   
   480
   
   535
   
   397
   297
   
   527Midstream
   
   
   
   
   
   
   
   27
   
   21
   
   27
   
   
   
   
   
   Exploration and development
   
   
   
   
   
   1,109
   
   822
   
   876
   
   496
   431
   
   633Property acquisitions1Midstream acquisitionsProceeds on dispositionsOther non-segmentedNet capital expendituresProperty,
    plant and equipment
   
   
   
   
   
   5,642
   
   4,955
   4,773
   
   2,710
   2,921
   
   2,831Goodwill
   
   
   
   
   
   
   291
   
   291
   
   291
   
   74
   
   46
   
   41Other
   
   
   
   
   
   
   403
   
   350
   
   265
   
   386
   387
   
   371Segmented assets
   
   
   
   
   
   
   6,336
   
   5,596
   5,329
   
   3,170
   3,354
   
   3,243Non-segmented assetsTotal assets




|1 Excluding corporate acquisitions. | 2
    North America | 2003            |        | 2002  | 2001 |       |       | 3North Sea |  | 2003            | 2002        |             | 2001 |      
|----------------------------------- | ------------------- | --------------- | ------ | ----- | ---- | ----- | ----- | ---------- |  | --------------- | ----------- | ----------- | ---- | -----
|                                    |                     | Revenues        | Canada | 2,018 |      | 1,674 | 1,808 |            |  | Revenues        |             | UK          |      |      
|                                    |                     |                 | US     | 152   |      | 5     |      |            |  |                 |             | Netherlands | 26   | 27   
|                                    |                     |                 |        | 2,170 |      | 1,679 | 1,808 |            |  |                 |             | Norway      |      |      
|                                    |                     | Property, plant | Canada | 5,238 |      | 4,848 | 4,769 |            |  |                 |             |             |      |      
|                                    |                     | and equipment   | US     | 404   |      | 107   | 4     |            |  | Property, plant | UK          |             |      | 2,555
|                                    |                     |                 |        | 5,642 |      | 4,955 | 4,773 |            |  | and equipment   | Netherlands | 39          | 46   |      
|                                    |                     |                 |        |       |      |       |       |            |  |                 |             | Norway      |      |      
|                                    |                     |                 |        |       |      |       |       |            |  |                 |             |             |      |      















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C o n s o l i d a t e d   F i n a n c i a l   S t a t e m e n t s

---

Southeast Asia4
   
   
   Algeria
   
   
   
   
   
   Sudan
   
   
   
   
   
   Other
   
   
   
   
   
   Total52003
   
   2002
   
   2001
   
   2003
   2002
   
   2001
   
   2003
   
   2002
   
   2001
   
   2003
   
   2002
   
   2001
   
   2003
   
   2002
   
   2001345
   
   323
   
   276
   
   89
   
   
   
   
   
   209
   
   828
   
   638
   
   
   
   
   
   
   
   2,882
   
   3,655
   
   3,094211
   
   163
   
   163
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   2,365
   
   1,606
   
   1,918
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   42
   
   42
   
   40
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   6
   
   (4)(5)556
   
   486
   
   439
   
   89
   
   
   
   
   
   209
   
   828
   
   638
   
   
   
   
   
   
   
   5,295
   
   5,299
   
   5,047156
   
   130
   
   90
   
   46
   
   
   
   
   
   97
   
   328
   
   248
   
   
   
   
   
   
   
   894
   
   927
   
   989400
   
   356
   
   349
   
   43
   
   
   
   
   
   112
   
   500
   
   390
   
   
   
   
   
   
   
   4,401
   
   4,372
   
   4,058
   
   1
   
   1
   
   
   
   
   
   
   
   (1)
   
   1
   
   1
   
   
   
   
   
   
   
   76
   
   80
   
   82400
   
   357
   
   350
   
   43
   
   
   
   
   
   111
   
   501
   
   391
   
   
   
   
   
   
   
   4,477
   
   4,452
   
   4,14065
   
   65
   
   54
   
   16
   
   
   
   
   
   18
   
   84
   
   66
   
   
   
   
   
   
   
   753
   
   787
   
   64822
   
   21
   
   16
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   280
   
   260
   
   232
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   22
   
   19
   
   20
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   44
   
   49
   
   4687
   
   86
   
   70
   
   16
   
   
   
   
   
   18
   
   84
   
   66
   
   
   
   
   
   
   
   1,099
   
   1,115
   
   94695
   
   87
   
   93
   
   17
   
   
   
   
   
   19
   
   93
   
   77
   
   
   
   
   
   
   
   1,443
   
   1,495
   
   1,3139
   
   4
   
   8
   
   1
   
   
   
   5
   
   
   
   13
   
   16
   
   37
   
   20
   
   9
   
   251
   
   174
   
   11317
   
   19
   
   8
   
   
   
   5
   
   2
   
   5
   
   6
   
   11
   
   83
   
   69
   
   27
   
   213
   
   185
   
   1479
   
   11
   
   (2)
   
   
   
   2
   
   8
   
   
   
   (5)
   
   11
   
   2
   
   (9)
   
   
   
   9
   
   131
   
   5217
   
   207
   
   177
   
   34
   
   7
   
   15
   
   42
   
   191
   
   181
   
   122
   
   80
   
   36
   
   3,015
   
   3,100
   
   2,524183
   
   150
   
   173
   
   9
   
   (7)
   
   (15)
   
   69
   
   310
   
   210
   
   (122)
   
   (80)
   
   (36)
   
   1,462
   
   1,352
   
   1,616152
   
   138
   
   108137
   
   164
   
   139(296)
   
   
   
   185
   
   
   
   7
   
   (18)
   
   73185
   
   284
   
   3201,277
   
   1,068
   
   1,29670
   
   36
   
   31
   
   4
   
   4
   
   22
   
   7
   
   27
   
   42
   
   151
   
   106
   
   52
   
   784
   
   628
   
   567246
   
   233
   
   110
   
   30
   103
   
   40
   
   (5)
   
   71
   
   75
   
   72
   
   15
   
   1
   
   1,369
   
   1,199
   
   1,288
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   27
   
   21
   
   27316
   
   269
   
   141
   
   34
   107
   
   62
   
   2
   
   98
   
   117
   
   223
   
   121
   
   53
   
   2,180
   
   1,848
   
   1,882638
   
   276
   
   301130
   
   
   
   (100)
   
   (72)
   
   (162)38
   
   26
   
   302,886
   
   2,078
   
   2,0511,079
   
   1,093
   
   924
   
   202
   244
   
   143
   
   
   
   772
   
   767
   
   145
   
   57
   
   23
   
   9,778
   
   10,042
   
   9,461108
   
   132
   
   135
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   473
   
   469
   
   467217
   
   205
   
   137
   
   27
   
   6
   
   4
   
   
   
   56
   
   44
   
   18
   
   12
   
   3
   
   1,051
   
   1,016
   
   8241,404
   
   1,430
   
   1,196
   
   229
   250
   
   147
   
   
   
   828
   
   811
   
   163
   
   69
   
   26
   
   11,302
   
   11,527
   
   10,75263
   
   67
   
   6711,365
   
   11,594
   
   10,819








|4               |  | Southeast Asia |  | 2003     | 2002 | 2001  |       | 5   |  | Certain comparative segmented disclosures have been reclassified to be consistent with the current year presentation. | 
|--------------- |  | -------------- |  | -------- | ---- | ----- | ----- | --- |  | --------------------------------------------------------------------------------------------------------------------- | 
|Revenues        |  | Indonesia      |  | 304      | 302  | 332   |       |     |  |                                                                                                                       | 
|                |  |                |  | Malaysia |      | 85    | 50    | 18  |  |                                                                                                                       | 
|                |  |                |  | Vietnam  |      | 11    | 5     |    |  |                                                                                                                       | 
|                |  |                |  |          |      | 400   | 357   | 350 |  |                                                                                                                       | 
|Property, plant |  | Indonesia      |  | 383      | 515  | 508   |       |     |  |                                                                                                                       | 
|and equipment   |  | Malaysia       |  | 673      | 565  | 407   |       |     |  |                                                                                                                       | 
|                |  |                |  | Vietnam  |      | 23    | 13    | 9   |  |                                                                                                                       | 
|                |  |                |  |          |      | 1,079 | 1,093 | 924 |  |                                                                                                                       | 















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19.     Information for US Readers

Accounting Principles Generally Accepted in the US

The Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in Canada (Canadian GAAP) which, in most respects, conform to accounting principles generally accepted in the United States (US GAAP). Significant differences between Canadian and US GAAP are as follows:

Net income in accordance with US GAAP:

Years ended December 31(millions of Canadian dollars)
   Notes
   
   2003
   
   2002
   
   2001Net income  Canadian GAAP
   
   
   1,007
   
   524
   
   733Foreign exchange loss
   4,6
   
   (62)
   
   (56)
   
   (44)Depreciation, depletion and amortization
   1,2,3,6,8,9
   
   45
   
   (26)
   
   (66)(Loss) gain on derivative instruments
   4
   
   (17)
   
   (129)
   
   237Preferred security charges
   6
   
   (38)
   
   (42)
   
   (42)Deferred income taxes
   2
   
   15
   
   51
   
   (95)Gain on sale of Sudan operations
   8
   
   (296)
   
   
   
   ARO Accretion
   9
   
   (58)
   
   
   
   Results of discontinued operations, net of tax
   8
   
   (57)
   
   (237)
   
   (157)(468)
   
   (439)
   
   (167)Income from continuing operations
   
   
   539
   
   85
   
   566Results of discontinued operations, net of tax
   8
   
   330
   
   237
   
   157Income before cumulative effect of changes in accounting principles
   
   869
   
   322
   
   723Cumulative effect of changes in accounting principles, net of tax
   4,9
   
   53
   
   
   
   (48)Net income  US GAAP
   
   
   922
   
   322
   
   675Income per common share (Canadian dollars)BasicContinuing operations
   
   
   4.19
   
   0.64
   
   4.20Discontinued operations
   
   
   2.56
   
   1.76
   
   1.16Before cumulative effect of changes in accounting principles
   
   
   6.75
   
   2.40
   
   5.36Cumulative effect of changes in accounting principles,
    net of tax
   
   0.41
   
   
   
   (0.36)Net income
   
   
   7.16
   
   2.40
   
   5.00DilutedContinuing operations
   
   
   4.14
   
   0.63
   
   4.12Discontinued operations
   
   
   2.53
   
   1.74
   
   1.14Before cumulative effect of changes in accounting principles
   
   6.67
   
   2.37
   
   5.26Cumulative effect of changes in accounting principles, net of tax
   
   0.41
   
   
   
   (0.35)Net income
   
   
   7.08
   
   2.37
   
   4.91


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Comprehensive income in accordance with US
    GAAP:Years ended December 31(millions of Canadian dollars)Notes
   
   
   Notes
   
   2003
   
   2002
   
   2001Net income  US GAAP
   
   
   
   
   922
   
   322
   
   675Other comprehensive income, net of tax:Foreign exchange gain on translation of self-sustaining operations        
    7
   
   650
   
   170
   
   Comprehensive income  US GAAP
   
   
   
   
   1,572
   
   492
   
   675Balance sheet items in accordance with US GAAP are as follows:December 31(millions of Canadian dollars)Notes
   
   
   
   2003
   
   
   
   2002Canadian
   
   US
   
   Canadian
   
   USGAAP
   
   GAAP
   
   GAAP
   
   GAAPCurrent assets
   8
   
   975
   
   975
   
   917
   
   861Sudan assets held for sale
   8
   
   
   
   
   
   
   
   842Property, plant and equipment
   1,2,3,8,9
   
   9,778
   
   10,531
   
   10,042
   
   9,653Other non-current assets
   4,6
   
   612
   
   607
   
   635
   
   65111,365
   
   12,113
   
   11,594
   
   12,007Current liabilities
   8
   
   1,218
   
   1,218
   
   989
   
   960Sudan liabilities held for sale
   8
   
   
   
   
   
   
   
   87Long-term debt
   4,6
   
   2,203
   
   2,696
   
   2,997
   
   3,530Future income taxes
   2,8,9
   
   2,088
   
   2,062
   
   2,236
   
   2,127Other non-current liabilities
   9
   
   897
   
   1,208
   
   870
   
   8706,406
   
   7,184
   
   7,092
   
   7,574Shareholders equityPreferred securities
   6
   
   431
   
   
   
   431
   
   Common shares
   
   
   2,725
   
   2,725
   
   2,785
   
   2,785Contributed surplus
   5
   
   73
   
   90
   
   75
   
   92Cumulative foreign currency translation
   4,6,7
   
   (114)
   
   (832)
   
   140
   
   (30)Accumulative other comprehensive income
   7
   
   
   
   820
   
   
   
   170Retained earnings
   1-9
   
   1,844
   
   2,126
   
   1,071
   
   1,416Total liabilities and shareholders equity
   
   
   11,365
   
   12,113
   
   11,594
   
   12,007


|1 | Gains on property exchanges Under both US and Canadian GAAP, property exchanges are recorded at the carrying value of the assets given up unless the exchange transaction includes significant cash consideration, in which case it is recorded at fair value. Under US GAAP, asset exchange transactions are recorded at fair value if cash consideration is greater than 25% (10% under Canadian GAAP) of the fair value of total consideration given or received. The resulting differences in the recorded carrying values of these properties result in differences in depreciation, depletion and amortization expense in subsequent years.                                                                                                                                                                                                                                                       
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2 | Income taxes and depreciation, depletion and amortization expense In 2000, the Company adopted the liability method to account for income taxes. The change to the liability method has eliminated a difference between Canadian and US GAAP, however, in accordance with the recommendations of the Canadian Institute of Chartered Accountants (the CICA) the effect of the adoption under Canadian GAAP resulted in a charge to retained earnings, whereas, under US GAAP the future tax costs that gave rise to the Canadian GAAP adjustment have already been reflected in property, plant and equipment. As a result of the implementation method, further differences in depreciation, depletion and amortization expense result in subsequent years. Other adjustments to the Canadian GAAP net income required under US GAAP, as described in this note, have been tax effected as necessary.



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|3 | Impairments Under both US and Canadian GAAP, property, plant and equipment must be assessed for potential impairments. Under US GAAP, if the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, then an impairment loss (the amount by which the carrying amount of the asset exceeds the fair value of the asset) should be recognized. Fair value is calculated as the present value of estimated expected future cash flows. As disclosed in note 1(c),under Canadian GAAP, the impairment loss is the difference between the carrying value of the asset and its net recoverable amount (undiscounted). The resulting differences in recorded carrying values of impaired assets result in further differences in depreciation, depletion and amortization expense in subsequent years. The CICA has adopted a new standard effective for 2004 that will eliminate this US/Canadian GAAP difference.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|4 | Forward foreign exchange contracts and other financial instruments The Company has designated, for Canadian GAAP purposes, its derivative financial instruments as hedges of anticipated revenue and expenses. In accordance with Canadian GAAP, payments or receipts on these contracts are recognized in income concurrently with the hedged transaction. The fair values of the contracts deemed to be hedges are not reflected in the Consolidated Financial Statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

|  | Effective January 1, 2001, for US GAAP purposes, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, as amended, Accounting for Derivative Instruments and Hedging Activities. Effective with the adoption of this standard, every derivative instrument, including certain derivative instruments embedded in other contracts, is recognized on the balance sheet at fair value. The statement requires that changes in the derivative instruments fair value be recognized currently in earnings unless specific hedge accounting criteria are met.                                                                                                                                                                                                                                                     
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  | Management has not designated any of the currently held derivative instruments as hedges for US GAAP purposes and accordingly these derivatives have been recognized on the balance sheet at fair value with the change in their fair value recognized in earnings. In accordance with the transition provisions of SFAS No. 133, on January 1, 2001, the Company recorded a $48 million after-tax non-cash loss in current earnings as a cumulative effect of accounting change.                                                                                                                                                                                                                                                                                                                                                        
|5 | Appropriation of contributed surplus In 1992, concurrent with a change in control of the Company, $17 million of contributed surplus was appropriated to retained earnings to eliminate the deficit at June 30, 1992. This restatement of retained earnings is not permitted under US GAAP as the events that precipitated it did not constitute a quasi-reorganization.                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|6 | Preferred securities Under US GAAP, the Companys preferred securities are treated as debt rather than equity and accordingly are translated at the rates of exchange in effect at the balance sheet date. Under Canadian GAAP, the preferred securities are translated at the historical rate of exchange. In addition, the annual preferred security charges under US GAAP are classified as an expense rather than a direct charge to retained earnings. Under US GAAP, the cost associated with the issuance of the preferred securities is recorded as an asset and is amortized over the term of the preferred securities. Under Canadian GAAP, this cost, net of tax, is charged directly to shareholders equity. The fair market value of the preferred securities at December 31, 2003 was $389 million (2002  $494 million).
|7 | Foreign exchange gains and losses on translation of self sustaining operations Under US GAAP, foreign exchange gains and losses on translation of self-sustaining foreign operations are added, net of tax, to net income in determining comprehensive income. Under Canadian GAAP, such gains and losses are included as a separate component of shareholders equity referred to as cumulative translation adjustment.                                                                                                                                                                                                                                                                                                                                                                                                                
|8 | Discontinued operations Under US GAAP, effective November 1, 2002, the Sudan assets were classified as Assets Held For Sale with the Sudan operating results, net of tax, classified on the income statement as results of operations held for sale. No depreciation, depletion or amortization has been recorded commencing November 1, 2002 related to these assets. The sale closed March 12, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                  
|9 | Asset Retirement Obligations (future site restoration and abandonment liabilities) Effective January 1, 2003, for US GAAP purposes, the Company adopted SFAS No. 143, which changes the method of accruing for costs associated with the retirement of fixed assets which an entity is legally obligated to incur. The standard requires entities to record the fair value of a liability for an asset retirement obligation in the period it is incurred and a corresponding increase in the carrying amount of the related long-lived asset.                                                                                                                                                                                                                                                                                          

The majority of the Companys asset retirement obligations relate to the abandoning of oil and gas wells, pipelines, processing facilities and offshore production platforms. During 2003, the Companys asset retirement obligation changed as follows.

(millions of Canadian dollars)ARO liability at January 1, 2003

   1,123Liabilities incurred during year
   97Liabilities settled during year
   (28)Accretion expense

   58Foreign currency translation
   (99)ARO liability at December 31, 2003
   1,151




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SFAS No. 143 calls for the ARO liability to include as a component of expected costs, an estimate of the price that a third party would demand and could expect to receive, for bearing the uncertainty inherent in the obligations. This is referred to as the market-risk premium. No amount of market-risk premium has been included in the estimate of the Companys ARO liability as management does not believe there to be sufficient evidence in the oil and gas industry to estimate any such market premium.

The following table presents the pro forma effects of the retroactive application of this change in accounting principle. There was no pro forma effect on income from discontinued operations.



2003
   
   2002
   
   2001Pro forma net income1
   869
   
   342
   
   665Pro forma per common shareBasic
   6.75
   
   2.55
   
   4.93Diluted
   6.67
   
   2.51
   
   4.84


1 Pro forma net income for 2003 has been adjusted to remove the $53 million cumulative effect of a change in accounting principle attributable to SFAS No. 143.

Newly Issued US Accounting Standards

Variable Interest Entities

In 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46 Consolidation of Variable Interest Entities (FIN 46), which is effective January 1, 2004. The Canadian Institute of Chartered Accountants (CICA) issued a similar accounting guideline (AcG 15). FIN 46 and AcG 15 provide guidance as to when a company should consolidate another entity into its Consolidated Financial Statements. A variable interest entity (VIE) is a corporation,partnership, trust, or any other legal structure used for business purposes that either (i) does not have equity investors with voting rights or (ii) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN 46 and AcG 15 require a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIEs activities, is entitled to receive a majority of the VIEs residual returns, or both. If a company has previously consolidated a VIE but is not subject to a majority of the risk of loss of its activities nor entitled to receive a majority of its residual returns, such a VIE is required to be deconsolidated. Management is currently evaluating the potential impact of FIN 46 and AcG 15 but does not expect their application to have a significant impact on the Companys financial position, operating results or cash flows.

Oil and Gas Drilling Rights

Talisman has classified all of its mineral drilling rights as oil and gas properties under the heading property, plant and equipment. Management believes this treatment is consistent with industry practice and managements understanding of the relevant accounting standards. It is managements understanding that the Staff of the Securities and Exchange Commission (SEC) is questioning registrants regarding the appropriateness of this accounting treatment, specifically as to whether these costs should be classified as intangible assets on the balance sheet separate from other property, plant and equipment. Further, it is managements understanding that this issue is being considered by the US Financial Accounting Standards Board (FASB). Management believes resolution of this issue will not materially affect the Companys results of operations.

Summary US Dollar Information

Unless otherwise noted, all amounts in the Consolidated Financial Statements, including Accounting Principles Generally Accepted in the United States above, are reported in millions of Canadian dollars. The following information reflects summary financial information prepared in accordance with US GAAP translated from Canadian dollars to US dollars at the average exchange rate prevailing in the respective year.

US$ million (except as noted)
   2003
   
   2002
   
   2001Total revenue
   3,194
   
   2,835
   
   2,673Net income
   658
   
   205
   
   436Net income per common share (US$/share)
   5.11
   
   1.53
   
   3.23Average exchange rate (US$/C$)
   0.7135
   
   0.6368
   
   0.6457




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